Showing posts with label Clients. Show all posts
Showing posts with label Clients. Show all posts

Wednesday, May 22, 2013


Here are two instances from the recent tax-filing season that concern excess withdrawals from an IRA and the tax consequences, federal and state (NJ), thereof.

Both taxpayers are retired and over age 70½, so they are receiving annual RMDs (Required Minimum Distribution) from their traditional IRA investments.

Client A is a widow with income from Social Security, her IRA, a state pension, and interest, dividends and capital gains.

Client B, who is married, has income from Social Security, his IRA, a small corporate pension, taxable interest, dividends and capital gains, and a large investment in tax-exempt municipal bonds that generate substantial supposedly tax-free income.

Normally Client A would take the RMDs from her various IRA accounts, and Client B would take a distribution of the earnings from his IRA investments, which was slightly more than his RMD.

In 2013 both had investments in their traditional IRA come due - a CD for Client A and a corporate bond for Client B - resulting in excessive cash in the IRA.  Both took significant cash withdrawals from their traditional IRAs that were in excess of their RMDs for specific reasons.  For Client A the excess amount was $43,000+ and for Client B the excess amount was $35,900.

Here is what I explained to Client A –

Oi vey!

The $43,413.00 extra IRA withdrawal increased your AGI, so it decreased the amount of your medical and miscellaneous expense deductions. The $43,413.00 added $47,547.00 to your net taxable income.

Plus it pushed you well into the 25% tax bracket, and caused your long-term capital gains and qualified dividends to be taxed at 15%. Without this additional income they would have been taxed at 0%.

It cost $12,164.00 in additional federal taxes, but only $4,341.00 (10%) was withheld - leaving a shortage of $7,823.00.

It also reduced the amount of medical expenses I could deduct on the NJ return - the $43,413.00 added $44,281.00 to your net NJ taxable income. It cost $1,121.00 in NJ state income taxes, and nothing was withheld for NJ.

So the total tax cost of this withdrawal was $13,285.00 - or about 31%.”

But there was more –

“Plus it kicked your actual gross income to over $100,000 – much more than the $80,000 income threshold to qualify for the Property Tax Reimbursement (PTR) {A special NJ state program that reimburses seniors and the disabled each year for the increase in property taxes – rdf} for 2012 AND 2013 (you need two consecutive years of under $80,000 to qualify). You will not get a PTR check for 2012 or 2013.”

So the actual cost of the excess IRA withdrawal was increased by over $1,000.

Client B’s additional IRA withdrawal also reduced his deductible medical expenses – so the additional taxable income went from $35,900 to approximately $38,600.  In the past he did not have to worry about the dreaded Alternative Minimum Tax, so his portfolio included a substantial amount of interest from “private activity bonds”.  As a result, the increased IRA withdrawal caused B to become a victim of AMT.  The bottom line was about $6,300 more in federal income tax. 

Luckily Client B lives in a state that does not have an income tax.

Because neither client had a “tax basis” in their IRA investments the amount of the IRA withdrawals were fully taxable as ordinary income.

Neither A nor B had to take the money from their traditional IRA accounts.  Both could have come up with the same amount of cash by selling available current investments – mutual fund shares for Client A and tax-exempt bonds for Client B.  At most there could have been a capital gain on the sale – which would have been taxed at the 0% rate on the federal level.

Both taxpayers were already being taxed on the full 85% of their Social Security benefits.  But for those who are not - for each additional unnecessary $1,000 IRA withdrawal they could be taxed on $1,850, making an unnecessary IRA withdrawal even more costly.

Obviously neither A nor B consulted me before taking the additional IRA withdrawals.

What can we learn from the experience of these two clients? 

For one, do not take money in excess of your RMD out of an IRA when you have an alternate source in “current” investments.

And, of course, do not take a substantial excess withdrawal from your IRA without first talking to your tax professional.  If A or B had called me before withdrawing the money I could have worked up a projection and showed them just how much the IRA withdrawal would cost.


Friday, June 3, 2011


(1) The biggest time waster during this past tax season was spending time staring at a frozen computer screen. My GDMFPOS computer was FSAM on occasion – wasting valuable time. As you know I do not use tax preparation software to prepare federal returns, but I do submit NJ returns online when possible and use the computer extensively during the season for research and word processing.

