Taxes and a Financial Crisis

Sally Herigstad, CPA offers some interesting suggestions in “Help I Can’t Pay My Bills,” such as using tax law to help in a financial crisis. The IRS is not generally considered a friend during times of crisis or any other time for that matter, but knowledge of tax codes can actually help in seriously desperate situations, one more reason to have a CPA on your side when filing your taxes.

Most middle and lower middle class Americans intentionally over pay their taxes during the year, as an enforced savings program. I certainly did this in the early days of our marriage. The author is adamantly opposed to this practice. If you can’t make the ends meet on your monthly budget, adjusting your withholding can provide a little extra when needed. For most Americans, she suggests withholding at the same rate as would have generated a zero balance in the previous year. No refund, nothing owed is the goal. For higher income families (over $150,000 a year) she suggests last year’s taxes owed plus an additional ten percent. In her experience many of her clients are over paying their taxes and carrying a balance on their credit cards. This means they are lending the Government money at 0% interest while paying credit card companies 18%, certainly a bad idea. In addition, she notes that many of her customers do not use their tax refunds wisely. Instead they are inclined to use the money on something like a family vacation that not only spends all their refund but adds to their credit card balances.

One subject she doesn’t cover in this chapter is the 1099 employee. Most of us have our taxes withheld by your employer who then provides us with a W2 form at the end of the year. Employees considered independent contractors do not have their taxes withheld by their employer. At the end of the year they receive a form 1099 instead of a W2. If they haven’t filed and paid their estimated taxes on a quarterly basis, they can face a really ugly financial emergency on April 15. Not only do these people owe taxes like everyone else, but they will be hit with a double Social Security and Medicare bill, the so called self employment tax, since their employer paid nothing toward this tax burden.

Estimated taxes are also a problem for those who have enough investment income to raise their tax bill far enough beyond their withholdings to trigger the penalties associated with inadequate withholdings. Watch out for this one following the death of a family member. Inheritances that generate unpaid taxes can create unforeseen liabilities; talk to your CPA whenever something the least unusual occurs in your financial life.

Herigstad believes that the Earned Income Tax Credit (EIC), a program for low income tax payers, is the most often overlooked opportunity for a larger return. This credit can lower or even eliminate your tax bill if you meet all the necessary criteria. However, it does require that the tax filer submit an extra EIC form. Government statistics indicate that only 25% of the filers eligible for this benefit file the necessary form to receive this benefit. She notes that this benefit can be used in calculating your withholdings. It is estimated that only 0.5% of those eligible for this benefit ever receive it. Imagine how even a few extra dollars a month could help in a financial emergency. She also offers tips for those eligible for the EIC including the dependency exemption for children. In the case of a divorce where both parents are contributing to the support of their children, both parents, if eligible for the EIC, can claim an exemption for their child or children.

The author has found that she can often help out a client in dire straits by filing a 1040X amended tax return for up to three previous years. If you have overlooked certain deductions you may be able to get back some money from previous years.

Frequently overlooked deductions include:

Social Security Withholdings: If you have worked for more than one employer during the course of a tax year, it is possible that you have overpaid Social Security.

Noncash Charitable Contributions: If you have put anything in the Goodwill box and failed to claim it on a tax return, you can claim it on your amended tax return.

Education Credits or Deductions: If you had educational expenses during a tax year, you may be able to take a deduction for part or all of your expenses. While this is a frequently overlooked benefit, what can be claimed looks a bit complicated for the do it yourself filer. When in doubt, talk to your CPA.

Sales Tax Deductions: This deduction will allow you to take an itemized deduction for state and local income taxes or state and local sales taxes but not both.

Child Care Credit: You might be able to claim a deduction for the cost of child care.

Volunteer Expenses: If you have worked as a volunteer you can claim a deduction for expenses associated with your charitable efforts.

Bad Debt: If your no good brother-in-law failed to repay the money you loaned him, it is possible that you can claim this as a deduction in the year it became worthless.

If you potentially have any money due you from the three previous years because you overlooked some deduction, it might be worth your while to file amended forms for these years. The author has been able to rescue some of the people she helps with refunds from years gone by.

As always, my advice is that if you are facing an unusual tax situation, look for professional guidance. Do it yourself computer programs such as Turbotax seem to work fine for most people most of the time, but don’t be afraid to pay a professional for their advice when confronting tax complexities or a time of crisis.