When do you need to pay taxes from gambling winnings?

I’m writing this week’s post on a flight to Las Vegas, NV which is also my inspiration for my post. The running joke among family and friends has been that if I win big I’ll have to pay taxes on my winnings. Sadly, they’re right (and I know it) so I’m sharing my knowledge on how I plan to reduce my winnings.

What is considered gambling winnings?

Gambling winnings are any monies earned as a result of wagering in a casino or gambling establishment. Illegally earned money from gambling is also taxable but I’m not going to cover that in this article. Winnings can include money earned as well as the fair market value of prizes such as cars, houses, and trips. You know all the prizes people win on game shows? The fair market value is taxable to each winner.

Let me bring in an example. Let’s say you’re rolling the dice at the hottest craps table on the strip and you’re up big, $10k, those earnings are technically taxable. Most casinos traditionally do not complete issue form W-2G for earnings from table games. What’s better yet is that you can walk away from the table with all of your chips and redeem chips as you wish rather than all at once to prevent the casinos from having to report a large transaction. Remember, despite how you win or how much, it’s all subject to tax.

But let’s say instead you win your money from an electronic game such as a slot machine or keno. Well, then the rules are a little different for reporting purposes.

What is form W-2G?

Typically form W-2G is issued to taxpayers that win any amounts as follows:

1. $600 or more in earnings;
2. $1,200 or more in earnings from bingo or slot machines;
3. $1,500 or more in earnings from keno; OR
4. Any gambling winnings subject to federal income tax withholding.

The last one is where gamblers might get tripped up. You see, casinos have the authority to dictate whether they should issue form W-2G if a patron earns an amount that should have federal income taxes withheld. It’s safe to assume that somewhere around $10k (per transaction) is the limit where a casino will issue a W-2G regardless of how you won your money. However, this is only on redeemed amounts. So if you win $10k at a table, go catch some sleep, and come back and lose back $8k hours later, you’re now only up $2k and would potentially receive a W-2G on that amount only (if at all). If instead you cashed in the $10k first and completed the paperwork necessary to receive a W-2G, and then subsequently lost $8k back to the casino, you’d then receive a W-2G for $10k.

Can I deduct my losses?

Great question! If you find yourself losing your shirt on your next trip out to Sin City then you’re out of luck. You can only deduct gambling losses up to the extent of gambling winnings in the same tax year. Gambling losses are also subject to the miscellaneous itemized deductions limit of 2% of AGI so you may not even receive the full benefit of all of your losses depending on your filing situation. So if we refer back to my earlier examples, in the first instance a W-2G would have been issued for $2k at most which is simple enough to cover taxes on. But in the second example the gambler received a W-2G for $10k with $8k in losses to write-off which will undoubtedly give them less than $8k in a tax deduction because of the 2% of AGI rule.

Expense such as airfare, hotel stays, meals, and transportation cannot be considered “losses” for tax deduction purposes. Only professional gamblers would have the luxury of writing off any of their expenses to generate income as a gambler, and even then, receiving such recognition from the IRS would be a feat in itself. Unless you’re a world famous poker player, there probably isn’t much luck for you.

What records should I keep for my deductions?

In order to deduct any losses you will want to be very detailed in your record-keeping. Unless you religiously use a player’s club card to help track your cash in / cash out, and receive a report from the gaming establishment, it can be very challenging for casinos to accurately monitor cash activity for every player. A handwritten notebook that can be supported by bank statement activity and ATM or withdrawal receipts would be extremely useful for tracking your gambled cash in to deduct losses against any earnings you may have. Remember, just because you don’t receive form W-2G doesn’t mean your earnings aren’t taxable. All gambling winnings should be reported when preparing your taxes.

I hope you found this week’s read interesting. I post about every two weeks so make sure you follow me on social media and share with others!

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Is Your Financial Future at Risk from President Trump’s Latest Tax Proposal?

It’s been about 9 months since President Trump took office and no matter your political opinions and views, I think we can all agree he seems determined to make changes while he’s in office. Whether those are for the better or worse remains a mystery. As of the writing of this post, he’s already attempted to repeal healthcare, and subsequently reform it healthcare, neither of which have had much success. His next target is tax reform, rather, the largest tax reform seen in the United States in about 30 years. If he is successful, this could dramatically change how millions of Americans are taxed each year. It also stresses the importance of tax planning, especially for this year and next year.

Late last year I wrote about Trump’s first tax reform proposal. You can read that here and see how it stacks up against his new plan. Below are the top 10 highlights from his new proposal that are likely to have an impact in some way on every taxpayer.