The second biggest time waster was trying to determine whether purchases of new windows, doors, water heaters, boilers and furnaces by clients qualified for an energy credit (is seems more so for 2010 returns than for 2009 returns).

While I instructed my clients to send me the Manufacturer’s Certification for all energy-efficient purchases, which verifies qualification for the credit, few actually did. For the most part I was given a copy of a bill or receipt for a potential energy-efficient item, or a note stating “I purchased a new hot water heater for $800.00”.

I then had to email the client and ask if they had a Manufacturer’s Certification, and, if not, explain the specific qualifications and ask if the item met these qualifications (a certain statutory minimum measure of energy efficiency), When the reply said they did not have a Certification and they did not know if the item met the specifications I would then have to ask for the make and model number of the product and, upon receipt, search through online listings to see if I could find a match.

This will not happen during next year’s tax season, when a limited energy credit is still available (as I discussed yesterday). If I am told “I bought a new hot water heater for $800.00” I will reply “Isn’t that special”.

If clients want to claim an energy credit on their 2011 federal return they will have to either send me a Manufacturer’s Certification Statement or verify by some other method that the item qualifies for the credit.

As I suggested in yesterday’s post, if a client has purchased what he/she thinks may qualify for the credit, but was not given a Manufacturer’s Certification Statement at the point of purchase, they should, before sending me their stuff, go back to the salesman and ask for one, or go the website of the item’s manufacturer and download a statement.

Clients can also go to the Energy Star website to find out what the specific qualifications are for individual items and compare these specifications to those identified in any manuals or paperwork received with the item. Those who do not have easy access to a computer can email me during 2011 and I will provide them with the required specifications.

I will not waste any of my time during the tax season trying to determine if the item qualifies.

Here is another great example of a tax credit that, while the main purpose of which is legitimate, has no business being in the Tax Code and only increases a tax preparer’s workload.

The credit for qualifying energy-efficient products should be given as a direct discount at the point of purchase – much like the Cash for Clunkers program of a few years back.

(2) While I provide most clients a Medical Expense Worksheet in my annual January mailing, telling them to fill it out themselves, I still receive from some a pile of medical bills, receipts and statements, as I did from one whose GD extension I just completed.

I tell clients not to send me their medical bills – and try to discourage them by saying I will charge $50.00 per hour for my time to sort through these bills – but some still do not listen.

Much of what I receive, as was the case with this client, is Blue Cross+Blue Shield, Medicare, or other insurance statements. For my purposes these statements are like tits on a bull – totally useless. They tell what the insurance provider has paid, but not what the client has actually paid during the year. What they often say is “you may be asked to pay” a certain amount – the amount not covered by insurance – but this is not always the case. Many medical providers will accept as payment in full what is given to them by the insurance company.

Next tax season if I receive a pile of medical bills, receipts and statements from a client I will promptly mail the pile back with another copy of my Medical Expense Worksheet.

Thank you for letting me vent!


Monday, June 7, 2010


OOPS! I forgot to include an obvious but important point in my response to the email from MK –

In order to build a list of loyal 1040 clients from referrals you must know what you are doing and do it right.

You must be more than just competent in the preparation of individual tax returns, and you must keep up-to-date by taking more than a token number of federal and state continuing education classes and taking advantage of the many online tax news resources. Join the National Association of Tax Professionals (and if you do, use me as your referral).

You must show interest in and concern for your client’s tax and financial situation. Don’t simply be a data entry clerk, typing the information provided by the client into a computer program and accepting what is spit out. Dig for legitimate deductions and credits and make sure your clients take full advantage of all that is available to them in the Tax Code and state tax law.

You must act honestly and ethically with your client and with the IRS and appropriate state agencies.

As a companion to HOW I GOT MY CLIENTS I suggest you also read my post DEAR GRADUATE.

Ok, that should cover it.


Here is an email I received from a fellow tax preparing Twit and TWTP reader:

I enjoy reading your blog, and just read your post about Twitter. I follow you on Twitter, and other tax professionals, as well as family, but I don't think I will get clients from it. I agree that Facebook would not bring me clients either.

