The answer to the question "What income is taxable?" can have some surprising outcomes, and this article explores some of the commonly encountered situations that could have unexpected results.
But first, we need to visit Section 61(a) of the Internal Revenue Code. That code section defines gross income as income from whatever source derived unless excluded explicitly by other parts of the tax code, including (but not limited to) compensation for services, including fees, commissions, fringe benefits, and similar items. Taking that to extremes, if you are walking down the street and find a $10 bill that you keep, that is technically $10 of taxable income.
We all know or should know, that the W-2 wages, 1099 income from interest, dividends, retirement, business and farming profits, investment income, capital gains, etc., are taxable in some manner. However, there are other sources of income that individuals do not associate with taxable income or ignore because they want to avoid reporting the income. Here are some examples:
No 1099 – Payers of certain types of income must issue a Form 1099 to the IRS, with a copy to the income recipient, when the income they paid to an individual exceeds a certain amount, generally $600 or more. Many individuals misunderstand the $600, thinking that income less than $600 is not taxable. This is not true; the $600 is simply a filing threshold for 1099s, and all the income is taxable, even amounts under the $600 threshold. The same holds for interest income, where a bank or brokerage company's filing threshold for a 1099-INT is $10. Even if the account holder receives interest under $10, that income will still be reported on their tax return.
Cash Sales – Some businesspeople tend not to include cash sales in their income, thinking it cannot be tracked. The IRS, being aware of that behavior, created the Form 1099-K some years back that required third-party transactions such as those by credit card companies, eBay, Stub-Hub, TaskRabbit (when hiring out their services) and others to be reported on 1099-Ks when an individual's transactions exceeded a threshold of $20,000 and the aggregate number of transactions were 200 or more during the calendar year. At the same time, the IRS conducted studies of various types of businesses to determine what percentage of income was derived from cash sales. This allowed the IRS to compare a business's reported gross sale to the 1099-K said transactions and identify those businesses under-reporting their income and not including an amount for cash sales.
Beginning in 2023, the threshold for third-party 1099-K reporting has been dropped to $600, which may shock individuals with side hustles selling goods online with a service like eBay who have yet to report the business on their taxes.
Reselling Sports and Concert Tickets – The profit is taxable when someone purchases an event ticket and resells it at a higher price. If the resale transaction is handled by a third party, such as StubHub, the third party must issue the 1099-K if the sales exceed the reporting threshold. This may surprise some individuals now that the 1099-K reporting threshold has been reduced to $600. Based on the price of event tickets these days, it won't take much to reach the $600 threshold.
Another issue is whether this is an occasional act by the taxpayer or a concerted effort to turn a profit. If a rare act, the transaction can be reported as a short-term capital gain (a long-term capital gain, which has a lower tax rate, requires tickets to be held for a year and a day, which is almost always impossible), the same as a stock sale. However, if reselling tickets is frequent and consistent, it is likely a business, and the income must be reported on Schedule C. The profits from Schedule C are not only subject to income tax, but they are also subject to a 15.3% self-employment tax. The 15.3% combines the SE and 2.9% Medicare tax rates.
Crowdfunding - Money raised from online crowdfunding sites for purposes other than business is generally treated as a nontaxable gift if the contribution is made with a detached generosity. But a "gift tax trap" occurs when an individual establishes a crowdfunding account to help someone else in need (whom we'll call the beneficiary) and takes possession of the funds before passing the money on to the beneficiary. Because the fundraiser possesses the funds, the contributions are treated as a tax-free gift to the fundraiser. However, when the fundraiser passes the money on to the beneficiary, the money then is treated as a gift from the fundraiser to the beneficiary; if the amount is over $17,000 ($18,000 in 2024), the fundraiser is required to file a gift tax return and to reduce their lifetime gift and estate tax exemption. Some crowdfunding sites allow the fundraiser to designate a beneficiary so that the beneficiary has direct access to the funds, in which case the fundraiser avoids encountering gift tax problems.
When raising money for business projects, two issues must be contended: the taxability of the money raised and the U.S. Securities and Exchange Commission (SEC) regulations limiting the amount that can be contributed and the income qualifications of the contributor. These SEC rules are not covered in this article.
No Business Ownership Interest Given – If no business interest is given and the fundraiser only provides the contributor nominal gifts, such as products from the business, coffee cups, or T-shirts, the money raised is taxable to the fundraiser.
Business Ownership Interest Provided – This applies when the fundraiser provides the contributor with partial business ownership in stock or a partnership interest. In this circumstance, the money raised is treated as a capital contribution and is not taxable to the fundraiser.
Online Garage Sales – Some individuals will occasionally sell some of their personal property on eBay, Etsy, or a similar web platform. If the total amount received is $600 or more, they will also receive a 1099-K. Although these sales are generally not taxable since used personal items are usually sold for less than their cost, the IRS does not know the circumstances of the sale, and the gross proceeds from the 1099-K need to be reconciled on the individual's tax return, generally treated like a stock sale. A sale of personal property that results in a gain is taxable income, but if the result is a loss, the loss is not deductible for tax purposes. Alternatively, the IRS provides a reporting procedure that cancels the 1099-K income.
Feel free to contact this office with questions or concerns about any issues discussed.