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Do I Have to Pay Taxes on Contest Winnings? And More Free Tax Advice – Ask the Tax Pro 10/25/12

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On Thursdays, CPA and Vice President of Corporate Tax Network, Gary Milkwick and his team, answer tax questions for free on the LegalZoom Facebook Page. Did you miss the last Ask the Tax Pro? Don’t worry. We’ve got it all right here.

Darrell: Mr. Wilkwick,What is the general rule for paying taxes on prizes you win in contests. For example,I won a piece of luggage this year with a retail value of $995,will I have to pay taxes on it?

Corporate Tax Network: Darrell, anything won in a contest is taxable as ordinary income. Since you didn’t earn it, you do not pay any employment taxes on it, such as Social Security and Medicare, but you do have to pay federal income tax on it, plus state and local taxes where applicable. All prizes won in contests are assigned a dollar value that represents the fair market value of the prize, including vacations won in shows like Wheel of Fortune. So the $995 luggage that you won will have to be included on your tax return as income and will be taxed at your ordinary tax rate.

You should have received a 1099-Misc form showing the amount of taxable prize winnings from the organization that awarded you the prize, and they will also report that information to the IRS. In turn, the IRS will know to expect to see this amount reported on your tax return. So the good news is that you won, the bad news is that you have to pay taxes on your winnings…

Lacey: My daughter and I live with my boyfriend. He is the Head of Household and makes the income. Her dad has no right to claim her on his taxes. Can my boyfriend claim her and myself on his?

Corporate Tax Network: Hello Lacey, your boyfriend will need to file as “Single” since he does not live with a qualifying relative. However, if he is providing more than ½ of your support and if you and / or your daughter do not make more than $3,800 each in gross income, he can claim each of you as dependents.

Kimberly: I am sole owner of a company in Texas (C Corp). Is it legal for me to take owner/shareholder dividends monthly instead of a salary as to keep my taxes lower? Dividends are paid at 15% I believe.

Corporate Tax Network: Kimberly, it is legal to take dividends instead of salary in a C Corp. However, a C Corp pays taxes on its profits and then you pay taxes on the dividends personally – this situation is known as “double taxation” because the profits of the corporation are taxed at the corporate AND personal level.

For this reason, many small business owners elect for their corporation to be taxed as an S Corp, which does not tax at all on owner distributions – profits flow through from the S corporation to the individual, and the individual pays taxes personally on the income.

The type of corporation that would minimize total taxes paid for you and your business depends on many factors – your personal tax rate and corporate tax rate (if you’re set up as a C Corp), the amount of profits generated by the business, your other sources of personal income, etc. I would suggest you to go through the details with a tax advisor to determine how to minimize your tax liability. Best of luck to you and your business!

Jeff: I have sent over a detailed explanation to the irs and was just denied. The problem is the mom who is being coerced by the step dad is not cooperative….every year we engage in a back and forth who can claim her, they have always backed down. The status quo is I have been consistant
ly claiming her since birth. For 2010 however they ended up claiming her which set off red flags with the irs. They are going to be uncooperative filling out form 8332 as they don’t want to have repay the money back to the irs…as far as being the sole provider 50 % or greater. I would consider myself for 2010. I paid child support and all travel expenses…my daughter went to public school which was free….what do you recommend? Does it sound like I am screwed? Also are audits random? Meaning now from this point forward I can never claim my daughter if step dad is claiming her? I claimed her for 2011 and haven’t been audited…lastly if I am screwed and have to pay the money back being that I am receiving unemployment would they garnish my unemployment checks??? Thanks again…you guys are really awesome….

Corporate Tax Network: Hi Jeff, I am sorry to hear that the IRS denied your claim. I would suggest to contact the IRS directly (800-829-1040) and speak to an agent, who will explain why the claim was rejected in order for you to provide stronger evidence. This is a complicated situation, and I would advise you to hire a CPA, EA or a tax attorney to contact the IRS on your behalf, if possible.

If you and the mother / stepfather both claim the same dependent on your tax returns, an IRS notice will be automatically be triggered because the same person cannot be claimed as a dependent on 2 different tax returns. For each year, you would need to provide sufficient evidence to the IRS proving that you qualify to claim your daughter as a dependent if this point is being disputed by the other party.

In general, the second (last) person to file the tax return claiming the same dependent has the burden of proving that the first person who claimed the dependent did so incorrrectly; the way the IRS’ system is set up, it automatically rejects the dependent on the second tax return.

If you decide not to challenge the decision made by the IRS, and cannot make a full payment of the taxes you owe, you may be able to set up an installment agreement. You can either contact the IRS directly or file Form 9465 – Installment Agreement Request.

Shaun: When selling a service, as a small business in Florida and using personal taxes for filing, what would be a comfortable percentage to save per transaction in order to pay at tax time?

Corporate Tax Network: Shaun, it sounds like you’re saying that you’re running your business as a sole proprietorship, which is reported on Schedule C of your personal tax return. If that’s the case, you pay self-employment tax of 13.3% on your business profits of up to $110,100 for 2012. For 2013, that rate goes back up to 15.3% because the payroll tax holiday of 2% ends this year.

In addition to self-employment tax, you are also taxed at your normal personal income tax rate for the profits of your business (although you get a deduction for 1/2 of the self-employment tax paid) PLUS you have to pay state income tax. Since there are no state income taxes in Florida, that saves you a bit of money! Since I don’t know your personal tax situation, it’s tough to say exactly how much you should hold back for taxes, but hopefully this gives you enough information to make a rough estimate.

One other item to note is that if your Schedule C business is generating profits, in most cases the IRS wants you to make quarterly estimated tax payments. You can be penalized if you do not make these payments but meet the criteria for making them. Filing estimated tax payments is done by completing Form 1040-ES each quarter. See the following link for more information on quarterly estimated tax payments.

LegalZoom: More tax Q&A coming up next Thursday. In the meantime, check out our free legal Q&A tomorrow:

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October 29th, 2012 at 5:39 am