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What's Deductible, What's Not

The best things in life are free. Almost everything else is taxable.

Your start-up company gives you stock options. You get fired but receive a golden parachute. You win a lawsuit settlement.

What's taxable, and what's not? Generally, if it looks like money and spends like money, it's probably taxable.

There are weird exceptions, and the guys at the IRS think of all contingencies. For example, if you're the victim of a terrorist attack, and receive disability payments as a government employee, those payments are tax exempt. See, they think of everything.

Employees who get severance pay packages must treat it as income on their tax return. The same is true of unemployment compensation. The government will send you a Form 1099-G showing how much you received. That income, however small, goes straight onto line 19 of your Form 1040.
Bonuses and awards for quality work are also taxable in your gross income, even if the bonus was a vacation trip to Hawaii for meeting a sales goal. However, if it was an achievement award for such things as safety or length of service, that isn't taxed.

Got stock appreciation rights or stock options from that new high-tech start-up company? Stock appreciation rights shouldn't be included as income until you actually exercise the rights. Be sure to keep track of the fair market value of the stock on the date you got the appreciation rights. At the point you exercise the appreciation option and are entitled to the cash payment, you can be taxed on the total amount the shares appreciated over that original value.

Stock options may be quite different. An option to buy or sell stock as payment for your services is usually considered income. That's because you are given an opportunity to benefit monetarily during the option's exercise period without risking any capital.

If the fair market value of the option is easily determined at the time you get the option, it should be treated like any other compensation and reported as income. But if the fair market value is not readily determined, you generally don't have income until you exercise the option.

Some stock options are called "statutory" options granted as an incentive or as part of an employee stock purchase plan. Generally, you don't include any amount in your gross income either when the option is granted or when you exercise it to purchase the stock.

Income or loss is reported at the time the stock is sold. The profits generally may be treated as capital gain in this case, which may have a lower tax rate than regular income. Check with your employer if you're not sure which kind of options you own. Or check the IRS guide to taxable and nontaxable income, Publication 525.

Suppose your boss drives you crazy. You sue. A jury awards you compensation for lost wages and emotional distress. The compensation for lost pay is taxable, but the award for emotional distress isn't.

If your boss was really nasty and the jury awarded pnitive damages, those are generally taxable because it doesn't relate to a physical injury. Some punitive damages are exempt from taxes, and your lawyer better know the difference (or you may have a legal malpractice lawsuit as well).

Bartering, the exchange of property or services with someone, must be included in your income the year you received it. For example, you're an accountant who meets a house painter at a barter club. You provide accounting services and the painter paints your home. You both must report the fair market value of the services you received.

Gambling winnings -- taxable. Veteran's benefits -- nontaxable. Alimony you received -- taxable. You get a free tour from a travel agency because you organized a group of tourists. The value of your trip is taxable. Win a beauty contest? Miss America, the prize is taxed. Kickbacks or side commissioners, both taxable.

But win the Pulitzer prize for writing or the Nobel prize for peace and that's a recognition of past accomplishment. They're not taxed. Certain scholarships are not taxed. That $10,000 gift from Aunt Minnie -- not taxed. Federal disaster relief grants, particularly important during El Nino, are not included in income. Disaster unemployment assistance, however, is taxed just like unemployment benefits.

Oh yeah, illegal income, steal from widows and orphans or embezzle from the bank? Taxed.

Remember, illegal income was how the IRS got Al Capone.

By Pam MacLean
©1998, L.L.C

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