How the IRS Determines the Nature of Money Transfers

Sending or receiving money from family and friends is a normal part of life. Parents may help with a child’s living expenses, family members may provide financial support, and friends often exchange money for shared expenses.

From a tax perspective, however, these transactions are not always as simple as they seem. The IRS does not view every transfer as a routine movement of funds. Instead, it looks at the nature of the transaction itself. Whether money is classified as a gift, a loan, or income can significantly affect its tax treatment.

Understanding these distinctions can help prevent unnecessary tax issues and avoid questions later.

Gift or Income?

For tax purposes, money transfers generally fall into one of two broad categories.

A gift is a transfer made without receiving something of value in return. In most cases, gifts are not taxable to the recipient. Income, on the other hand, represents compensation for work, services, business activity, or other earnings and is generally taxable.

For example, when parents provide financial support to a child, the transfer is typically treated as a gift. However, if someone receives money in exchange for helping a friend with work or providing services, the payment may be considered taxable income.

The important point is that tax treatment is determined by the actual purpose of the transaction, not by what the parties choose to call it.

Common Situations That Create Confusion

In practice, many transactions fall into gray areas.

Common examples include:

• Parents paying a child’s rent
• Friends reimbursing one another for shared expenses
• Informal loans between family members with no written records
• Large one-time transfers for financial support

When these transactions are not clearly documented, they may be interpreted differently if questions arise later.

Real-Life Examples

The same movement of money can have very different tax consequences depending on the circumstances.

For example:

A parent sends a fixed amount of money to a child each month.

• This is generally treated as a gift.

A business owner receives money from an acquaintance.

• If the payment is actually compensation for services, it may be considered taxable income.

Friends split the cost of a vacation and transfer money to one another.

• If the transfers simply reimburse shared expenses, they are generally not taxable.

The context behind a transaction is often more important than the amount itself.

Common Misconceptions About Gift Tax

Many people assume that giving money automatically creates a tax liability. In most cases, that is not true.

Federal law allows individuals to make gifts up to certain annual limits without filing a gift tax return. Even when those limits are exceeded, the result is often a filing requirement rather than an immediate tax payment.

The key point is that filing a gift tax return and owing gift tax are not the same thing.

Why Large Deposits Can Raise Questions

Even when a transfer is not taxable, large deposits can sometimes require explanation.

This is particularly important for:

• Self-employed individuals
• Business owners with significant cash flow
• Accounts with frequent deposits

The IRS may review bank deposits as part of determining whether income has been properly reported. If a deposit represents a gift or a simple transfer, supporting documentation may be needed to demonstrate its nature.

How the IRS Distinguishes Between a Loan and a Gift

Simply saying that money was “loaned” is not always enough.

To support loan treatment, it is helpful to have:

• A written agreement
• A repayment schedule
• A genuine expectation that the funds will be repaid

Without these elements, the IRS may view the transaction as a gift rather than a loan.

Practical Steps That Can Help

Although the rules may seem complicated, a few basic habits can help prevent problems.

When significant amounts of money are transferred, it is helpful to keep a simple record of the purpose. Clearly noting whether the transfer is intended as a gift or a loan can make a meaningful difference later.

Even between family members, maintaining a record through bank transfers is generally preferable to using cash. Cash transactions can be much harder to explain if questions arise.

If funds are intended to be a loan, having a basic written agreement can help establish the intent of the parties. The document does not need to be overly complicated, but it should demonstrate the structure of the arrangement.

Business owners should also keep personal and business funds separate. Using the same account for both can make otherwise innocent transfers appear to be taxable business income.

What Matters Most: Intent and Documentation

The transfer of money itself is usually not the issue. The challenge lies in how the transaction is characterized.

The IRS looks beyond labels and focuses on the actual purpose of the transaction, the surrounding facts, and the supporting documentation.

When intent is clear and records are properly maintained, most transactions can be handled without difficulty. When documentation is missing or inconsistent, even routine transfers can create unnecessary tax questions.

A small amount of organization today can prevent significant issues later.

Why Capital Gains Tax Still Deserves Attention

Because Washington State does not impose a personal income tax, many property owners assume there are no significant state tax considerations when selling real estate. However, the tax picture is often more complex than many people expect. While direct real estate sales are generally excluded from Washington’s Capital Gains Tax, other taxes and reporting considerations may still apply.