But what do you recommend for someone who is just starting out? I don't have any of the clients from my former firm, because those clients belong to the firm. I believe I provided good service to them, but they won't recommend me personally - they'd recommend the firm.

Do you have any advice on how someone starting a practice gets those first clients, who would then refer others?

I am not a CPA yet. I've passed REG and FAR, and taken AUD but don't know if I passed yet. I've had 5 seasons of tax experience with firms.

Thank you for your advice,


Glad you enjoy TWTP.

I may not be the best person to ask how to build a practice – as the bottom of my shoes are sticky and smelly. But I will tell you what has worked for me over the years. I will be talking about building a tax preparation practice, and not an accounting one.

In my 38+ years in “the business” I have never taken out an ad – other than a “business card ad” in a charity journal. I do believe that clients who look to the yellow pages and print advertisements to find a tax preparer are “shopping” and are more driven by price rather than quality of preparation. These will not be loyal clients, and will probably leave the herd when they find a better deal.

As I have said many times before the best source of clients is referral from existing ones. While I have gotten a few “clunkers” this way, for the most part referrals from satisfied clients usually become good and loyal clients who will themselves provide good referrals.

Think of the tv ad of a few years back where “you tell two friends, and they tell two friends, and they tell two friends . . .”.

Initial referrals often come within a specific field, industry, trade or profession. So it pays to be proficient in particular types of client returns. Learn the unique deductions and loopholes available to specific professions.

Many years ago, on an escorted cross-country train trip, I met a young fireman from Newark who was just starting out in his career. I did his taxes and he was pleased. He then sent me many of the other young firemen in his company, who in turn followed suit.

But I did not get only firemen. The members of the Newark Fire Department also sent me friends and neighbors who were policemen and public works employees, and if a wife happened to be a teacher I would get referrals of other teachers.

And I also eventually “did” the parents and siblings of many of the firemen, policemen, teachers, etc.

I sat down one day and did a “tree” of client referrals, listing the various branches that “grew” from the initial Newark fireman. I turned out that almost half of my clients at the time had come either directly or indirectly from that traveling fireman.

Similarly, also many, many years ago, I did the tax return of a casual high school friend who was ordained as a Lutheran minister and was assigned a “parish” in our home town. As a result I added other Lutheran ministers in the “diocese” (not, I am sure, the correct term) to my list of clients. It seemed that when a new minister was assigned to a church in the county my business card was among the items that he was given.

I still prepare the returns for that initial fireman, and that initial Lutheran minister (who is now in Maryland).
As soon as you are introduced to someone and you tell them that you prepare tax returns for a living you are bound to be asked for free advice. While you shouldn't "give away the store" you should not hesitate to provide basic answers. Seem interested in their situation and add something like, "I really can't properly answer that question without knowing more about your specific situation {which in most cases is actually true}. Why not stop in the office sometime and we can discuss this further?"
{As an aside, when I met Elliot Gould's aunt and uncle on a cruise to Alaska and told them I was a tax accountant the response was in effect, "Those damned accountants stole Elliot's money!"}
Back in the 1980s I taught courses in tax planning and tax return preparation in the evening at various Adult Schools near where I lived. Many Boards of Education will offer classes and workshops for adults in a wide variety of topics in the evening held in actual school classrooms.

My courses were not for individuals who wanted to prepare tax returns professionally, but for average middle class taxpayers who wanted to learn how to pay the absolute least amount of tax possible on their own individual 1040s. I had various models – a one session overview, a 2-3 session review of year-round tax planning techniques, and a multi-session in depth line-by-line review of the Form 1040 and Schedule A.

The pay was not great – a modest per hour or per student stipend – but the reason was not to make money as a teacher but to “spread the word” of my abilities as a tax professional.

A large percentage of my students also became clients, some who have been with me for 25+ years now.

When I first started out I had a “regular” 9-5 W-2 job - as the business manager and accountant for a suburban YWCA branch - and, during the tax season, worked for my mentor Jim Gill on week-ends. I began my own little 1040 practice by making house calls and doing “kitchen table” tax preparation, initially for co-workers from my 9-5 job. I then began teaching, as discussed above, and making house calls to my students. By the time I met the fireman I was sharing an office with a fellow accountant.

