Thursday, February 21, 2013

Adventures in Taxland, Part III

I recently had a client who had received a letter from the IRS regarding her 2011 tax return. The gist of the letter was that the IRS had received information that the person associated with social security number xxx-xx-xxxx, claimed as a dependent on my client’s return, had earned more than $3700 in 2011. Exceeding that income threshold had made the person ineligible to be claimed as a dependent. The letter asked the client to verify whether this was true of not. If true, she would have to amend her 2011 return.


Me: “Who did you claim as a dependent?”
Client: “My brother. He must have had a job I didn’t know about for a few months.”
Me: “Why don’t you ask him?”
Client: “He’s in prison. He wouldn’t know how much he made before he went in.”
Me: When did he go to prison?”
Client: “I’m not real sure. It was early in 2011. He would have only worked a couple of months before he went in.”
Me: “So your brother was in prison for most of 2011, but you still claimed him as a dependent? Maybe he was working in the prison laundry, or was stamping out license plates. Those guys get paid something for that, even if it is prison wages.”
Client: “After I paid for all those collect calls, and bought him all that stuff he asked for, I figured I needed to get something back for all the money I spent. If he was working, he should have bought his own stuff.”
Me: “Let’s get started amending your return. You’ll have to pay back part of your refund from 2011. I’ll print out a payment voucher you can use to send with the money.”

After I finished amending the client’s 2011 return, I started thinking about prison wages, so I looked it up. In my state, prison wages run from $.17 to a little over $.50 an hour, depending on the type of work. You can’t get up to $3700 in annual earnings at those rates. So unless the brother worked a lot of hours before he got sent away, he wasn’t the person working for those wages.

It occurred to me that my client’s brother could have been the victim of identity theft. His social security number could have been sold to an illegal immigrant, who was using it to hold down a job. Until he gets out, he would have no way of knowing, nor would the Social Security Administration, because only one person would be working under that number. He is actually benefitting, because whoever is using his social security number is building up credits for him to use in retirement (assuming he eventually gets out).

It further occurs to me that such a scheme could be run on a large scale, providing a funding source for organized crime. On the macro level, I wonder what a cross check of prisoners with social security payers would reveal.

On the micro level, I wouldn’t want to go back to the IRS and claim that the earnings reported couldn’t be associated with my brother, because he was in jail the whole time. They would probably take a dim view of that explanation. So identity theft or no, I’m glad we amended the client’s return for 2011.

When we did her return for 2012, she filed as single, no dependents.

Tuesday, February 19, 2013

Adventures in Taxland, Part II

I have done the taxes for a couple of people who cashed in their retirement plans so far this year. Let me tell you, from a tax perspective it is a really bad idea.


I had a client this weekend who pulled all the money out of her 401K plan. First of all, the IRS considers 100% of that to be current income. The real whammy, however, comes from the 10% penalty tax. This penalty is applied even if you have no taxable income.

For example, let’s say you are a single parent of two kids with $9000 of earned income, combined with closing out a 401K worth another $9000. With a Head of Household standard deduction and three personal exemptions, your taxable income is reduced to $0. You get all your withholding back, plus Earned Income Credit, plus Additional Child Tax Credit. But the penalty tax of $900 is applied anyway, reducing your refund by that amount.

For this weekend’s client she got the double whammy. She cleaned out her 401K, and thought she had protected herself by withholding 20% of the money. But there was enough money in the 401K account to double her income for the year. What that increase did was push her into a higher tax bracket. She was in the 25% bracket for almost all of the retirement money. So instead of withholding 20%, she should have withheld 35%.

Let’s add up the damage:
• She had to pay in an additional $1100 to the IRS due to the unplanned tax liability.
• A third of her money was lost before it ever hit her bank account.
• And the real kicker: she doesn’t have a retirement fund anymore.

For low income individuals, the temptation to tap into the pot of money represented by a retirement account is pretty strong. But the results of giving in to that urge are never pretty.

Monday, February 11, 2013

Adventures in Taxland, Part I

Tax season is in full swing. I enjoy doing taxes. Only working nights and weekends, it is difficult to make much money, but the puzzle solving aspect appeals to me. And you get great stories out of it.


Last week I had a client come in whose primary source of income was Social Security disability payments. He lived off about $20,000 a year of tax free income. He also had a small pension from a previous employer.

For reasons that the client was not able to articulate, the client had not been drawing on the pension. When he turned 60, he took a large distribution from the pension, a little over $27,000. But he only had $250 in withholding taken out of the payment. The rest was deposited into his checking account. He knew that the distribution was taxable income, so the client came into the tax office.

The pension distribution was not marked as a lump sum payment, so I don’t know the specifics of payout. The client was a little vague on when he had received the cash. Maybe June, maybe July.

Because of the pension distribution, the client owed about $3000 in taxes for 2012. This included a penalty for failure to pay sufficient withholding. Clients are never too pleased when they learn they owe the IRS money, and this gentleman was no exception. For my part, I was starting to worry about how he was going to pay for the tax prep fees. But it turned out he had brought in enough cash to pay the bill.

When I printed out the payment voucher to send in along with his payments, the client told me he was going to have to set up a payment schedule with the IRS. I was surprised. “I hate it for you that you’re going to have to write that big check, but you must have the money in your checking account, right? You knew this day was coming.”

He looked at me like I was his idiot nephew. “I don’t have any money in my checking account. That money done been spent.”

This guy had received a chunk of money into his account that exceeded his normal annual income, and six months later it was gone.

I took the cash he had brought to pay his tax prep fees, gave him his return, with payment voucher, and wished him well. When he left, he was on his cell phone to his girlfriend, finding out what the monthly amount was on her payment agreement.

Now I have more insight into those stories about lottery winners who run through all the money in just a couple of years. The character of some people is just put together in a way that they will never build any wealth.

Friday, February 1, 2013

Billionaire Boy's Club

An extraordinary conversation took place on air at CNBC earlier this week. Carl Icahn, billionaire investor and financier, and billionaire hedge fund manager Bill Ackman of Pershing Square Capital, phoned in to a live show being aired from the floor of the New York Stock Exchange.


Ackerman makes his money, among other things, by short selling stocks. This is the practice of placing large bets that a company’s stock price is going to drop. Short selling is one of the ways that capital markets self correct. If the price of a stock becomes irrationally high, short sellers begin to emerge, hoping to make money when the rest of the market realizes they have overbid a particular company. If you think that a company is overvalued, and you have bet that the price is going to fall, you should tell people that, by way of getting the ball rolling. That is what Ackman is doing, making presentations to investors about why he thinks a company called Herbalife is a “pyramid scheme.”

Ackman was calling into CNBC, when Icahn joined the conversation. Icahn thinks Ackman is wrong about Herbalife, and impugns Ackman’s ethics, integrity, business judgment, and manhood. He also shouts down the moderator about ten minutes into the segment. The on air moderator asks Icahn if he owns shares in Herbalife, if Icahn is “long” on the stock. If Icahn owns shares, he does not want to see the stock price drop. Instead of answering a direct question, Icahn claims the moderator is “bullying” him, and threatens to never go back on air at CNBC in the future.

Frankly, Ackman comes across as pretty calm and reasonable. He may be completely blowing smoke about Herbalife, but he lays out his positions without getting personal and calling names.

Icahn, on the other hand, comes across as a piece of crap. He acts like if you can keep the other guy from talking, you automatically win the argument. He may be an amazing investor, and he has made billions of dollars, but based on this segment, Carl Icahn is a pretty miserable human being. 

You can watch the exchange here.