#1 – Adjust tax brackets (revised from last year’s proposal)

Trump’s latest proposal would collapse the current seven brackets into three. The new tax brackets (slightly higher than last year’s proposal) would be adjusted to 12%, 25%, and 35%. Most married couples filing jointly with income less than $225k would likely remain unaffected, or have a reduced tax bill.

#2 – Increase standard deductions & eliminate personal exemptions (consistent with last year’s proposal)

One of the few items unchanged from last year’s proposal. Trump is proposing to double the standard deduction and eliminate personal exemptions which would likely result in a slight increase in tax deductions for most taxpayers. However, this change could serve as a blow for families of larger sizes since the number of dependents claimed would not necessarily yield any additional tax benefits.

#3 – Eliminate itemized deductions (revised from last year’s proposal)

This is different from last year’s proposal in that Trump previously wanted to cap itemized deductions for single and married filers. The itemized deduction elimination would still allow for taxpayers to itemize deductions for mortgage interest and charitable contributions. However, the changes could have significant repercussions for taxpayers when you take into account #4 below. It may also cause a ripple effect on the economy, for example, the housing market may cool off as many taxpayers would not be likely to itemize their deductions going forward and therefore would have less incentive to buy real estate.

#4 – Eliminate the deduction for state & local taxes (new from last year’s proposal)

An item not noted in Trump’s previous tax reform proposal is the elimination of the state and local tax deduction. Most taxpayers rely on the combination of state & local taxes, real estate taxes, and mortgage interest paid on their home to itemize their deductions. By removing the deduction for state and local taxes, it will become ever challenging for most American households to itemize their deductions going forward. This will make tax planning crucial to ensure that any lost tax benefits can be recovered elsewhere from other available strategies.

#5 – Eliminate the Alternative Minimum Taxes (new from last year’s proposal)

Again, not noted in the previous proposal, but one that I support, eliminating the Alternative Minimum Tax (AMT). This is a separate tax that is assessed when “high income earners” suddenly find themselves deducting a disproportionate amount of items against their income. The AMT kicks in to ensure that taxpayers don’t take advantage of excessive deduction. The problem with AMT is that it went silently by the wayside for years and was not increased to keep in line with inflation and increasing wages. As such, many taxpayers today find that they are subject to AMT and consequently paying more in taxes because of an out-of-date tax law. With itemizing deductions becoming harder to do (under the proposed plan) there will not be much need for the AMT so eliminating it only makes sense.

#6 – Increases the Child Tax Credit (new from last year’s proposal)

Another item not noted in the previous proposal, the child tax credit would actually be increased for taxpayers with children. Unfortunately, that amount has not yet been made clear. However, the phase-out for claiming the credit would be $250k for single filers and $500k for joint filers. These limits are much higher than the current limits of $75k and $110k, respectively.

#7 – Lower the maximum corporate tax rate (revised from last year’s proposal)

This applies only to C Corporations. The previous plan called for a reduction to 15% but the revised rate of 20% is still significantly lower than the current tax rate of 35%.

#8 – Lower the maximum tax rate for small businesses to 25 percent (new from last year’s proposal)

This applies to other business entity structures such as partnerships & S Corporations. Unfortunately, unless a business earns excessive profits, this will not likely have a meaningful impact on most small businesses.

#9 – Allow to fully deduct the cost of depreciable assets (consistent with last year’s proposal)

This is relatively consistent with the previous proposal. Businesses would be allowed to fully deduct depreciable assets in the year of purchase. It’s the equivalent of allowing taxpayers to use IRC Section 179 on everything they buy rather than deducting assets over time. My presumption is also that there would be no recapture rules, but the proposal isn’t clear on the surface about that. Physical structures would be excluded from this change meaning you can’t buy a building or warehouse and take a full deduction in the first year.

#10 - C corporations would no longer be able to deduct interest expense (new from last year’s proposal)

This is not an item that was seen in the previous proposal but it certainly would reduce the number of C Corporations borrowing money to fuel growth. Instead, a change like this would likely stimulate private equity investments and possibly increase IPOs to raise capital.

There has been much speculation around the likelihood of the proposed plan passing but regardless taxpayers should not make any major tax changes until new rules are passed and become effective. I’m not sure how I professionally feel about these changes. In some cases it simplifies the tax code, which is great for taxpayers. Preferably, I would rather see small bite size changes occur over time rather than such a massive overhaul all at once. My primary concern in all of this is the economic fallout that may arise from such major changes.

If you do nothing else this coming tax season, pay attention to what’s happening with these proposed changes. The end of this year could bring some surprises that might make you wish you had a year-end planning session with your tax advisor.