After my tenure with the YWCA I worked briefly, as a “para-professional”, for one of the then “big-eight” CPA firms – Deloitte Haskins + Sells, becoming my department’s resident tax expert. I was able to go totally on my own through contacts made during my year at DH+S. When I left I did actually take a few of my small business clients, who did not need a CPA, with me.

My mentor’s office was a storefront, initially steps from “Journal Square” in Jersey City (where the Jersey Bounce started), the city’s transportation hub (we later moved to another storefront steps from the County Courthouse and Administration Building). Because of our locations, and being a storefront, we had a steady source of walk-in clients – some of whom stayed for only a year or two (often thankfully) and some who are still with me today.

I was able to limit my practice to tax-season 1040 preparation (except for a very few select long-time year-round business clients) when my mentor (with whom I had worked for at least 25 years at the time), having turned age 75, said to me, “I’m tired of doing this. You can have the practice.”

While I no longer seek new 1040 business, because of my profile as a tax blogger I often receive emails from taxpayers asking me to take them on as clients. I am thankful but decline. Writing a tax blog, with correct advice and information, is a good way of "spreading the word" about your ability and soliciting clients.

I hope my little walk down memory lane has been helpful.


Saturday, January 24, 2009


Kay Bell brings the Wandering Tax Pro and the taxguy together again in her post “Are You a Good or Bad Tax Client?” at DON’T MESS WITH TAXES.

Kay starts off the post by telling us – “There are lots of stories each tax season about how taxpayers can find a reputable, qualified tax preparer. . . But there's a flip side to this coin. How do tax professionals find good clients?
The post goes on to list a handful of the gripes we tax professionals (taxguy and I, some fellow twits we all share) have about how some of our clients behave. Believe me, Kay only scratches the surface.
She does make some good points. For example, “if you and I were better clients, we'd not only make our tax advisors' jobs easier, we'd likely end up with a better tax result”.

Her bottom line is also something all clients should take to heart – “A little bit of planning and preparation on your part will enable your tax pro to do a better, and bigger tax-saving, job for you”.

Check out the post when you get a chance!

Friday, December 19, 2008


Here is an update on my post “Converting to a Roth IRA for 2008” from last Friday, in which I dealt with a retired client’s question about converting from a traditional IRA to a ROTH.

I received this email reply from the client-

After reading your response I decided to visit the IRS web site and some others to try to learn more about converting, especially as it applies to an already retired person, and to find out if there is a worksheet to play around with. Boy, I'm sorry I did. I just got more confused than before. I couldn't find anything that pertains to a retired person wanting to convert nor any kind of worksheet to use.

I'm not sure just how much of my IRA's I would like to convert in January, let's say approximately $ 20K. How much would my liability be?

If converting is going to cost the same or nearly the same as leaving it as a Traditional IRA, then I wonder if I'm better off not doing anything. At this point I don't know because I have no way of evaluating the two

He also touched on the issue of the “0%” capital gains tax rate.

Now I remember where I read about the 0% tax on capital gains. It was in YOUR client update newsletter!!! Anyway, perhaps I can look to doing something in the New Year if my AGI and deductions will be such that I can. If I could sell my (XXX shares of XYZ) with no capital gains tax and roll the proceeds into more shares of (ABC), whose dividend yield is much better, then I could greatly increase my annual dividend payout.”

Here is my reply to the client -

It is indeed a confusing subject. Taxes in general are confusing.

The benefit of a ROTH account comes from the tax free accrual of earnings over an extended period of time.

The ROTH is best suited for the taxpayer just starting out in the workforce. Over his/her working life he/she can accumulate $500,000 and upwards in a tax free ROTH retirement account - whether from an IRA or 401(k) (assuming, of course, that Congress doesn’t change things in the future).

Even the middle-aged worker will benefit from ROTH tax-free accrual because of the period of time involved before retirement.

The ROTH option is not usually considered for a retiree because of the lack of continued contributions and the possible limited period of time involved. That is why you could not find much info on the situation in your online search.

Why it is even thought of for a retiree today is because the economic mucking fess has substantially reduced the value of current taxable retirement accounts and short-term future growth is anticipated to be at an accelerated rate as the economy “recovers”.

