Cashing in their Chips

[Snaggletooth]

I've got a couple of customers who cashed out their retirement plans. One of them for $400,000 and they are prepared for the consequences. Another for $500,000 so they could buy a $500,000 house, and they have nothing left.

Both customers owe around $50,000 apiece, and I would like to help reduce this. Are there any deductions common to this situation, or any strategy to reduce the effect of this? It would have helped if they had contacted me before they did this, but alas, the deeds are done.

I'm not aware of anything, except to find as many unrelated deductions as I can. The income is so huge that it phases out just about everything. My question is: is there anything peculiar about these distributions that allows for certain expenses or some way to bail out of the income?

I don't think there's much that can be done, but I thought I would ask and benefit from the collective experience of other board members.

[Black Bart]

Hey, Snag

Whatcha dune? Insomnia?

I can't think of anything for them. I'm like you though, when I get these monstrous tax cases, I think that maybe there's something out there to help, only what? Usually, there isn't, but we tell ourselves (and them) that we'll "try to think of something" and it still mostly works out that they just have to pay the tax. Like you say, the income rules out the normal dodges (IRAs, etc.)

Anything new goin' on in Tennessee?

[Snaggletooth]

It's 3 oclock...

...in the morning, but unlike the song, I have not been "dancing the whole night
through..."

Been trying to research ways to reduce the tax for these cashouts. My post above failed to reveal the extent of idiocy -- first of all, one of the cashouts, $125,000 from an employers
401k plan, was made 30 days before his 55th birthday. If he could have waited 30 days, he would have an exemption from the penalty.

Stupid #2. Believe it or not, these guys are 55 and buying their first home. They cash out their IRA ($81,000) after they have already bought their house, and buy furniture with it. I can't make a case for them to qualify for the $10,000 penalty exemption because their IRA was cashed out AFTER the house was bought. Only the IRA qualifies, and this was their only IRA.

Stupid #3. If they are only 55, then they can't be 59.5. That's right, we're looking at some $40,000 in penalties alone. All of their distributions had heavy withholding - they didn't even think they OWED anything. Geez...

If I can beat their taxes down to $25,000, these people will be very appreciative and look upon me as a genius. Problem is, if I can do this, I really WILL be a genius.

Good to hear from you Bart, - and go get 'em take a bite out of Jainen. Rude and crude no doubt, but hilarious.

[Black Bart]

Tax Planning

That is an impressive list of "stupids." Your clients sound like mine--their idea of tax planning is not to ask you anything before they do it, but to come in either six months after the deed is done or on January 1st of the following year and ask "What do you think I should do about this?" or "I did so-and-so and there's not going to be any tax on that, is there?"

[Black Bart]

Hey,

Just thought, is there any medical or extenuating circumstances, such as malfeasance on the part of an employer, bnak, other who didn't properly advise them about the consequences of taking the stuff out, not rolling it over, etc.? I had a client a couple of years ago whose husband passed away, left a large IRA at an out-of-town bank. She told her son to go get it and move it to a local bank. He did and just put it in a regular CD. No penalty (over 65) but she didn't need the money and was gonna owe about $20K. Nobody at either bank advised her that it would have to be rolled over in 60 days or it would all become taxable. She had mucho medical problems and I wrote IRS (sent copies of med bills) asking that they allow us to move it to a qualified account. They did.

No-no, wait. Just realized--your guys have already spent their money. Hmm, let's see...maybe you could lend them the money?

How do we get ourselves in these fixes?

[Bees Knees]

Sometimes people just want to pay the tax and penalty to get their dream. They may not want any debt. They want to pay off that mortgage, or buy a new house with cash, or a new car with cash, or whatever.

I'm not so sure that is stupid. Yes it is stupid when they could have avoided the penalty just by waiting a few extra days. But living debt free is not always a bad idea. As you get older, your earning power starts to go away.

Imagine how much cheaper we all could live if we had zero debt.

[Matt Sova]

If I can beat their taxes down to $25,000, these people will be very appreciative and look upon me as a genius. Problem is, if I can do this, I really WILL be a genius.