Feel free to comment below or reach out directly to me via e-mail at jared@eliseocpa.com. You can also follow the firm on social media for future posts like this one!

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Cancelled Debt and How It May Affect You

Sometimes things happen in life that are outside of our control. Medical bills, job loss, and catastrophic uninsured damage to a home are just a few things that could happen to each and every one of us. When unwelcome events like these happen it may make paying bills harder and can ultimately lead to losing a car or house in exchange for debt forgiveness. Although you would be relieved of your obligation to pay back your debt, there is another party waiting in the distance to collect; the IRS.

What is Cancelled Debt and How is it Reported?

Cancellation of Debt "COD" income, as the IRS defines it, is any debt for which you are personally liable, which is forgiven or discharged for less than the full amount owed. The debt is considered canceled in whatever amount remains unpaid. Creditors are responsible for reporting cancelled debt to taxpayers for amounts $600 or greater on form 1099-C. Taxpayers who receive COD income (regardless of whether or not they receive a 1099-C) must report the cancelled debt on their income tax return and pay income tax for the amount forgiven.

What to Do if You Receive COD Income

Like anything else tax related, don’t ignore any tax forms you receive, including a 1099-C. Remember, anytime you receive a tax document from a third party, there is a very high likelihood that the IRS has also received a copy. The IRS is expecting that you will report all tax information, and if you don’t, they’ll correct your return for you and throw on some penalties & interest for their trouble. Even if you don’t receive a 1099-C, you are still responsible for claiming any COD income on your return.

There are however some exceptions and exclusions as to when COD income is taxable (listed below). Visit the IRS website for more information about each.

Exceptions (do not reduce tax attributes)
1) Gifts, Bequests, Devises, and Inheritances
2) Student Loans
3) Deductible Debt
4) Price Reduced After Purchase
5) Home Affordable Modification Program

Exclusions (may reduce tax attributes)
1) Bankruptcy
2) Insolvency
3) Qualified Farm Indebtedness
4) Qualified Real Property Business Indebtedness
5) Qualified Principal Residence Indebtedness

Before you get too excited, it’s important to understand that the exceptions and exclusions listed above exist in a very narrow set of circumstances and the rules have changed numerous times over the last decade. Discuss any tax ramifications with your tax advisor if you have any COD income. I will go into more detail on two of the most common types of COD income in the next section.

Mortgage Relief and Consumer Credit

The most common types of COD income include Qualified Principal Residence Indebtedness and consumer credit. For taxpayers whose primary homes are foreclosed or sold in a short sale, they are required to report COD income, but may not be responsible for paying income tax on the COD income they receive (effective through December 31, 2016 as of the time of this writing). This is thanks to the Mortgage Forgiveness Debt Relief Act of 2007. The good news here is that there is talk (as of the time of this writing) to extend the Qualified Principal Residence Indebtedness relief permanently for all future years.

For consumer credit (such as credit cards), taxpayers can almost always expect to pay income tax on any COD income they receive, unless one of the exceptions or exclusions from the above section apply. In instances where a car or boat is repossessed and a loan is forgiven there may also be tax consequence. These are common examples of when taxpayers are blindsided. Remember this if you ever need to negotiate with your credit card company to reduce an amount due.

One more note of caution. Although there are exceptions and exclusions at the federal level, some states may still require that income tax be paid on COD incomeregardless of the federal exclusion. Again, consult with your tax advisor to whether this pertains to your situation or not.

How Much Will I Owe?

If you find yourself faced with a situation where you know you’ll have to pay tax on COD income then it might be wise to plan ahead. COD income is taxed at your marginal income tax rate. So for example, a taxpayer with COD income of $10k in a 15% tax bracket (plus state) will face at least $1,500 in additional income tax related to the COD income. In a separate example, if you had a car with a $20k note on it and you returned the vehicle worth $18k and were forgiven for your debt, only the $2k difference would be taxable at your marginal tax rate. What these examples tell us is if you’re going to attempt to have debt cancelled or forgiven, it would be ideal to do it as early in the year as possible to afford you more time to save up to pay your tax bill.

Debt forgiveness has more than just an income tax effect. It can also impact your credit score. Sometimes it may make more sense to get out from under a loan rather than try to endure the hardship of paying it back. In those cases, COD income and lower credit scores may be worth the trade-off. However, given all of the adverse consequences of debt forgiveness, taxpayers should consider debt forgiveness as a strategy only as a last resort.

I hope this was informative to readers. It’s not common that taxpayers receive COD income but it is a growing trend and more people are finding themselves faced with the issue. Feel free to leave comments or questions below!