Understanding the broader picture, including federal taxes, Washington’s Real Estate Excise Tax (REET), and the structure of the transaction itself, can help avoid unexpected tax consequences.

Washington Capital Gains Tax and Real Estate

Washington’s Capital Gains Tax applies to certain long-term capital gains, but direct sales of real estate are generally excluded from the tax. This exemption applies to most sales of residential property, rental property, commercial real estate, and land when the real property itself is being sold.

However, not all real estate-related transactions receive the same treatment. The tax treatment can vary significantly depending on how the transaction is structured.

For example:

• Selling real estate directly is generally excluded from Washington Capital Gains Tax.
• Selling an ownership interest in an entity that owns real estate may be subject to different tax rules and could create capital gains tax considerations.

This distinction is frequently overlooked but can have a meaningful impact on the overall tax outcome.

Federal Tax Considerations Still Matter

Even when Washington Capital Gains Tax does not apply, federal tax consequences may still be significant.

A real estate sale can potentially trigger:

• Federal capital gains tax based on the appreciation of the property
• Depreciation recapture for rental or business property where depreciation deductions were previously claimed

A primary residence may qualify for certain federal gain exclusions if ownership and use requirements are met. Investment and rental properties, however, are generally subject to federal tax when sold at a gain.

Washington REET (Real Estate Excise Tax)

Separate from Capital Gains Tax, Washington imposes a Real Estate Excise Tax (REET). Unlike capital gains tax, REET is based on the selling price of the property rather than the profit earned from the transaction.

Because REET is based on the sale price rather than profit, it may apply even when the gain on the sale is limited. As a result, REET often represents a significant closing cost and should be considered early in the planning process.

Why Tax Costs May Be Higher Than Expected

Many property owners focus primarily on whether Washington has an income tax and overlook other tax considerations that may apply.

Rental properties are a common example. If depreciation deductions have been claimed over time, a portion of the gain may be subject to depreciation recapture when the property is sold. When REET is combined with federal tax obligations, the overall tax burden may be larger than expected.

Understanding these factors before listing a property can help avoid surprises at closing.

Timing and Structure Still Matter

Even when Washington Capital Gains Tax does not apply, the timing and structure of a transaction remain important planning considerations.

Factors worth reviewing include:

• The timing of the sale relative to other income during the year
• Whether the property is held individually or through an LLC or partnership
• Whether the transaction is structured as a direct property sale or the sale of an ownership interest
• Whether a 1031 exchange may be available

The earlier these factors are evaluated, the more planning opportunities may be available.

Documents to Organize Before a Sale

Preparing documentation in advance can make the tax analysis and reporting process much smoother.

Important records may include:

• Original purchase and closing documents
• Records of capital improvements and major renovations
• Depreciation schedules
• Loan payoff information
• Rental or business-use records

Having these documents readily available can improve the accuracy of tax projections and reduce delays during the transaction process.

What Property Owners Should Remember

Washington Capital Gains Tax generally does not apply to direct real estate sales. However, that does not mean a real estate transaction is entirely free of tax considerations.

Depending on the circumstances, property owners may need to evaluate:

• Federal capital gains tax
• Depreciation recapture
• Washington REET
• Ownership structure and transaction design

Selling real estate is more than a simple transaction. Understanding the tax implications before a sale can help property owners make more informed decisions and avoid unexpected tax consequences.

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Happy Holidays from Alisa Na CPAs and Advisors!

As 2026 approaches, we would like to share several timely reminders for our individual and business clients. The Internal Revenue Service is encouraging taxpayers to take proactive steps now to prepare for filing 2025 federal income tax returns next year. With year-end approaching, there are practical actions you can take to streamline the filing process and avoid last-minute surprises as the 2026 tax season begins.

The One Big Beautiful Bill Act (OBBBA) introduces multiple changes and new provisions that may affect federal taxes, credits, and deductions. Key updates include modifications related to tips, overtime pay, car loan interest, senior taxpayers, and the permanent extension of several provisions that were previously scheduled to expire on December 31, 2025.

Gather and Organize 2025 Tax Documents
To make tax time easier, establish an adequate record-keeping system, either electronic or paper, to organize all essential documents in one place. This includes year-end income forms such as:

• Forms W-2 from employers
• Forms 1099 from banks or other payers
• Forms 1099-K from third-party payment networks
• Forms 1099-NEC for non-employee compensation
• Forms 1099-MISC for miscellaneous income
• Forms 1099-INT for interest income
• Records of all digital asset transactions

Having complete documentation helps ensure an accurate return and can reduce processing delays or refund issues.

