Prize money = unearned income for kiddie tax?

[Jesse]

Have a snowmobile racer that won price money just under $2,000 and this is the only income for a Senior high school student age 18.

Definitely no profit motive and much more expenses than income. The 1099Misc is non-employee compensation and I thought I could do a dummy Schedule C and transfer to line 21 other (hobby) income but then I am taxed on the excess over $950.

If I leave it on Schedule C it's subject to SE tax and it really is a hobby.

Any suggestions on how to file?

[ChEAr$]

But who's to say it's really a hobby? (grin

[Jesse]

I get your point, I'm just not real comfortable with it.



It's been a very long weekend and I'm over tired so I think I'll finish up some straight forward returns and sleep on this and hope my mind is clearer in the morning.

[S T]

What form

Jesse,
Curious,
what form was the income reported on?

Sandy

[Jesse]

On a 1099misc box 7 Nonemployee Compensation

[taxea]

It is prize money which puts it on ln 21 and yes, it is taxable

[Jesse]

It is prize money which puts it on ln 21 and yes, it is taxable

Thanks - I had no idea!!!!!!!!!!!!!!!!!!!!!!!!!!

[Koss]

Solution

Jesse, you mentioned that you were rather tired, and that this may have clouded your thinking...

What you are seeing on the tax return is not the Kiddie Tax, i.e., tax on the child's investment income at the parents' tax rate.

The threshold for the Kiddie Tax is indeed $1900. But I think it is just a remarkable coincidence that that is also approximately the amount of the prize that your client won. I don't think it's "triggering" the kiddie tax.

The question you raised in the title of your post--whether the prize is treated as unearned income that is potentially subject to the Kiddie Tax--is an interesting question. And I don't have a definitive answer. But I don't think the Kiddie Tax is present on the return you are working on. Calculating the Kiddie Tax requires entering data that includes the parents' income. I don't think that's what you're doing.

You mentioned that the kid is getting taxed "on the excess over $950."

That's the child's standard deduction.

Because he is a dependent, he doesn't get a personal exemption. So any AGI in excess of $950 is subject to regular federal income tax. It doesn't matter whether the income in question is earned income or unearned income, and it also doesn't matter whether you treat it as self-employment, prize money, or hobby income. If the kid's AGI is over $950, he's going to have a tax liability.

But I do understand your original question, and I have a solution for you.

The problem you are facing is how to account for the expenses. If you do a full-blown Schedule C, you reduce the net income, but then it is subject to self-employment tax. If you treat it as hobby income or prize winnings, then you have to enter the gross on Line 21, and then the AGI exceeds the standard deduction.

I actually have two potential solutions for you:

(1) You said the expenses exceed the income. Therefore, it seems that you could treat it as a genuine business activity, and have a net loss on Schedule C. Even if there was a small net profit, if the net profit is under $400, there won't be any self-employment tax, and the standard deduction of $950 will reduce taxable income to zero.

But I think that's what ChEAr$ was trying to say, i.e., who's to say it's a hobby, and you said you weren't real comfortable with treating it as a genuine Schedule C business.

So here's a better idea:

(2) Treat the prize winnings as hobby income, and report the total amount on Line 21. Then, deduct the hobby expenses. Hobby expenses are deductible only to the extent of hobby income. Hobby expenses are deducted on Schedule A, subject to the 2% limit.

By now you probably think I'm smoking something, but this will actually work.



Your 18-year old client, who is a dependent of his parents, has the right to choose between standard and itemized deductions just like anyone else. And since his standard deduction is only $950, his itemized deductions will be greater than his standard deduction if you include the hobby expenses.

If the hobby expenses are greater than the hobby income, he can only deduct the amount of the income.

It should reduce his taxable income to almost zero. Due to the 2% limitation on Schedule A, he'll have a microscopic tax liability.

BMK

[Jesse]

So here's a better idea:

(2) Treat the prize winnings as hobby income, and report the total amount on Line 21. Then, deduct the hobby expenses. Hobby expenses are deductible only to the extent of hobby income. Hobby expenses are deducted on Schedule A, subject to the 2% limit.

By now you probably think I'm smoking something, but this will actually work.



Your 18-year old client, who is a dependent of his parents, has the right choose between standard and itemized deductions just like anyone else. And since his standard deduction is only $950, his itemized deductions will be greater than his standard deduction if you include the hobby expenses.

If the hobby expenses are greater than the hobby income, he can only deduct the amount of the income.

It should reduce his taxable income to almost zero. Due to the 2% limitation on Schedule A, he'll have a microscopic tax liability.

BMK

I think this may be my solution, thanks so much Burton. With the little bit of interest and the 2% that is not deductible we have a balance of $9. The program triggers Form 8615 but since it's not investment income we're fine there too!

Thanks again!

[Koss]

Clarification

I stand by my previous post, in that I recommend reporting the prize on Line 21, and then deducting the related expenses on Schedule A.

But just to clear this up a little further...

Any amount reported on Line 21 will be treated as unearned income when you calculate the standard deduction for a dependent. This is why the standard deduction is only $950 when you put the income on Line 21, but it increases when you put the income on Schedule C.

Whether an amount on Line 21 is treated as investment income that is potentially subject to the Kiddie Tax is a completely different question. I admitted in my first post that I don't have an answer to that one. But I'm not convinced that it's relevant to your client. I don't think the Kiddie Tax is involved in this affair.

BMK