Q:

Subject: Question for the blog site

 

How does anyone find time to do this stuff? Anyway I’ll try out a question on you.

On 31 Dec 05, I was terminated from my position at a major telecommunications company. I was given a severance package that provided me to be paid at my old salary for approximately 10 months this year, payable bi-weekly as normal. This allowed me to get involved with a startup company I had always wanted to try  – at zero salary for at least the next several months.

Since my former employer is no longer taking out my 401K deduction, my life insurance deduction, my flex pay deduction etc, I was anticipating a larger cash flow from my severance check. On receiving my first severance paycheck, I found to my dismay that my old HR department was now taking out THREE times as much for Federal income tax. The explanation from the company was that the IRS requires this since they assume I have another new job that pays similar in addition to the severance! This will cost me cash flow of approximately $12,000 this year until I can get a refund in ’07.

This sounds pretty fishy to me though I wouldn’t put it pass the IRS. Do you have any knowledge of such a requirement or is this perhaps an example of a corporation bureaucracy ineptitude instead of government bureaucracy ineptitude?

Thanks for any info.

A:

That is just one method of calculating withholding on out of the ordinary payroll checks.  

Depending on how your relationship is with the payroll department, there is a lot of flexibility in how the withholdings are calculated.

I have seen cases where the former employee submits a written request to the former employer stating that he is aware of his tax situation and is making a formal request that the taxes either be taken out based on the standard withholding table at a certain number of W-4 exemptions, or at a certain specified percentage.  You should work with your personal tax advisor to figure what would be appropriate for your situation.

It really shouldn’t matter to the former employer how much money is taken out for income taxes because any shortfall will be your responsibility when you file your 1040

Good luck.

Kerry Kerstetter

Follow-Up:

Much obliged Kerry…thanks very much for the reply…didn’t really expect one ….I would think you would get tons of mail after the WSJ mention.

All the best man.

 

Q:

Subject: false choice

It seems like every year I’m faced with a false choice: fill out my own taxes with the help of tax software like TurboTax or work with a professional.

This isn’t CPA bashing. $200/hr to fill out forms seems pretty steep, but I would pay double that for advice that really saved me money. I would vastly prefer to work with a tax accountant who adds value by improving my tax return.

So is there a way to work with a CPA in combination with a package like TurboTax?

A:

You’re exactly right, and that is precisely what I tell other tax pros who are worried about TurboTax and other DIY tax software costing them a loss in business.  It is a waste of time to pay someone to just fill in tax forms without adding any of their knowledge and expertise, when you can just use TurboTax to do that.

As I’ve also said on several occasions, I have had some clients use TurboTax instead of my normal organizer as a means of sending me their year-end data. When I am finished, the final returns usually bear little resemblance to the original TurboTax version because I move things around and fine tune the return to be both legally correct, as well as coming up with the lowest tax possible.

If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you.

Good luck.

Kerry Kerstetter

 

Q-1:

Subject: Question about contributions to an IRA

 

My question has to do with the contribution to a spousal contribution.  Here is the background.  My spouse does not work, and every year I have been making a  contribution to her IRA because my salary was under the limit.  I took that amount as a reduction to my AGI.  In March 2005, I made a contribution to her IRA. I now may have a problem for the tax year 2005. 

 

  Last year (2005), I got laid off from my work in August.  When this happened, I took a large part of my pension, and this caused our taxable income to go to $164K.  My question is whether I can take the contribution to my spouse’s IRA as an adjustment to my taxable income on line 32 of Form 1040.  I think I can. I am basing this on the fact that I was still unemployed at year end, and so neither my spouse nor I was covered by an employer retirement plan from August through December, and I thought the rule was that I can  take a total deduction for the contribution as long as I nor my wife had an employer retirement plan for any part of the year. Am I correct, or does my income level this year mean that I have to treat the contribution as a non deductible IRA contribution?.

 

  Thanks for your help.

A-1:

Unfortunately, your interpretation of the rules regarding being a participant in an employer sponsored retirement plan is completely opposite from the way the IRS and the courts interpret it.  If you or your spouse were covered for even one single day during the year, the elimination of the IRA deduction for evil rich people applies to you. 

I have always hated this rule, especially when it applies to people who are unwilling participants in company plans from which they will never receive much of any actual retirement benefits.

You should be working with a professional tax advisor, who may be able to help you get your AGI below the magic $150,000 level where the evil rich penalty is assessed.  For example, a loss from a side Schedule C business would help move your AGI in the right direction.

Otherwise, as you noted, you are limited to the nondeductible IRA since the Roth IRA has the same penalty on evil rich people.

Sorry to be the bearer of bad news.  It is very unfair; but that is how our tax code is set up.

Good luck.

Kerry Kerstetter

Q-2:

Dear Kerry,

 

     Thank you so much for this answer.  As a follow up question if I may, I want to know how to report the withdrawal from my employer’s 401K plan that I had to take when I got laid off.  Do I report it as “pension and annuity income” on line 16 on the 1040, or do I report it as an IRA withdrawal  I don’t think it is an IRA withdrawal, because I think a 401K plan is not a traditional IRA, so I was going to put it on line 16.  Am I correct?

 

      I want you to know that I enjoy your blog site.  It is one of the best that I have ever seen. 

 

     By the way, I totally agree with your comments in the attached e-mail.

 

     Have a wonderful day.

A-2:

A 401k is different than an IRA; so it is reported on Line 16 of the 1040.  Put the full amount in Box 16a and the portion that you didn’t roll over into an IRA or other retirement plan in Box 16b.

You didn’t say how old you are,  If you are under 59.5 years old, you will also need to include the taxable 401k withdrawal on Form 5329 (as well as state equivalent) to compute the early withdrawal penalty, which will then go on Line 60 on Page 2 of your 1040.

Again, it would be wise to work with a tax pro, who may be able to help you reduce the taxes and penalties.

Good luck.

Kerry