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When Reinvesting Profits in Your Business May Still be Taxable

Over the summer I have had several consultations with small business clients and a constant theme that I have come across is that these small business owners have been “reinvesting” their profits into their businesses. I thought it was time to dispel the “reinvestment” mantra. Whatever your passion or business pursuit, you’re likely going to want to grow your business as big as possible, but part of being a small business owners is knowing when you're investing and when you're spending. This week I’m going to attempt to break down the difference between an investment in a business and a straight-up expense. Note for the purposes of this blog, I am specifically excluding the rules related to C corporations, and will focus only on pass-through entities.

What is an Investment?

First, let’s talk about making the initial investment. To do this we’ll use an example. I’m going to assume that my fictitious entity is a newly minted consulting firm known as ConsultCo, LLC “CC”. It doesn’t really matter what kind of consulting services CC provides, just that it is taxed like every other disregarded LLC. The owner decides on day one that she wants to invest $10,000 into CC. So let’s break that $10k investment down a little further. If all she did was deposit the funds into the business’s checking account, then she would have done nothing more than make an investment in her business. Just because she opened a business and transferred her personal funds into a business bank account doesn’t mean that she gets to deduct that amount on her tax return. In fact, in this very simple example, there is no taxable event.

What is an Expense?

Every business has typical operating costs. Expenses for everything from postage & shipping, to business meals, are deductible. The list of deductible items is extensive so I won’t go into much detail but qualified expenses are truly tax-deductible items. Businesses usually also have start-up costs associated with forming the entity, which can be deducted in full (up to $5,000); after that the excess is capitalized over 15 years. But what about when the company starts gaining traction and the owner decides to “reinvest” the profits, how does that work

Reinvesting Profits

To understand how reinvestment works we have to understand a little more about how the math works. It's also important to understand that cash usually must change hands for a taxable event to occur. This is key. Even if a business owner has future plans for that cash, there typically has to be some movement of money to receive any tax benefit.

So let's work with another example. If the entity above, CC, provides services and earns $1,000 in consulting fees, and immediately uses those funds to purchase a new computer, then the profits have truly been reinvested. In this example, CC exchanged cash for an asset, and with the proper guidance on how to navigate her tax return efficiently, the owner can make that asset purchases fully deductible at the time of purchase. But if CC instead takes that money and decides to put it in the business bank account for future use, well then she has taxable income. You see, the profits were not actually used for anything else, but were instead set aside for future-use. In this case, the business owner would actually have to pay income taxes on the amount put in reserve. Even if the business owner used profits to purchase assets and not elect to fully deduct them at the time of purchase, that event would also likely create taxable income.

When it comes to taxes, it’s usually all about the cash…

Investment vs. Expense

Some owners find themselves continually feeding funds into their business accounts to keep their business afloat. In theory, as they do this, they should be incurring expenses, or at the very least purchasing business assets, both of which are deductible. But what about when the business becomes profitable, and the owner decides to withdraw cash? This is where it becomes important to track equity contributions and withdrawals, as well as revenues and expenses. It is only with this information that an accountant or CPA would be able to successfully determine to what extent there is truly net income vs. withdrawals and how much of each is taxable. In the majority of pass-through entities this irrelevant because all profits are taxable whether or not they remain in the business. But when it comes to tracking cash-flow (the only thing that really matters), a business owner will want to know how much out-of-pocket cash has gone into their operations and how much is coming out (before and after tax).

I hope you found this brief overview insightful. It’s great to reinvest your profits into your business but keep in mind that your net income is still taxable and setting enough cash aside to cover your year-end tax liability is critical. Just because you are leaving some money in the business does not mean you won’t have to pay taxes on the business net income so be mindful when planning your quarterly tax bills.

Have a question or comment? Feel free to post it below, I’d love to hear from you!

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Is Your Small Business Failing on its Sales Tax Obligations?

This is a question I have been asked almost daily lately. Whether it’s a new business owner approaching me, or owners of existing businesses, I am regularly asked the simple, but sometimes complicated question, “should my business be collecting sales tax”? It may seem simple to answer, but in reality, there is no hard and fast answer anymore. Many factors dictate whether a business is required to collect. In this week’s post I’ll do my best to walk business owners through their responsibility and requirements when it comes to sales tax.

But first, a note to readers. Every state and local jurisdiction has different rules regarding sales tax. Rules can differ from amount to collect to how often a business owner must remit payment. I can’t stress enough the importance of consulting with a local expert or the taxing authorities directly for more information on requirements specific to where your business operates.

