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Feb. 3, 2004, 7:51 a.m. EST

Only a few items escape the IRS

Most income is taxable, but there are exceptions

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By Kay Bell, Bankrate.com

NORTH PALM BEACH, Fla. (Bankrate.com) -- There's not much the Internal Revenue Service doesn't consider taxable income. Of course, there are the standbys: salaries, wages, tips, commissions, interest and dividends, rent on property you lease out and all the money you make from that photography business on the side.

Bartering your services won't help, either. The value of noncash items must be determined and then counted as income. Neither can you put money in a foreign bank to earn interest out of Uncle Sam's reach. If it's in your name and you can get to it, it's considered income.

And don't think for a minute you can get away with some underhanded ways to make a few extra bucks. The IRS specifically says kickbacks and embezzlement proceeds are taxable too.

The tax folks don't care if you steal it, as long as they get their piece of the action. Remember, it was the IRS that tripped up Al Capone.

This stuff's going to cost you

Even trying to get a better grip on your finances could cost you at tax time.

Did you negotiate with a lender or other account holder to eliminate some of your debt? While you may no longer have a recurring payment, you'll probably now have to make one to the IRS. Any debt you owe that is canceled or forgiven (other than as a gift or a bequest) generally is considered income -- taxable income.

This tax rule could even apply when you pay off your home. If your lender offers a discount for the early payment of your mortgage, the amount of the discount is canceled debt and you must include it in your income.

Then there are those minimal amounts you get when trying to do the right thing. Fulfill your civic duty as a juror and get a few bucks and you owe taxes on that pay. Serve as the administrator or executor of an estate and any stipend you get is taxable.

Efforts you made to reduce one year's tax bill also could come back to bite you if you get what the IRS terms recoveries. For example, your itemized deductions last year included medical expenses, mortgage interest and real estate taxes. This year, however, your insurance had a change of heart (or at least policy) and paid you back for some of those expensive tests. In an election-year frenzy, your county government rebated some of your past property tax payments. And your lender discovered that it had misapplied some of your payments as mortgage interest when the money really went toward your home's principal. The IRS requires you to include these amounts as income in the year you receive them up to the amount you previously claimed them as a deduction or credit.

Rewards for a job well done could cost you too. If you get a bonus, it's income. Many fringe benefits, such as a company car or use of a health club, also are included in your income as compensation unless you pay fair market value for them or the law specifically excludes them. Your employer generally must withhold income tax on these benefits from your regular pay.

You can't get around taxes by claiming the company reward was a gift. The IRS will let it slide if your boss hands out a turkey, ham or nominally priced item at holiday time. But if you're given cash, a gift certificate or an item you can easily exchange for cash, you must include the gift's value as extra salary or wages regardless of the amount involved.

Heck, even if you're out of a job you're out of tax luck. Unemployment benefits are taxable .

Here are some more instances where the taxman wants his cut:

  • Alimony received

  • Awards, prizes, contest winnings and gambling proceeds

  • Back pay awards

  • Notary public fees

  • Patent, royalties, license receipts and any infringement compensation

  • Profit on sales between family members

  • Punitive damages

  • Residence sale profit above the exclusion limits

  • Severance pay

  • Strike benefits

In the tax clear

There are few sources of income that are not taxable. Unfortunately, many represent money you wish you didn't need to get in the first place. They are:

  • Black lung disease benefits

  • Disaster relief grants

  • Cash rebates from a dealer or manufacturer

  • Casualty insurance and other reimbursements

  • Child support payments

  • Compensatory damages awarded for physical injury or physical sickness

  • Damages for emotional distress due to a physical injury or physical sickness

  • Disability payments if you paid the premiums on the policy with already taxed dollars

  • Foster care payments when the care is for youngsters

  • Most moving expense reimbursement from your employer

  • Supplemental Security Income (SSI)

  • Veterans' benefits

  • Welfare benefits

  • Workers' compensation

And while an inheritance of property is not a taxable event, you'll owe Uncle Sam on any income the bequest produces.

Navigating murky tax waters

As with almost every tax situation, it's not always clear-cut when it comes to taxable vs. nontaxable income.

For example, the tax laws treat various scenarios regarding life insurance payments differently. If you surrender a life insurance policy for cash, you must include as taxable income any proceeds that are more than the cost of the policy. But life insurance proceeds paid to you as the beneficiary of the insured person are not taxable unless the policy was turned over to you for a price.

Another instance where income may or may not be taxable is scholarship or fellowship grant money. If you are a candidate for a degree, you can exclude from income amounts you receive as a qualified scholarship or fellowship and used to pay tuition, fees or buy books or other required educational equipment. Grant money used for room and board, however, is taxable.

These examples are not all-inclusive. So if you have an unusual income situation, check out what the IRS rules are. You may -- or may not -- have to pay taxes on the money.

A complete list of what the IRS considers taxable or nontaxable is available in Publication 525, Taxable and Nontaxable Income .

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