IRS Online Account
Individuals can create or access IRS Online Accounts for both individual and business purposes.
IRS Online Account for Individuals
IRS Business Tax Account

With an IRS Online Account, you can:

• View, make, and cancel payments
• Set up or change payment plans and check your balance
• View key details from your most recent tax return, such as adjusted gross income
• Request an Identity Protection PIN
• Obtain account transcripts, including wage and income records
• Sign tax forms such as powers of attorney or tax information authorization

Deadline for Final 2025 Estimated Tax Payment – January 15, 2026
Taxpayers who receive non-wage income—such as self-employment earnings, annuity payments, unemployment compensation, or income from digital assets—may need to make estimated or additional tax payments.

Wage earners can use the IRS Tax Withholding Estimator on IRS.gov to determine whether additional withholding is needed and help avoid an unexpected balance due when filing.

If you make estimated tax payments and qualify for any new deductions, you may want to review whether your final estimated payment should be adjusted. Similarly, wage earners should consider whether their current withholding remains appropriate.

Digital Assets and Taxes in 2025 – Form 1099-DA

The IRS has finalized new cryptocurrency reporting rules beginning with the 2025 tax year. If you buy, sell, or trade crypto through a custodial digital asset broker (such as Coinbase, Kraken, Binance, or a custodial wallet provider), these platforms will be required to report certain taxable transactions to the IRS using Form 1099-DA.
Form 1099-DA will include your information, the digital asset and amount sold, the sale date, and gross proceeds. The first 2025 forms are expected to be issued by March 31, 2026.
Please note: for the 2025 tax year, Form 1099-DA will not include cost basis. You will still need to track and calculate your basis before your return can be filed. Beginning in 2026, brokers will also be required to report cost basis.
Information on how to report digital asset transactions, including calculating capital gain or loss, determining basis, and reporting the income on the correct form, can also be found on the digital assets landing page.

Refund Timing and How to Avoid Delays

Most IRS refunds are issued within 21 days; however, you should not rely on receiving your 2025 federal refund by a specific date. Some returns take longer if the IRS needs to review them for errors, missing information, or possible identity theft or fraud.
Under the PATH Act, the IRS cannot release refunds for returns claiming the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit (ACTC) until mid-February.

IRS Moves Toward All-Electronic Refunds
The IRS has announced it will largely stop issuing paper refund checks, with limited exceptions. Taxpayers will be required to receive refunds electronically.
Filing electronically and selecting direct deposit remains the fastest and safest way to receive your refund. Please provide your tax preparer with updated bank account information to avoid delays.

One Big Beautiful Bill Act (OBBBA):
Key Federal Tax Changes Affecting Individuals

Senior Tax Deduction
For tax years 2025 through 2028, taxpayers age 65 or older may qualify for an additional $6,000 deduction per person, or $12,000 if both spouses qualify. The deduction phases out for income over $75,000 (single) or $150,000 (married filing jointly).

No Tax on Tips
Qualified cash tips received in eligible occupations may be deductible up to $25,000 annually. The deduction phases out for income over $150,000 (single) or $300,000 (married filing jointly).

No Tax on Overtime
Qualified overtime compensation may be deductible up to $12,500 ($25,000 for married filing jointly), subject to the same income phase-out thresholds as tips. This applies to overtime required under the Fair Labor Standards Act that exceeds your regular rate of pay.

Trump Accounts (New Child Savings Accounts)
A new savings account for children, similar to a traditional IRA. Parents may begin contributing on July 4, 2026. For children born between January 1, 2025, and December 31, 2028, the government may provide a one-time $1,000 deposit, provided both the child and parent have valid Social Security numbers.

Car Loan Interest Deduction
Through 2028, you may deduct up to $10,000 of interest on loans for qualifying passenger vehicles purchased after December 31, 2024. The deduction phases out for income over $100,000 (single) or $200,000 (married filing jointly). The vehicle must be new, manufactured primarily for public road use, and final assembly must occur in the United States.

State and Local Tax (SALT) Deduction
The SALT deduction cap increases to $40,000 for 2025 and $40,400 for 2026, with 1% annual increases through 2029, then reverting to $10,000 in 2030. The enhanced deduction phases out for taxpayers with income over $500,000 ($250,000 for married filing separately).

