Tax

Ask a Tax Question, Get an Answer ASAP!

Have your own Tax question?

4 Tax Professionals are Online Now

characters left:

Not a Tax Question?

Question

My brother has told me something that I cannot belief about his taxes and I need advice from a tax specialist. He has delayed his 2008 taxes until October 15th. He is in the real estate business. Last year he made fairly good profits, but this year his businesss is suffering from the bad economy.

He has told me that he is in a 40% tax bracket (not quite sure if that is rounding up). He has an IRA which he says he has typically contributed the maximum amount of $40,000. He says that $40,000 is non-taxable income. If he had contributed the $40,000, that would be a 0.4*40,000 = $16,000 savings to him.

He is literally begging to me to borrow $40,000 which he says he will put into his IRA account for short time, perhaps 1 day or one week. He says that by doing so, this will qualify him for making a $40,000 contribution. He says that he will be given a 10% penalty next year.

I have argued with him that next year the IRS will want $16,000 in uncollected taxes + a penalty. Please clarify.

Submitted: 89 days and 10 hours ago.

Category: Tax

Value: $15

Status: CLOSED

Country/State/Province of question: US/IL

Posted by Merlo 89 days and 10 hours ago.

Answer

Hello Karl,

I assume that your brother is self employed and has his own SEP IRA. If he is operating as a sole proprietor, then the maximum contribution he can make to his IRA would be 20% of his adjusted earned income. So in order for your brother to qualify to contribute $40,000 to his IRA, he would need to have adjusted earned income of $200,000 for the year.

You said his business is suffering this year, so I assume that he does not have earned income anywhere near this amount. And he would therefore not be allowed to contribute this much to his IRA and still claim a tax deduction for the contribution.

If this was helpful please press the Accept button. Positive feedback is also appreciated.

Thank you Karl.

89 days and 9 hours ago.

Reply

Yes, he made more than $200 K last year. What he is asking does not make sense to me. He did not make the contribution last year. He is paying last year's taxes. He says that he wants to put in $40 k for one day, to claim that he made a contribution.

It just doesn't make any sense to me. I absolutely don't understand what he is trying to do.

Accepted Answer

Hello again Karl,

What your brother is proposing to do makes no sense whatsoever, if he plans to take the contribution out in the same year he made it.

The way an IRA works is that when you make a contribution to the IRA account, you are allowed to deduct the amount of your contribution from your taxable income. So if he contributes $40,000 to his IRA, then he could exclude that amount from his taxable income this year.

However, with an IRA account, whenever you withdraw money from that account, it becomes taxable income to you in the year withdrawn. So if he puts money in to the IRA and then takes it out the same year, in the same year he would claim a deduction for the contribution, but at the same time he would then have to show the withdrawal as taxable income. So he gains no ground. In fact, if he is under the age of 59-1/2 he actually loses ground, because he will pay an additional 10% penalty for making a withdrawal prior to the age of 59-1/2.

Your brother either does not realize that the withdrawals from an IRA account are fully subject to tax (and penalty if under age), or he is just trying to get a loan from you and using this as his reasoning. But that is not how it works.

If this was helpful please press the Accept button.

Thank you Karl.

Accepts:
Expert:	Merlo
Pos. Feedback:	99.8 %
Answered:	8/25/2009

Accountant

25+ years tax consulting. Specializing in returns for US citizens living abroad

89 days and 9 hours ago.

Reply

Thank you Merlo. It makes absolutely no sense to me.

He is putting tremendous pressure on me, saying that this idea is legitament and that his own accountant is saying that it is "ok". Asking for me to lend $40 K is asking a lot. My wife does our accounting (she was an accountant) and she doesn't understand what is driving him to make this request.

I forwarded yesterday's information from you about developing a repayment plan with the IRS. That makes sense to me, but he's balking at the idea.

Posted by Merlo 89 days and 9 hours ago.

Answer

Hello again Karl,

Well his idea of contributing to an IRA to claim a deduction makes no sense, when he would just have to turn around and claim the withdrawal as income. And if he really did discuss this with his accountant, his accountant would have told him the very same thing. So it sounds to me like he is just trying to convince you that the loan would be a good thing for him, when in fact, it would do him no good whatsoever from a tax standpoint.

