Accountants: Help me protect my windfall from the IRS!

Yeah, I know. I can’t except by using my most powerful tool, being poor, which I’m going to do anyway. My wife, though, thinks there’s some magical Thing THEY Don’t Want Us to Know About, and I should talk to an accountant or tax lawyer before going any further. :rolleyes: I’m not going to take time off from work to pay some guy to tell me what I already know, but I want to do some collaborative thinking wit’chall just in case she’s right. Here’s my situation in a coconut shell:

I worked for a company for ten years and got vested in its pension plan. I’m a big, fat guy with asthma and balance problems and never expected to live until retirement, so when they sent me yearly letters saying how much I’ll get monthly when I turn 65 I kinda ignored it as fantasy money, especially when it started out at about $125. Big whoop.

Since that job I’ve seen some good times and some bad times, and this is one of the bad times. I’m massively under-employed and my wife is unemployed. We owe a lot of money, from back real estate taxes to credit cards to medical bills, and have a leaking roof and a busted furnace and stove. When I got a letter from my former employer telling me I could cash out my pension I thought, “How lovely! We don’t have to freeze next winter.” I was figuring about ten or fifteen grand. Uncle Sam would withhold about a third or half of it and I could use the rest to fix the house stuff and file Chapter 13 before the company that bought my first year of back taxes takes the house next April.

Speaking of April, I’m a W-2 employee, but my company doesn’t withhold Federal taxes. I’m pretty sure that’s illegal, but their thinking seems to be that they pay us so little that, between our poverty and a judicious use of the Earned Income Tax Credit, none of us pay taxes, anyway, and the withheld amount of the pension will cover that. And yes, I am actively looking for another job. Why I stayed here this long is another story.

It turns out, though, that the pension is over fifty-thousand, American, making it a bit more complex and causing my wife to assume I haven’t thought everything out and that there are tricks to protect it that I don’t know. I don’t have exact numbers on me but let me bounce my cunning plan off you.

Sam will take $20,000/40% or so off the top, leaving me with $30,000. Back taxes are about $18,000, repairs are $2000 to $4000, Chapter 13 is $3500 upfront, according to a lawyer I spoke to last year. However, with the back taxes out of the way and the probability that, as I have stopped receiving letters and calls about my biggest medical debts, those may have been written off as bad debts (I’m delaying poking that hornet’s nest until I’m stronger financially), I think I could skip the bankruptcy and work with somebody who doesn’t advertize on daytime TV to restructure my debt. I’ll get a fair chunk of the $20k back from Uncle Sam next spring and be able to fix up this dump enough to sell it for more than I owe on it. Wife starts her new job in a couple weeks and I’ll find a better one and we’ll all live happily ever after.

So, that’s my plan. How stupid and short-sighted is it?

IRS might give you a break on back taxes if you go in and ask nicely and offer to pay cash.

Taxes off the top are where an accountant or tax expert can help you. Buying a house is usually a good tax hedge.

f your medical bills were more than $1000 they’ve probably been bundled w/ other people’s bad debts and sold to a debt collector for pennies on the dollar. They’ll try to collect from you and then take you to court and get a judgment against you, then garnish wages and/or put a lien on your car/home, depending on the state you live in.
If your employer doesn’t withhold taxes, I wonder if it’s worth you doing a quarterly return now rather than wait till next year to do annual taxes? Has your wife worked another job this year? Have you?

Roll it over into an IRA. Then only pay taxes on the amount you withdraw from the IRA in a given tax year, to cover your proposed expenses. If you’re not yet 59.5 years old, there’s a 10% penalty on top of that; but I suspect a similar penalty will apply to the cash-out anyway, depending what kind of plan it is, if you don’t roll it over.

Remember the part where I was drowning in debt and was surprised I lived this long, never expecting to retire? This has a lot more in common with “putting my affairs in order” than it does “planning for a day that will never come.”

Hmmmm, as I won’t be 59.5 until early December that is something I need to look into. Thanks!

I totally understand. You don’t need to already have an IRA- you can open one just for the rollover, and just use it long enough for tax protection until you use the money. Good luck!

Definitely talk to a lawyer. Two points:

  1. You may not need to do a Chapter 13 to keep your house. You can do a 7 and reaffirm the mortgage. YMMV, ask your attorney about this.

  2. Definitely roll it over into an IRA and don’t take cash. The IRA assets are not part of your bankrupt estate.

  3. $3500 up front is pretty damn steep for a Chapter 13. What is typical here is $3000. $1500 up front, and the other $1500 rolled into your monthly 3 year payments with other creditors.

Very possible, but eligibility for Ch. 7 is determined by a means test…if his family income is below a certain level, which varies by location, he may qualify.