What is Sales Tax and Who Sets the Rates?

If you have ever bought anything you know the advertised price and the price you pay are never the same. The difference is most likely due to sales tax. Sales tax is considered a consumption based tax and is only imposed when goods are purchased by the end user. Taxing authorities often impose sales tax as a way to finance various projects such as public use facilities (think of public hospitals) or to cover operating costs of state and local governments as well as public services such as emergency services. In some cases, these taxes may also be used to expand roadways and public use streets. These are just a few examples of where sales tax revenues may be used. The tax rate itself is typically a combination of a state base rate plus a county rate, which may vary from county to county. The rates are consistent with the budgets established to meet the needs of the public

Who Must Pay Sales Tax?

Who pays sales tax depends primarily on the purchaser’s intent of the goods being purchased. In most cases, the end user is responsible for paying sales tax. Business-to-business (B2B) transactions are more commonly sales tax exempt because businesses may or may not be the end user of a good. A business that is not the end user and is not responsible for paying sales tax may present a sales tax exemption certificate, a state provided certificate basically stating to the seller that they will not being using the goods, but instead selling them back to someone else who may be the end user.

Who Must Collect Sales Tax?

For every payer of sales tax there is a collector and the collection responsibility falls on business owners. If end users are required to pay sales tax, then business that sell to consumers (B2C) must collect sales tax. This seems pretty straight forward when you think about it but when we start to dissect what products and transactions are subject to sales tax it can become complicated. For example, in Georgia, sales tax is not only collected on the sales of most goods, but is also collected on some labor performed. This recently enacted legislation has been a struggle for business owners to grasp given the unique nature of imposing sales tax on a service. Again, every state is different but it remains the responsibility of every business owner to determine which items and transactions are taxable and which are not. Business owners should also keep clear documentation for tax collected and not collected in case of an audit.

How Does Sales Tax Collection Work?

Once a business has successfully established itself as a legal operating entity and has determined it is indeed required to collect and remit sales tax it must first register with the appropriate state(s) for a sales tax withholding ID number. A withholding ID number is typically required in every state that a business has a liability in, although some states participate in the Streamlined Sales and Use Tax Agreement. As for collecting, that's quite simple; as sales are made, the final sales price is marked-up by the combined sales tax rates, which is collected and held by the business owner until they are required to make a payment to the taxing authorities. It’s important to track sales by state, county, and local levels (where applicable) to ensure appropriate allocation when remitting sales tax. Everyone is going to want their fair share.

Something to note here is that sales tax is a liability to every business and should not be deducted as an expense. I see this very often and have spent countless hours educating my clients about the difference between including it on the P&L versus the Balance Sheet. Regardless of where it is reported on the financial statements, the cash received for every sale related to sales tax should not be used by the business for operating purposes. Businesses that use cash from sales taxes they collect tend to find themselves in hot water pretty quickly because they are often short when it comes time to pay the taxing authorities or they become too cash-strapped to run their business. The proper accounting system established from the onset of business will dramatically reduce the likelihood of this from happening.

How Often Must a Business Make Sales Tax Payments?

How often a business is required to pay the taxing authorities is dependent on the rules set by each respective state. In most cases, states set the collection rules so rarely will you find an instance where a county requires monthly payments and the state requires quarterly payments or vice versa. The payment frequency is also usually provided by the state when a business applies for a sales tax withholding ID number. It’s best to follow the instructions provided by the taxing authorities for tax payments, especially if they change. Payments are also usually made to just one party for the full amount via a sales tax return,  which breaks-out payments by county and local levels so the taxing authorities know how to allocate the funds.

What Happens If a Business Fails to Collect or Pay?

If a business is required to collect and remit sales tax and fails to do either or both, the business could be in a world of trouble. Messing with state and county sales tax can get a business shut down. State revenue officials can easily come to your place of business and pull your license to operate. No matter who approaches me about this or their opinion on the matter, I always explain that it can single-handedly be what shuts a business down or temporarily halts operations. There is harsher enforcement that may be taken by but this is in the realm of worst case scenarios.

I covered a lot of technical material this week and it's only the tip of the iceberg. Given that this topic that has been red hot in my firm over the past couple of months I felt it was time to spread awareness. Contact me for a consult or follow-up with your state’s revenue department if you’re unsure of whether your business should be collecting and remitting sales tax. Whatever you do, don’t ignore the issue. It’s better to come clean and catch-up than to continue to disregard your responsibility as a business owner.

Have tips on how to ease the burden of collecting or paying sales tax, or maybe a story to share? Leave it in the comments below.

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