Partial conversion would also reduce the amount of future required minimum distributions from traditional IRA accounts. This would not be a benefit if you were to receive annual distributions in excess of the statutory minimum from the tables due to cash flow needs (for example your required minimum distribution based on asset value was $20,000 but you withdrew $25,000 annually).

If you were to convert $20,000 of your traditional IRA to a ROTH account you would pay tax now on $20,000, with a minor adjustment for tax basis consideration (recovery of non-deductible contributions), but that $20,000 could grow to $40,000 or more over time and you, and future beneficiaries, would get a net benefit of $20,000+ in totally tax free income.

The problem with conversion is that it increases your Adjusted Gross Income (AGI) – and anything that increases AGI could reduce deductions and credits and increase taxable income elsewhere.

If you would not already be taxed on the maximum 85% of Social Security the conversion would increase your taxable benefits. It would reduce any potential itemized deduction for medical expenses by $1,500 ($20,000 x 7.5%). It would reduce any portion of qualified dividends and long-term capital gains that would be subject to the 0% tax rate (or if repealed 5%), resulting in a 15%, or at least 10%, additional tax on such income – or up to $3,000 in tax on the $20,000 example.

Just as a ROTH conversion would increase your AGI so would capital gains generated to take advantage of the 0% tax rate. While the gains themselves are taxed separately at 0% or 15%, by increasing AGI the amount of the gains could increase taxable Social Security and reduce medical deductions.

Perhaps a ROTH conversion, even a partial one, is not wise, even at this time. The sale of appreciated current assets to take advantage of the 0% tax rate and reinvesting the proceeds in an investment that will generate higher dividends is a good idea. But because of the already higher AGI for 2008 this should be done in 2009.

Before doing anything we would need to review your anticipated AGI, deductions and taxable income for 2009 to see how much capital gain and qualified dividend income would be available for the 0% rate.

I realize your head must be spinning with this “stuff”.


Friday, November 14, 2008


A while back I blogged here at TWTP on my “wish list” for changes to the federal income Tax Code.

Here is a “wish list” for my clients – things I wish they would all do:

(1) I wish that when a client receives a letter or notice from the Internal Revenue Service, or a state tax authority, about a tax return they would put it in the mail to me, fax it to me, or include it as a “pdf” format attachment in an email to me IMMEDIATELY.

I still have some clients who insist on trying to call me first to tell me that they got a notice from the IRS. This is a total waste of time. My telephone answering machine is turned off during the “regular” year – it is only on during the tax filing season (January 15 to April 15).

And what would happen if they did manage to reach me by telephone? They would tell me that they got a notice from the IRS or the NJ Division of Taxation or whoever and I would tell them to mail, fax or email it to me!

Here is an example. A client tried repeatedly to call me with no success. So he told his mother to try to call me, which she did for a week or so, again without success. The mother mailed me a note saying that her son was trying to get in touch with me. I mailed a note to the son, along with a self-addressed envelope, telling him to mail me the notice.

The notice, which was from the NJ Division of Taxation, was dated October 1st. I received the notice in the mail from the client, finally, on November 10th. Look at how much time was wasted!

(2) I wish clients would keep track of the cost basis of all their investments and give the information to me at tax time when they have sold investments.

Or at the very least tell - not ask – their brokers to provide them with – or send directly to me - a detailed Profit and Loss Statement showing dates of purchase and cost basis for every investment sold during the tax year.

Some clients do it right. They set up a file folder for each investment at purchase and put the original purchase confirmation in the file.
If dividends are reinvested they put the annual DRP statements in the file each year. If the investment spins-off or merges or whatever they put any related correspondence, notices and statements in the file.

If they purchase real estate they put the Closing/Settlement Statement in the file along with any receipts for expenses involved in the purchase that were not paid through the closing. They also place any receipts for capital improvements in the file each year.

If they receive an investment (including real estate) by gift they ask the giver to provide them with the cost basis of the investment gifted. If they inherit an investment (including real estate) they ask the Executor of the estate to provide them with the market value or appraised value on the date of death that was used in filing the federal estate, if required, and/or state inheritance tax return or filing.

When the investment is sold they put the sale confirmation, or Closing Statement, in the file and give me the file folder with their tax “stuff”.