Even if a Ch. 7 is not an option, some bankruptcy courts will approve a 0% to unsecured creditors plan in some circumstances. Definitely worth looking into.

Around here, some lawyers are doing Ch 13 for only the filing fee…about $310…up front, with the remainder of the fee paid through the plan. He should shop around for a better deal than what’s he’s been offered.

CPA here.

The other comments are good advice. Rolling the balance over into an IRA is probably the best way to proceed, and then withdraw the money from the IRA as needed. You will also definitely also want to wait until you are 59 and 1/2 to avoid the 10% penalty on top of any taxes you will owe. There are certain ways to avoid the 10% penalty when you are below that age, but since you are reaching that age in December, I would wait until after.

You could also withdraw the amounts needed across both 2013 and 2014 to spread out the income over 2 tax years, by withdrawing part of it in December after you attain 59.5 and then again in January. The custodian for the pension, or the IRA if you roll it over, will allow you to withhold as much or as little tax on the proceeds as you wish, including withholding nothing at all. Depending on your other items of income and deductions for the applicable year of the withdrawls(s) will determine how much tax you owe on the distributions, which will be included as regular ordinary income on your tax return.

The others have noted good advice if you are going to be going ahead with a bankruptcy filing and the advantages of holding the funds in an IRA to protect them.

If back taxes are old enough, they can be cleared through a bankruptcy.

Other than that… go talk to the necessary professionals. Giving tax advice with information this limited, through an internet forums, is like a doctor trying to talk you through how to remove your own gall bladder.

If they’re not withholding FICA (Social Security and Medicare), that’s definitely illegal. Withholding of income tax is different. You would have filled out a W-4 form which tells your employer how many dependents you’re claiming. If you claimed Exempt or claimed enough dependents, they might not have withheld income tax because your earnings didn’t rise to that level.

I don’t know that you need to talk to a lawyer, but you should talk to an accountant or financial planner.

If you were in better shape financially, I’d agree that a rollover would be best. But with everything that’s going on, it seems more logical to use that money to get yourself back on track. Heck, maybe lessening the stress will help your asthma!

Personal question: Was your former employer Electrolux? They’re offering lump sum pension buyouts now.

Paging Rand Rover!

Don’t hold your breath.

Thanks for all your help, folks! I definitely need to talk to somebody face-to-face, it seems, but now I know what questions to ask.

No. An elevator company that had its ups and downs. rimshot

The boyfriend of one of my daughters wants to buy the car she’s been using. Silly girl first thought that she could put one over on me by pocketing the money. :dubious: Then she thought that buying new plates for it meant the title changed to her name. :dubious:

She’s not the smart daughter, obviously, but he’s willing to pay $1500 for a POS that cost me $1200 and has started to demonstrate its disloyalty–and he doesn’t want me to fix it first! She can have the difference and that $1200 could really help me.

Out of curiosity, why would the IRS take 40% off the top? If your income is that low, I’d think your marginal rate would be 10 or 15%. If the payout put you in the 25% bracket, that would still apply only to a marginal amount, not the whole thing. Would you be subject to the 10% penalty for early access of a retirement fund? If so, I agree with the others that you should park it in a rollover until December at least.

Talk to a lawyer. Rule of thumb: don’t pick a large firm that advertises for bankruptcy representation. It generally means they recently expanded into the area to take advantage of the number of filings.

When I was unemployed I cleaned out my pension fund, which was a lot less – only $12K. The bank wouldn’t even let me have it all – they withheld 20% and sent it off to the IRS for taxes. So your 40% might be high unless the bank specifically told you so.

Presumably, though, it all counts as income in the year you receive it, if it was withheld pre-tax in the job where you earned it. Dunno that there’s anything you can do except make sure you claim every possible deduction. It turned out to be pretty easy for me, as I earned almost no other money that year and I paid more than 6 grand in property taxes and mortgage interest.

Do NOT touch a dime until age 59.5. Roll it over. It will cost you $5000 not to wait for a couple of months.

Next Bankruptcy does not dissolve US tax debt, so you need to roll it over.

Talk to a lawyer.

Here’s how it breaks down:

25% withholding, 10% penalty fed, + whatever State taxes and penalties, this can easily get to 40- 50%.

He hasn’t said he has US tax debt though. He owes back real estate taxes (property tax) on his house.

Since he’s benefiting from the Earned Income Tax Credit, it sounds like he has no income tax debt.

If he has to count $50K as income, he will surely owe taxes on it. Also, I’ve met dropzone, who’s in the Chicago area, so almost certainly all the tax issues are US or state.

I don’t know how old dropzone is, so given his stated financial condition I don’t know how practical it would be to roll it over until past age 59. But it’s great advice if tax avoidance is the only issue to be addressed in the short-term.