THE WANDERING TAX PRO
Up-to-the-minute advice, information, resources, and, on occasion, commentary on federal and New Jersey state income taxes, and the various New Jersey property tax rebate programs, and insights and observations on tax policy and professional tax practice, by 40-year veteran tax professional Robert D Flach.
Tuesday, October 24, 2017
TAXES AIN'T FAIR!
reform has become a hot political topic.Reduce taxes on the middle class, or increase taxes on the “wealthy”
simply because they can afford it.
see a great need for substantive tax reform not to reduce, or for some
taxpayers increase, the actual amount of taxes paid – but to simplify the Tax
Code and make it more fair.
ever said taxes are fair.There are many
inequities in the US Tax Code, some purposeful and some unintended.
the biggest inequities concerns how the Code treats some aspects of “gross
income” and expenses related to generating this income.I speak specifically of the taxation of
gambling winnings and legal settlements.
have gambling winnings you must report, in most cases (how to report some
winnings is a topic for another post), the gross
winnings as income on Page 1 of the Form 1040.This is the amount that is reported on Form W-2G.So gross winnings are included in Adjusted
Gross Income (AGI).But gambling losses,
to the extent of winnings reported, are deducted as a Miscellaneous Deduction
on Schedule A if you are able to itemize
(although not subject to the 2% of
the gross amount of legal settlements,
except for settlements for physical injuries or sickness (any damages or
settlement you receive to compensate you for your medical expenses, lost wages,
and pain, suffering, and emotional distress is not included in income), is
included as income on Page 1 of Form 1040.The legal fees, often as much as 1/3 of the settlement, and other related
are also deducted as a Miscellaneous Deduction on Schedule A if you are able to itemize (in this
case the deduction is subject to the 2% of AGI exclusion).
taxpayer can have $5,000 in gross winnings from gambling activities for the
year, but $6,000 in gambling losses.So,
the taxpayer’s gambling activity for the year has resulted in a loss.The taxpayer ended up with no money “in
pocket’ from gambling.
the taxpayer is able to itemize without taking into effect the allowed gambling
losses, the Schedule A deduction for $5,000 in gambling losses results in net
taxable income of 0 – so, in effect but not necessarily in reality, he/she does
not pay federal income tax on the winnings.But if the taxpayer is not able to itemize, even with the gambling loss
deduction, or if he/she is only able to itemize because of the gambling loss
deduction (without the deduction his itemizable deductions do not exceed the
applicable Standard Deduction), he/she will be paying federal income tax on up
to $5,000 of income that was not actually received – in the 25% tax bracket $0
in net gambling income could cost the taxpayer at least $1,250.
with a taxable legal settlement, the need to deduct legal fees as a
miscellaneous itemized deduction subject to the 2% of AGI exclusion could
result in federal income tax being paid on more than the actual “in pocket”
course, a large portion of the inequity comes from the fact that various items
of income are increased and deductions and credits are reduced or eliminated
based on one’s AGI.And the fact that
most itemized miscellaneous deductions are not allowed in calculating the
dreaded Alternative Minimum Tax (AMT).
a taxpayer may be able to wipe out gambling winnings with fully deductible
gambling losses, the fact that gross winnings are included in AGI could result
in more of the taxpayer’s Social Security or Railroad Retirement benefits (the
amount of benefits taxed is determined by a formula that is based on AGI) being
taxed – many frequent gamblers in the casinos of Atlantic City for example are
senior citizens – or could reduce or totally eliminate allowable tax deductions
or credits.So again, the taxpayer is in
reality paying federal income tax on $0 in net income.
same is possible with a taxable legal settlement – except for settlements for discrimination
claims, the related legal fees allowed as an “adjustment to income” which
reduces AGI.And, while there may be no
excess tax under “regular” income tax rules there may be AMT.Allowable gambling losses from Schedule A are
fully deductible in calculating the dreaded AMT – but because legal fees are a
miscellaneous deduction subject to the 2% of AGI limitation they are not deductible in calculating AMT.So, tax is paid on the full amount of the
gross settlement at a flat 26% or 28%.When adding the federal and state tax to the legal fees the taxpayer may
end up with only 1/3 or less of the actual award “in pocket”.
while in many cases net and not gross gambling winnings are taxed under AMT,
the fact that gross winnings are included in AGI, and therefore Alternative
Minimum Taxable Income (AMTI), could reduce the AMT exemption, resulting in AMT
tax on gambling winnings even if the net is 0.$5,000 in gross winnings can reduce the AMT exemption by $1,250 and
result in an additional $325 or $350 in AMT.
AMT issue would go away if tax legislation repeals this tax.And changing the way Social Security and
Railroad Retirement benefits are taxed and no longer allowing AMT to affect tax
deductions and credits would also help to remove inequities.But the best way to do away with the
unfairness of the tax treatment of these two types of income would be allowing
taxpayers to net gambling losses against gambling wins (still not allowing the
deduction of more losses than wins) and net legal fees against gross
settlements – either directly by entering the net amount on Page 1 or by
allowing the deductions as an adjustment to income reducing AGI – would certainly
fix the problem.
what do you think?
I will post on other inequities in the current Tax Code in future posts.