Green Energy Credits
Many residential and vehicle clean energy credits expanded under the Inflation Reduction Act are reduced or eliminated after 2025, including the Clean Vehicle (EV) Credit for purchases after September 30, 2025.

• The Clean Vehicle Credit (EV tax credit) was terminated for purchases after September 30, 2025. Existing credits claimed before the sunset remain valid.
• Credits for residential energy efficiency upgrades, such as heat pumps, windows, and insulation, are reduced or eliminated after 2025.
• The bill blocks future extensions of green credits without separate legislation, so Congress would have to pass a new law to revive these incentives later.

Enhanced Child Tax Credit
The Child Tax Credit increases to $2,200 per qualifying child for 2025 and with inflation adjustments beginning in 2026. The refundable portion is $1,700. Income limits of than $200,000 for a single return & $400,000 if filing a joint return apply, and Under new OBBBA SSN requirements, at least one parent/taxpayer must have a work-eligible SSN (not an ITIN), and the child must also have a SSN.

IRS Gift Tax Exclusion
The annual IRS gift tax exclusion is $19,000 per recipient for both 2025 and 2026. Gifts above this amount must be reported on a federal gift tax return.

Federal Lifetime Gift and Estate Tax
For 2025, the federal lifetime gift, estate, and GST tax exemption amount is $13.99 million per individual. While the 2025 lifetime estate and gift tax exemption remains $13.99 million per person, the One Big Beautiful Bill Act provides relief starting January 1, 2026. The exemption will permanently increase to $15 million per person (indexed for inflation), eliminating the previously scheduled reduction to approximately $7 million. This change provides much greater certainty for long-term estate planning strategies.

Educator Credit
You can deduct up to $300 of unreimbursed classroom expenses if you are an eligible educator. If both spouses are educators and file jointly, they can deduct up to $600 (with each capped at $300).

Estimated Tax Payments
The IRS underpayment and late-payment interest rate for individual taxpayers will be 7% in 2025. Please consider making estimated payments by April 15, even if you request an extension to file your tax return.
Rules to avoid an estimated tax penalty have not changed:

• Pay 100% of prior year tax (or 110% if AGI is over $150,000)
• For the four quarters of 2025, the estimated tax penalty rate is 7%
• If you qualify for new OBBBA deductions, we recommend reviewing whether a 4th quarter federal estimate is still needed

Social Security Updates
Social Security benefits will increase by 2.8% beginning in 2026. Social Security wage base will increase to $184,500 in 2026. For individuals under full retirement age (67), the earned income limit increases to $24,480 in 2026.

IRS Business Mileage Rate
The IRS standard mileage rates are 70 cents per mile for business purposes in 2025.
Standard mileage rates | Internal Revenue Service

Retirement, HSA, and RMD Planning
Maximum Retirement Contributions for 2025
Contribute the maximum allowable amount to retirement accounts such as 401(k)s, IRAs, or SEP IRAs. These contributions can reduce your taxable income and enhance your retirement savings.

• Traditional IRA or Roth IRA: $7,000 ($8,000 if age 50 or older). This limit is unchanged from 2024.
• SIMPLE IRA: $16,500 ($20,000 if age 50 or older).
• 401(k) elective deferrals: $23,500 for individuals under age 50.
• Catch-up contribution for those 50 or older: $7,500 (total $31,000).
• Some age bands (ages 60–63) may have a higher catch-up limit of $11,250 for 401(k) and $5,250 for SIMPLE under SECURE 2.0 provisions.
• SEP IRA: Contributions are limited to the lesser of 25% of compensation or $70,000.

Required Minimum Distributions (RMDs)
Required Minimum Distributions (RMDs) are mandatory, taxable withdrawals from IRAs and retirement plans that generally begin at age 73. The first RMD is due by April 1 of the year after you turn 73, with all future RMDs required by December 31 each year, potentially resulting in two taxable distributions in the first RMD year. For example, if you turned 73 in 2025, your first RMD is due by April 1, 2026, and your second RMD (for 2026) is due by December 31, 2026.

Maximum Health Savings Account (HSA) Contribution Limits for 2025

• Self-only coverage: $4,300.
• Family coverage: $8,550
• Those 55 and older can contribute an additional $1,000 as a catch-up contribution.