You won't be a genius, you will be a perpetrator of a fraud. Since they have no debt on these houses, perhaps they should go get a home equity loan to pay this off since the interest will be substantially less then the penalties and interest involved in the IRS payment plan.

[Snaggletooth]

Beeswax

Sorry my friend, stupid is stupid. Admirable though it might be to wish a debt-free existence, when you owe this kind of money, you may just as well owe the bank.

They had an IRA available to cash out to take advantage of the $10,000 penalty exemption, and instead opted to cash out a 401k. POOF!! there goes that exemption. Then they cash out yet another 401k from separation which would have created another $100,000 exemption had they just waited another 30 days.

Of course the clients aren't really stupid in that sense of the word -- they were just ignorant because of lack of tax planning. Quite a difference between simply not knowing and not capable of judgement, I suppose.

Jainen, where are you when I need you?

[Gretel]

Ron, the real problem is not your clients. They just have to bear the consquences. Such is life and they do not need any judgement. It is what it is.

The real problem is you. Having too much pity and sleepless nights, almost like it is your personal responsibility to lessen the bite. Well, I assume, you have enough to carry on your shoulders with what is your responsibilty, I mean, I do and I am pretty sure we all do.

Don't get me wrong. I know plenty of sleepless nights, wanting to soften edges, or whatever. But the truth is, we can't. Not beyond having true compassion, with ourselves first (no sleepless night) and with the other one (just doing our best within reason).

Gabriele

[Snaggletooth]

Gabriele

You may very well be right from a certain perspective -- but I can't reach the point of desensitivity such that I can stand by and watch people get socked with excessive taxes simply because they didn't know how to play the angles in a bureaucratic tax system.

I have repeatedly called my clients stupid for failing to take advantage of subtle nooks and crannies that only tax professionals know about. They are being penalized because they were ignorant and they are NOT really stupid.

They had four retirement plans to cash in, three 401k's and one IRA. They cashed in their IRA last, disqualifying them for using the $10,000 exemption. The husband cashed in his 401k upon severance from his employer, and had he waited another 30 days, he could have had a $100,000 exemption. Who (other than tax professionals) would have known to do any of this, when common sense tells you it shouldn't make any difference?

It's easy to move on to the next customer -- and leave these people with a monstrous problem that they simply didn't see coming. Not the same as people who you warn and then they ignore your advice.

Don't take compassion away from those of us who still have some left -- it is all that stands between us and the law of the jungle.

[Chief]

Compassion

Ron:

I think this situation speaks wonders about you. Heaven help us all if we lose compassion and concern for others. These are your clients and you want the best for them. They are indeed fortunate to have a tax professional of your calibre working for them.

Would it be that all we tax professionals have the same degree of human skills that you possess. Every client I have I try to get this best possible break for them in this every increasing blur or bureaucratic of tax legislation that we have to work with.

In the final analysis we have to settle for what is possible. Beyond that is a field of dreams. I'm sure Black Barth could and probably put this in more poetic language.

[Gretel]

Yes, Ron, yes, Chief, 100% with you.

I thought I made a big pledge FOR compassion. It's all that really matters. But I also made a pledge not to leave yourself out of the equation.

[Snaggletooth]

Gabriele

No real problem - I appreciate your concern over my late hours and hopeless customers.
You are a class lady -- nothing was misunderstood.

Best regards, Ron J.

[Bees Knees]

Sorry my friend, stupid is stupid. Admirable though it might be to wish a debt-free existence, when you owe this kind of money, you may just as well owe the bank.

Well, I wasn't exactly looking at the details of this particular case. There obviously could have been an intelligent way to accomplish their goal to pay cash for a house.

My point is, sometimes paying extra tax is not always a bad decision. We tax preparers sometimes look at the picture through the tunnel vision eyes of paying taxes. We advise people it is good to have a mortgage because the interest is deductible. We advise clients to spread the income out over several years to lower the marginal tax rate.

But there is more to life than saving a few tax dollars. Paying extra tax to have the freedom and less stress of living debt free has its own benefits. After 9/11, some close to retirement all of a sudden could not retire, because 50% of their portfolio went away, while that huge mortgage obligation was still there. Had they put that money into paying off their house instead of the stock market, they would have been less affected by the sudden crash of our economy.