FEDERAL INCOME TAX LAW ADVICE
PART 5
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I have a national tax advice consulting practice. I charge $150/hour for tax advice, tax research, and problem resolution.
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ANSWER: This client was indeed subject to income taxation at the federal level, in her state of residence, and in the place where she earned her income (D.C.). However, the federal tax return and most, if not all, state income tax returns have lines where the filer can receive a tax credit for taxes paid on that income to another jurisdiction. Because of the tax credit for taxes paid to another jurisdiction, the income would not be taxed twice. However, if NJ's marginal tax rate for this couple was higher than the D.C. tax rate for her income, then she might have to pay some additional tax to NJ.
Concerning the installment payments, every tax authority has set up an office to handle inquiries by people who do not have the funds to pay their taxes in one single payment. Many of the jurisdictions, including the IRS, are very understanding and will work with filers who in good faith are trying to pay off their tax bills. Normally, the tax jurisdiction charge interest on the taxes owed, which reflects the time value of money.
I advised her to change her current W2 designation for the summer of 2007 to reflect full withholding of federal and DC income taxes. Her employer will know the appropriate amount to deduct from her wages. She asked if she would be subject to penalties for not paying taxes on April 15. I advised her that she would likely incur some penalties, but they would not be enormous. I expect the tax authorities would charge about 10% extra as a penalty for failure to pay on time and failure to have the appropriate amount withheld from her income.
Michael A. S. Guth, Ph.D., J.D.
Federal Income Tax Advisor
QUESTION 22: I am 52 years old. I received a $12,000 gift, which I would like to put into an IRA of some sort. I have a SEP-IRA now through my corporation (a C-corp., I am the only employee). Schwab manages my SEP-IRA investment. I would like to place my gift money in the SEP-IRA if possible, but I dont know how to transfer my personal gift money into my corporation to do this. Is there a legitimate way to do this? What would this do to my maximum SEP-IRA contribution for this year?
If I cant do this, I will need to set up another IRA. What type would you recommend in my situation? Would contributions to the SEP-IRA be affected by contributions to the other, or vice versa? Would there perhaps be some global limit on IRA contributions of all types, SEP plus traditional, for this year and in the future?
ANSWER: Under the Internal Revenue Code, people can transfer gifts of money up to $12,000 without owing any income tax by either the donor or the donee (recipient). Therefore, your $12,000 gift income is not taxable, and there is no point in putting non-taxable income into an IRA.
You would not be able to put gift income into any type of IRA or retirement account, because it is not "earned income" or "business income." There are indeed annual limits on how much money can be contributed to IRA accounts. If you are the sole employee of your C corporation, you may want to look into establishing a Keogh account for your retirement. Keogh accounts offer higher annual contribution limits, but the IRS requires that a Keogh account holder have no other retirement accounts -- so you would have to rollover your SEP-IRA into the Keogh account or otherwise discontinue funding the SEP-IRA once you establish the Keogh account.
As a general rule, whenever you receive income, you can't simply establish a retirement account, put the money in the account, and avoid paying taxes on it. All of the retirement accounts are set up with maximums that are sometimes a dollar limit, such as $6,000 on SIMPLE accounts -- something I use as an unincorporated business -- to 15% of income for other types of accounts. The retirement accounts are meant to put a comparatively small portion of income aside for tax-free earnings on investment. None of the retirement accounts approved by the IRS enable plan participants to shield major portions of their business income or wage income from taxation.
Michael A. S. Guth, Ph.D., J.D. Federal Income Tax Advisor
QUESTION 23: The client used a CPA to prepare her joint tax returns with her husband. For the 2005 return filed in April 2006, the CPA accidentally wrote the federal tax withholding on her husband's paycheck was $7,010 instead of $710. As a result, the couple received a big windfall refund of about $6,000, which they spent. The client trusted the CPA and never was shown the actual return submitted. When they received a larger than expected refund, they assumed because she had returned to school that the CPA found a way for them to save on taxes. The client calls with two questions (1) will she be responsible for paying all the $6,000 back -- money that she and her husband do not have, and (2) should she sue the CPA?
ANSWER: The client had a legal responsibility to review the return submitted on her behalf by the CPA. The adage "ignorance of the law is no excuse" could be applied to this situation as "ignorance of the tax return submitted on your behalf is no excuse." To the extent that the client and her husband were not entitled to a $6,000 refund, they essentially borrowed that money from the U.S. government, and the IRS now wants that money back with interest. It would be difficult to prosecute a cause of action that states the CPA should have to pay for money loaned to the couple by the IRS. Instead, I recommended that she send a certified letter to the CPA indicating the CPA was negligent in stating the wrong amount of the couple's tax withholding. As a result of that negligence, the couple now owe the IRS interest on the $6,000 refund. She could argue that she and her husband would not have that interest liability "but for" the careless error of the CPA. I feel certain the CPA will raise the defense that she reviewed the return numbers with the client, but they will dispute that. If the CPA refuses to settle the case, then I advised the client that the costs of litigating (where the CPA lives in another state and they would have to fly down there for hearings) would outweigh the damages they are likely to get from the court.
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