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Don't forget that you might be able to deduct expenses related to winning that prize! I won a gaming tournament last year and was able to deduct my entry fee, travel to the tournament (since it was out of state), and even a portion of my gaming equipment as "cost of winning the prize." This reduced the taxable amount significantly. Just make sure you have receipts for everything and that the expenses were directly related to participating in the tournament. You enter these on Schedule A if you itemize, or possibly against the income directly on Schedule 1 (this is a bit of a gray area, so check with a tax professional).
Chloe Wilson
ā¢Thanks for bringing this up! I did pay for my flight to Atlanta (about $350) plus the hotel for 3 nights (~$600) and the convention entry fee ($150). Would all of these potentially be deductible against the prize money? And where exactly would I list these on my tax forms?
Yes, those expenses would potentially be deductible against your prize money! The flight, hotel, and convention entry fee would all count as expenses directly related to winning the prize. You would list these as a reduction to the income on Schedule 1, Line 8z. For example, if your prize was $2,500 and you had $1,100 in related expenses, you would report "Gaming tournament prize income $2,500 less related expenses of $1,100 = $1,400" on that line. Make sure to keep all your receipts in case of an audit.
One thing no one has mentioned yet - depending on your state, you might owe state income tax on this too! Some states have special rules for prize/gambling winnings. I won money in a tournament in Nevada but live in California, and had to pay CA state tax on it even though Nevada has no state income tax.
Ethan Brown
ā¢Yep, and if you won it while physically in Texas but live in North Carolina, you might need to file a non-resident tax return for Texas too if they require it for prize winnings. Tax rules vary by state!
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I made this exact mistake last year but with $37 in dividends that showed up after my conversion. My accountant said not to worry about it and just include it in the basis for next year's conversion. Haven't had any issues.
Did you have to pay any taxes on those dividends though? I'm confused about whether they count as income for the current year even if you're converting them later.
Mia Green
One thing nobody's mentioned - you should check if your traditional IRA has a "sweep" feature that automatically moves dividends to a money market fund. If it's set up right, you can have future dividends go directly to Roth if your brokerage allows it! Saved me a lot of hassle with these small amounts showing up randomly.
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From my experience as an S-corp owner with unequal distributions, your best option is to formalize a loan. Create a promissory note with reasonable interest rate (current AFR rates), specific repayment terms, and have both parties sign it. We made the mistake of taking informal draws for years and had a nightmare sorting it out during an ownership change. Also, don't overlook the benefits of a shareholder agreement that specifically addresses unequal distributions. We amended ours to allow for disproportionate distributions with specific accounting requirements that protect everyone's interests. Whatever you do, make sure EVERYTHING is documented properly. The distinction between loans, distributions, and compensation is exactly what the IRS loves to scrutinize in S-corps.
Thank you for this practical advice. If I go the loan route, do I need to create the documentation before or after taking the money? I've already taken about $15K more than my 1% share would justify in 2024, and we haven't filed yet. Can I retroactively document this as a loan? Also, any guidance on what a "reasonable" interest rate would be in the eyes of the IRS?
Ideally, loan documentation should be created before the money is distributed, but you can retroactively document it if you haven't filed yet. The key is to create the documentation before the end of the tax year - so you're still within the window for 2024. For interest rates, the IRS publishes Applicable Federal Rates (AFR) monthly. For a loan between related parties, you should use at least the minimum AFR for the appropriate term (short, mid, or long) from the month the loan was made. For April 2024, the short-term rate was around 5.25%. Using anything significantly below this could cause the IRS to impute interest, which creates tax headaches for both parties. The documentation should include a clear repayment schedule, consequences for default, and signatures from both parties. Make sure your accountant records it properly on the books as a loan to shareholder rather than a distribution.
Has anyone considered just increasing the 1% ownership stake to better reflect the economic reality? That seems simpler than all these loan structures and special distributions. If OP is consistently taking 10-15% of the profits maybe their ownership should reflect that?
Liv Park
ā¢This could trigger gift tax issues depending on the value of the company. If mom gives additional ownership percentage that has significant value, it might require filing a gift tax return. Also some S-corps have restrictions in their operating agreements about ownership transfers. But I agree it might be the cleanest solution long-term.
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One important thing nobody's mentioned yet - make sure you're also claiming Foreign Tax Credit (Form 1116) on your US taxes for any Japanese tax you've already paid! Even after you get the Form 6166 certificate and reduce future withholding, you should get credit for past payments. Also check if your specific work falls under "independent personal services" in Article 14 of the treaty rather than business profits in Article 7. The distinction can matter depending on how long you physically worked in Japan (if at all) and how your business is structured.
Thanks for mentioning the Foreign Tax Credit! I actually haven't been claiming that - do you know if I can amend previous years' returns to claim it? I've been paying both full US taxes AND the Japanese withholding for about 3 years now.
Yes, you absolutely can amend your previous returns to claim the Foreign Tax Credit! You generally have 3 years from the original filing deadline to file an amended return (Form 1040-X) along with Form 1116 for the Foreign Tax Credit. For each of those past 3 years, you'll need documentation showing the Japanese taxes withheld. The credit can significantly reduce your US tax liability since it's a dollar-for-dollar reduction (not just a deduction). Many people in your situation end up getting substantial refunds. Just be aware that the Form 1116 is somewhat complex, so using tax software or a professional familiar with international taxation might be helpful for the amendments.
Quick note about timing - if you're planning to apply for Form 8802, do it WELL before you need it. I applied in January thinking I'd get the certificate by March at the latest. It's now June and I'm still waiting! The IRS is seriously backlogged with these. If you need it urgently, include a cover letter explaining the financial impact and potential loss, and mark the envelope as "URGENT" though there's no guarantee that helps.
Joy Olmedo
ā¢You might want to try contacting the Taxpayer Advocate Service if you've been waiting that long. They can sometimes help with unreasonable delays. Worth a shot at least!
Connor Rupert
Have you considered looking for tax relief companies? My brother owed like $12k in back taxes from 1099 work and got help from one of those places advertised on the radio.
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Molly Hansen
ā¢Be REALLY careful with tax relief companies! Most of them charge huge fees and promise things they can't deliver. They basically do the same things you can do yourself (set up payment plans, apply for currently not collectible status, or submit an offer in compromise). The IRS has their own programs that don't require paying a middleman. Check out the IRS Fresh Start program before paying some company thousands of dollars for something you could do yourself for free.
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Brady Clean
Something else to consider - if you can put the tax payment on a credit card, sometimes that's better than the IRS payment plan depending on your interest rates. The IRS charges both interest and penalties on unpaid balances. Just be careful because there's usually a processing fee of around 2% to pay taxes with a credit card. But if you have a 0% intro offer or a very low interest rate, it might save you money compared to the IRS interest rates + penalties.
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