Adventures in Taxland, Part V

Last week I had a tax client that was a real success story. They went from a starting point of owing the IRS over $6000 to receiving a $175 refund. There were several twists and turns in the story, but by the proper application of tax law I was able to help the couple avert what would have been a calamity for their personal finances.


The first question is how they got into the position of having to pay in so much in the first place. The answer is that they made a lot of money. Sort of.

The wife worked a full time job, and made about $30,000 for 2012. She had taken out enough withholding to more than cover the taxes on that income, if that had been the couple’s only income.

The next piece of the puzzle was the husband. In 2012 his request for disability was approved. With social security disability, benefits accrue from the date you apply for disability. If and when you are finally approved, the accrued benefits are paid, up to the date of approval. In essence, you get back pay. The husband received a lump sum payment for 2010, 2011, and 2012, totaling $30,000. The worksheet for calculating the taxability of social security benefits is complicated, but the bottom line is that about $13,000 of the lump sum was taxable income. So now they were up to $43,000 in taxable income.

Then came a twist. Qualifying for disability is one of the few ways you can discharge federally guaranteed student loan debt. Death is about the only other way you can get out from under. You can’t even drop student loans debt through bankruptcy. The husband had old student loan debt that was written off. This one of those good news, bad news situations. The good news is that the bill collectors stop calling, trying to collect on the debt. The bad news is that cancelled debt is income. If you negotiate to close a credit card for less than the balance due, the amount written off is considered income. If your house is foreclosed on, and the bank sells it for less than the loan, the difference is income. More people are getting caught up in this since the Great Recession began in 2008.

With unpaid interest charges tacked on, the cancelled debt came to $21,000. So the couple’s income now included wages of $30,000, taxable social security of $13,000, and cancelled debt income of $21,000. Total income of $64,000. After taking the standard deduction and two personal exemptions, taxes due were over $6000. They sure didn’t take enough withholding to cover that.

From this starting point I sprang into action. Well, I didn’t actually spring. It was more of a tap, tap, tap on the keyboard, along with some filling out worksheets by hand.

First, we went to work on the cancelled debt income. Cancelled debt can be excluded from income to the extent that you are insolvent. You add up all your debts, including the student loan. Then you add all your assets, including your 401K, car, and personal possessions. To the extent your liabilities exceed your assets, you are insolvent. We went through the IRS approved worksheet, and determined that the couple was insolvent to well over the amount of the student loan debt. So we filed a Form 982 to exclude the income. That took care of that part of the problem.

The next step was to tackle the lump sum disability payment. The IRS allows what is called a Lump Sum Election (LSE). You go back through every year of the disability payments, and calculate how much of the Social Security would have been taxable under each year’s situation. In this case it required going over the couple’s tax returns for 2010 and 2011, as well as 2012, and figuring out how much of the Social Security was taxable in each year. Then that was lumped together and entered on their Form 1040, with a special notation. That reduced the taxable portion from $13,000 down to $5000. The bottom line of these machinations was to bring their reported income down from $64,000 to $35,000. And they had taken enough withholding to cover the tax bill on that, with $175 left over as a refund.

This case shows the benefit of training, experience, and cooperation among tax professionals can make a difference over just trying to use the software. The use of knowledge and judgment in applying the software made the difference between a big pay in and getting a refund for this client.

Not bad for a plumber who only does taxes part time.

Adventures in Taxland, Part IV

A few weeks back, at the start of tax season, I caught one of Turbo Tax’s television spots. This is the ad campaign that pokes fun at tax preparers who do taxes part time, and work other day jobs. The one that has been running most often features a husband coming home from the office, wearing a coat and tie. He walks into the kitchen to see that his wife has called in a plumber to fix the kitchen sink. The plumber pulls himself out from underneath the sink, and as he wipes muck off his hands, greets the husband by name. “Don’t you remember me?” asks the plumber. “I did your taxes.”


These ads are devastatingly effective. The first time I saw one, I thought to myself “Boy, who would use a plumber to do their taxes. You’d have to be an idiot to do that.” Then I realized that the ad was targeting my clients. I am a part timer who works for H & R Block on the side, and I was sucked in. Like I said, devastatingly effective.

The ad was targeting all users of office based tax preparation services. The message was that if you use Turbo Tax at home and have a question, you can call in and get answers from CPA’s and Enrolled Agents, licensed professionals in taxation. Go to a service like H & R Block, and you get a plumber.

What the ad doesn’t mention is that Turbo Tax is software that you use at home. You only get to talk to one of their professionals if you call in with a question. One of the advantages of coming in to a tax office to get your taxes done is the interaction with between you and the person doing your taxes. You may think you know your own tax situation, but someone with training and experience can guide you into areas of the tax code you didn’t even know about, to your benefit. The interaction should be less you asking questions of the expert, and more the expert asking questions of you.

Another problem I have with the ads is that I actually might qualify to meet Turbo Tax’s standards. After all, I have both an MBA and a Master’s degree in Accounting. But I will confess, I go to more experienced tax preparers for guidance on a regular basis. Some of the “part timers” I work with have decades of experience, and have handled thousands of tax returns. The least experienced person working in an H &R Block office takes 70 classroom hours of instruction before seeing their first client, and you are required to get continuing education every year to maintain your status.

So go ahead, trust that plumber to do your taxes. Now, trusting a marketing guy to unplug your drain? That’s a different story.