To be honest, I would prefer a complete and accurate Profit and Loss Statement from the broker, to save me the time of actually determining the gain or loss on each investment. However, the individual file folder system discussed above would provide more complete, and verifiable, information – and I do not always trust that the broker-provided statement is always totally accurate (sometimes a broker will state that a stock was purchased for “25 3/8 per share” on a certain date, and not give me the actual net dollar amount that includes all commissions and fees).

Under the new “Don’t Call It a Bailout” Act this problem will eventually be dealt with to a great degree, at least with stock, bond and mutual fund investments if not real estate – but not completely.

(3) I wish clients would provide me with specific numbers for deductions they are claiming – instead of telling me “claim the maximum” or “whatever I am allowed” or “same as last year”.

The maximum is what you actually paid. You are allowed what you actually paid. It is very rare that an expense or number of miles driven for an activity is exactly the same as it was the previous year.
I need clients to tell me “$1023.50” or “$20.00 per week for 50 weeks” or “4638 miles”!

Each year I include in my January client mailing worksheets that apply to specific clients’ individual situations – for medical expenses, charitable contributions, rental income and expenses, employee business expenses, etc. I wish clients would fill them out completely and accurately – or provide me with a detailed listing of your deductions in any other format.

When clients do not give me the proper information and I have to email or write to you this wastes valuable time and delays the completion of the return.

I want to make sure my clients take advantage of all the deductions and credits to which they are entitled – but I can only do this if I am given complete and accurate information.

(4) I wish clients would make and keep a photocopy of all their Form W-2s for the year before sending me their “stuff” – as I clearly instruct in my annual January client mailing.

Each year during the season I get two or three frantic calls or emails asking me to fax photocopies of the W-2s to a bank, mortgage company or to the client. This is not a big thing, but anything that takes time away from actual 1040 preparation during this time is bad.

(5) My invoices all clearly state “payment due upon receipt”. This means once you receive the invoice and not “30 days net”. I wish my clients would sit down and write my check, and put it in the mail, as soon as they have finished reviewing the finished returns

This is only the beginnings of my client “wish list”. I could probably fill several more posts - and may just do that.

I hope that my clients read this post and take heed. As for the rest of you – I know you will make your own individual tax preparers a lot happier if you make these wishes come true for them as well.


Wednesday, May 21, 2008


Over the years I have gotten lots of different reactions from clients when I tell them the “bottom line” on their federal and state tax returns.

Some clients breathe a sigh of relief – “At least I don’t have to pay.”

Some are not surprised by the result – “I figured I would owe this year.”

Some are actually giddy when I tell them the amount of their refund.

I remember the response from one of my mentor’s clients many, many years ago – “Gott in Himmel!

And there are always a few who are never satisfied and complain, “Is that all I am getting back!?!

This reaction is often followed by, “How come [my brother, my neighbor, or my co-worker] always gets back more than I do?

The client is convinced that you have done something wrong because his brother, neighbor or co-worker makes exactly the same as he does and is in exactly the same situation as he is and yet gets a much larger refund.

Well for one thing, how do you know your brother, neighbor or co-worker always gets back a lot more? Have you actually seen his tax return each year? And how do you know just what he makes or what situation he is really in?

Maybe this person is just practicing “one-upmanship” and tells you he gets back a lot more just to bust a certain part of your anatomy.

Even if this person to whom the client is referring has a base salary similar to that of the client and lives in a similar home in a similar community there are a variety of reasons why the refund is different.

· Your refund is a factor of the tax withheld. Perhaps this person has much more tax withheld.

· This person’s spouse may not work, while the client’s does. Or the client and/or his spouse may have a second job.

· This person may pay lots more in real estate tax (the amount of tax paid on a similar house can vary substantially from town to town) or have a much larger mortgage and/or more home equity borrowing. He may have a vacation home which generates additional expenses or rental property that produces a tax loss.

· This person may have a lot of out of pocket expenses connected with his job and be able to claim them as a miscellaneous deduction – or he may have excessive medical or dental expenses well in excess of the AMT exclusion amount.

· Perhaps this person has kids in college and can claim an education tax credit or tuition and fee deduction. Or his kids are under age 17 and eligible for a Child Tax Credit.

· This person or his spouse may have a sideline start-up business that generates losses.