2026 Tax Year – Charitable Giving
Beginning in 2026, OBBBA permits non-itemizers to claim an above-the-line deduction for cash contributions to public charities, up to $1,000 for single filers and $2,000 for married filing jointly, without using Schedule A.
Also, if you plan to make charitable contributions, consider donating appreciated assets (such as stocks or real estate) to potentially enhance your tax benefits while avoiding capital gains on the donated property. Be sure to keep thorough documentation for all contributions.

Washington State Tax Updates

Washington Long-Term Capital Gains Tax
Beginning in tax year 2025, Washington’s long-term capital gains tax applies at:

• 7% on the first $1 million of taxable Washington capital gains
• 9.9% (7% + 2.9%) on gains exceeding $1 million

Washington Capital Gains Standard Deduction
The Washington capital gains standard deduction for 2025 is $278,000, up from $270,000 in 2024. This amount is adjusted annually for inflation.

Please contact us in February if you would like to schedule a consultation regarding Washington capital gains planning. For additional details, visit the Washington Department of Revenue website.

These guidelines are intended to support year-end tax planning. Because every financial situation is unique, we recommend scheduling a meeting so we can review your specific circumstances and identify the most effective strategies.

Thank you for trusting us with your financial needs. We look forward to supporting your financial goals in the coming year. Please do not hesitate to reach out with any questions.

Sincerely,
Alisa Na CPAs & Advisors

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The Washington State Legislature has passed Engrossed Substitute Senate Bill (ESSB) 5814, which introduces significant changes to the state’s sales tax laws. These changes, which will take effect on October 1, 2025, are aimed at modernizing the tax code. It is important for all business owners to understand how these new rules may impact their operations.

This article provides a summary of the key changes based on interim guidance from the Washington Department of Revenue.

Digital Automated Services (DAS) and the Definition of a “Retail Sale”

ESSB 5814 broadens the scope of services subject to retail sales tax and the retailing Business and Occupation (B&O) tax. Here are the key takeaways:

• Data Processing is Now a Retail Service: Services such as data processing will now be considered a retail service and will be subject to retail sales tax.
• Expanded Taxation of Digital Services: Previously, certain digital services were exempt from sales tax. This law removes those exemptions. Now, services such as digital advertising, data processing, live-streamed presentations, and services that involve significant human effort are all considered taxable retail sales.
• New Exclusion for Telehealth: A new DAS exclusion has been created for telehealth and telemedicine services.
• Affiliate Sales Exclusion: Certain sales between members of an affiliated group are now excluded from the definition of a retail sale.
• Clarification on Professional Services: The legislature has clarified that professional services will not become taxable simply because they are delivered electronically. The Department of Revenue has provided a framework to distinguish between professional services subject to the service and other B&O tax and taxable DAS.
• Sourcing DAS Sales: The new law outlines a clear hierarchy for determining the location of a DAS sale for tax purposes.

Learn more: https://dor.wa.gov/laws-rules/interim_guidance_statements/interim-guidance-statement-regarding-changes-made-essb-5814-das-exclusions-and-definition-retail

New Tax Treatment for Custom Software

The new law also changes how custom software is taxed. Here’s what you need to know:

• Custom Software as a Retail Sale: The sale of “custom software” and the “customization of prewritten software” will now be considered a retail sale. This means these sales will be subject to both retailing B&O tax and retail sales tax.
• Previous Tax Classification: Previously, these sales were taxed under the service and other activities B&O tax classification.
• Key Definitions:
  • Custom Software: Software created for a single person.
  • Customization of Prewritten Computer Software: An alteration or modification of prewritten software for a specific person.
• Sourcing Custom Software Sales: The sale of custom software is generally taxed based on the location where the purchaser receives the service.
• Multiple Points of Use (MPU) Exemption: Businesses that license custom or customized software for use in multiple states may be eligible for the MPU exemption. This allows the purchaser to apportion and pay use tax directly to the Department of Revenue instead of paying retail sales tax at the time of purchase. However, the MPU exemption is not available for bundled transactions.

Learn More: https://dor.wa.gov/laws-rules/interim_guidance_statements/interim-guidance-statement-regarding-changes-made-essb-5814-custom-software

What This Means for Your Business

The changes introduced by ESSB 5814 are complex and could have a significant impact on your business’s tax obligations. It is crucial to review your sales of services and software to determine how these new rules will affect you.

Please note that the information above is based on interim guidance from the Department of Revenue. The Department will be issuing final guidance in the future.

We encourage you to contact us to discuss your specific situation and ensure you are prepared for these changes when they take effect on October 1, 2025.

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