Taxation Of Unemployment Benefits, Group Life Insurance, Prizes, Gambling & Alimony/Child Support

ARTICLE HIGHLIGHTS –

On 22^nd December 2017 Donald Trump, President of USA signed into law the Tax Cuts & Jobs Act (TCJA). Let us have a look at how these items are taxed and how a person can claim deductions or exclusions under various situations:

• Unemployment Benefits
• Group Life Insurance
• Prizes & Awards
• Gambling
• Alimony & Child Support

(1) Unemployment compensation – When a person is removed from employment and withdraws benefits/compensation from the government, the compensation received is fully included in gross income,

Just like salary & wages are included. During the 2008-09 recession, when many people were suddenly unemployed due to lack of work and a slow economy, the American Recovery and Reinvestment Act of 2009 excluded the first $2,400 of unemployment income from gross income, while the rest was includable.

However, later Congress chose not to extend this exclusion of $2400.

(2) Group term life insurance – Employers do sometimes provide life insurance coverage and pay the costs or premiums on that coverage for their employees. One may argue that since the employee is getting something of value from the employer, this benefit should be includable in the gross income of the employee. However, to incentivize life insurance coverage, Congress decided that employees do not have to include in their gross income the proportionate premiums paid by their employer on their behalf on the first $50,000 of group term life insurance coverage.

In case an employee wishes to have more coverage in excess of $50,000 and the employer pays for it, then the premiums paid for coverage in excess of the base $50,000 will be included in gross income.

This inclusion amount is based on IRS tables available at https://www.irs.gov/government-entities/federal-state-local-governments/group-term-life-insurance

However, if the group insurance coverage is planned in favour of senior employees and it discriminates against other employees, that is, the life insurance premiums paid by employers are only for the benefit of key managerial officers and not all employees of the organization, then this exclusion is not available to key employees. One point to note is that in such a case, the key employees will need to include in their gross income the actual premium paid by the employer for all the insurance coverage received, and not just the amount over $50,000 of coverage provided

(3) Prizes and awards – Generally, receipt of a prize or award, in the form of cash or property or service is included in gross income. Exceptions to this rule exist if the following conditions are fulfilled –

• The prize or award is made for scientific, charitable achievement or literary work and the prize money is immediately transferred to a qualified charitable organization
• The recipient did not enter the contest on their own accord

Another instance of a prize or award which is excluded is one where an employee is recognized for safety or length of service. In such a case, the exclusion is limited to $400 dollars only. So if an employee receives some painting from her employer worth $300 on completion of 10 years with the organization, the painting worth $300 is excluded while calculating the employee’s gross income.

(4) Gambling –  Winning from Gambling are also included while calculating gross income and gambling losses are deductible as miscellaneous itemized deduction.

However, if the person is a professional gambler, then he/she can deduct gambling losses while calculating AGI itself as a Above the line item. In such a case, the person has to provide strong evidence

that gambling is the person’s profession. Evidence like the time spent on gambling, number of gambling tournaments played, etc may help the person in proving that he/she is a professional gambler.

(5) Alimony & Child Support – Alimony is the transfer of cash made between two spouses, under a written separation agreement or divorce decree. Certain points which are important in relation to Alimony –

(A) Alimony requires that the payments stop upon the death of the recipient.

(B) Property divisions pursuant to a separation or divorce is not considered alimony, rather its just a division of assets amongst spouses after divorce or formal separation.

(C) The separated spouses cannot live together in the same house

(D) Certain payments to third parties on behalf of a spouse may be considered alimony.

Let us now see how alimony is taxed. For divorces occurring prior to 1^st Jan 2019, alimony is deductible by the spouse making the payment and is included in the gross income of the person receiving the payment.

However, for divorces occurring on 1^st Jan 2019 & later, alimony is non-deductible by the person paying it and is excluded from the gross income of the recipient of alimony.

Child Support payments that are specifically designated in the divorce decree as Child support are not considered Alimony. However, in cases where the language of the decree is not clear, one needs to distinguish between payments made for alimony and child support.  Child support payments are made in accordance of a legal obligation to support the child of the taxpayer. Therefore, the payment is neither deductible by the person paying it nor included in the income by the former spouse receiving it.

Sometimes, distinguishing whether a payment is alimony or child support can be tricky. In such a case, one needs to look at the nature and the covenants of the payment. For instance, If the payments  stop or change on an event based on the child’s life rather than the former spouse’s life, then the payment should be classified as child support.