· Or maybe this person lies through his teeth on his tax return while the client’s return is prepared honestly and correctly!

My response to this question from a client is – “Show me his tax return and I will tell you why.”


Monday, May 5, 2008


As an addendum to this morning’s post:

The source of many misconceptions about federal and state income taxes is often unsolicited tax advice from uninformed friends, family and even “Strangers on A Train”.
Talk about bad tax advice. You should check out the May 4th comment on my post “
ASK THE TAX PRO – STATE TAXES FOR A NJ RESIDENT WORKING IN NYC" from Schadenfreude and my response.


I find each tax filing season that my clients still have misconceptions about various tax deductions and credits. In many cases a little knowledge is dangerous. I will devote several posts to some of the misconceptions I came across during this and previous seasons.

One client, a single parent, needed to keep her Adjusted Gross Income (AGI) under a certain amount to qualify for a specific state program. To this end she made a contribution to a traditional IRA, thinking that it would be fully deductible and therefore reduce her AGI.

This was not the case. The client was an “active participant” in an employer pension plan, as evidenced on her W-2 by reference to the type of plan and amount of her contribution in Box 12 and the fact that the “Retirement Plan” box was “x-ed”. Because her AGI exceeded $62,000.00 she could not deduct her IRA contribution.

Her response to me when I advised her of this fact was, “But I thought I could contribute to both”.

That is totally true – you can contribute to both your employer’s plan(s) and a traditional - or if you qualify a ROTH - IRA. However you may not be able to deduct part or all of your contribution to the traditional IRA.

The amount of the contribution that can be deducted is “phased out” for active participants in an employer plan as “modified” AGI goes from $83,000 to $103,000 for married taxpayers filing a joint return and Qualifying Widow(er)s, and from $52,000 to $62,000 for Single and Head of Household filers.

The amount of “participation” in the employer plan does not matter. You can be covered by the plan for only one month. A contribution of $100.00 to an employer plan can keep you from deducting a $5,000 contribution to a traditional IRA.

If one spouse is an active participant in an employer plan but the other spouse is not, the “non-covered spouse” can deduct in full any contributions to his/her traditional IRA if the joint “modified” AGI is under $156,000. The deduction is “phased out” as the “modified” AGI goes from $156,000-$166,000. No deduction is allowed if MAGI exceeds $166,000.

“Modified” AGI in these cases is the Adjusted Gross Income adjusted by adding-back foreign income exclusions, excluded adoption assistance benefits, the “domestic production” deduction, and such educational items as excluded savings bond interest and the "above-the-line" deduction for student loan interest, and tuition and fees.

In both cases if a married couple is filing separate returns the IRA deduction is “phased-out” as MAGI goes from $0.00 to $10,000. Another way the Tax Code tries to keep married taxpayers from filing separately.

In my client’s situation I reported the traditional IRA contribution as non-deductible on Form 8606. This creates a “basis” in her IRA investments so that when she begins to take withdrawals a portion will be treated as a tax-free “return of basis”. A Form 8606 should be filed with each subsequent Form 1040, even if no additional non-deductible contributions are made, to keep track of the IRA basis so that it is not forgotten when withdrawals are ultimately made.

When calculating the amount of tax-free return of basis that applies to a withdrawal all traditional IRAs, regardless of the source of the original contributions (i.e. deductible, non-deductible, roll-over from employer plan) are taken into consideration - and it does not matter from which individual IRA account the withdrawal comes from. One client deposited deductible and non-deductible contributions into separate accounts – but this had absolutely no affect on the taxability of subsequent withdrawals.

I told the client the proper way to reduce her AGI was to increase her “pre-tax” employee contribution to her employer’s plan. This will reduce the amount of federal wages reported on her Form W-2 and therefore her AGI.

If the taxpayer is a participant in a 401(k) plan his/her contributions will most likely also reduce the state taxable wages. However, while “pre-tax” for federal purposes, the contributions of employees of federal, state and local government units and non-profit organizations to a 403(b), 457, 414(h) or similar plan may not be “pre-tax” for state income tax purposes. Such is the case in New Jersey.

The moral in all of the misconception stories is - contact your tax professional before doing anything tax related. If the client discussed above had simply emailed me before making the IRA contribution I would have set her straight.

Any questions?