89 days and 8 hours ago.

Reply

Thank you very much Merlo!

Posted by Merlo 89 days and 8 hours ago.

Answer

Thank you Karl, and good luck in getting this worked out.

89 days and 6 hours ago.

Reply

Sorry to bother you again, Merlo. I thought that your explanation was clear and I forwarded your notes to my brother. Unfortunately my brother tells me that I am stating the question wrong. Can you please help again with this issue?

He has said the following: He is putting $40,000 into his SEP IRA before October 15 (when he pays his 2008 taxes), to claim his deduction for his 2008 SEP IRA contribution. He is then taking the money out (perhaps 1 week later). He says that next year when he pays his 2009 taxes, he will be subject to paying a 10% penalty for taking the money out in 2009.

He said that once I explain it to you in these terms "you will understand it", because I certainly don't.

Can you please clarify what are the tax implications?

Posted by Merlo 89 days and 6 hours ago.

Answer

Hello again Karl,

The information your brother is giving you is still not correct.

You are allowed to contribute a certain amount of money each year to your SEP IRA based on your income. However, that contribution must be made prior to the tax filing deadline of April 15th. Even though he filed for an extension to file his 2008 taxes, and he has until October 15th, 2009 to file his return, the extension does not apply to IRA contributions.

In order to claim a deduction on his 2008 tax return for an IRA contribution in the 2008 tax year, his contribution had to be made no later than April 15, 2009. Any contribution that he makes now would be a deduction for him on his 2009 taxes, and not on his 2008 return. So once again, this would make no sense whatsoever, as it does not help reduce his 2008 tax liability.

Please refer to the following IRS publication under the section titled "When Can Contributions Be Made".

I think maybe it's time your brother got a new accountant, because he obviously has no clue what the rules are.

If this was helpful please press the Accept button. Positive feedback is also appreciated.

Thank you Karl.

http://74.125.95.132/search?q=cache:WBvCoxdZkQ8J:www.irs.gov/publications/p590/ch01.html+ira+contribution+deadline+2008+extension+irs&cd=1&hl=en&ct=clnk&gl=us

Edited by Merlo on 8/25/2009 at 8:14 PM

Posted by Bill 89 days and 6 hours ago.

Answer

Karl,

Your brother is correct that a SEP contribution can be made up until October 15th if he has an extension. Merlo is correct on IRA accounts but different rules apply to a SEP.

See page 6 "Time limit for making a contribution" - http://www.irs.gov/pub/irs-pdf/p560.pdf

Posted by Merlo 89 days and 6 hours ago.

Answer

Bill is correct that the extension does apply for the SEP IRA. However, your brother will still owe tax and penalty in 2009 when he makes the withdrawal, and not just the 10% penalty.

Sorry for the confusion.

89 days and 6 hours ago.

Reply

Yes. That is what I thought. He will own the tax on $40,000 plus the penalty.

Will the tax that he owes on the $40,000 be at his 2008 tax rate? This year he is making very little money and will be at a different tax rate.

Posted by Merlo 89 days and 6 hours ago.

Answer

Hello again Karl,

He will be making the withdrawal in 2009, so the tax on the withdrawal will be based on his overall income for 2009. It will not be based on the same tax rate as what he paid on his 2008 taxes.

So if he is having a bad year in 2009, then he would likely be taxed at a lower rate than what he is paying in 2008. How much lower will depend on what his total income actually ends up being for the year, including this $40,000 withdrawal. But he will still have to include that $40,000 withdrawal as income, and he will automatically pay a 10% penalty of $4,000 right off the top if he is under the age of 59-1/2. That penalty of $4,000 will be in addition to any tax that he owes on the $40,000.

Now if his income for 2009 is really way off from 2008, to a point where it only puts him in say the 15% tax bracket, then he may only end up owing tax of $6,500 and a penalty of $4,000, for a total of $10,500. So if his income is dramtically lower in 2009, then this could result in a net savings over the two years combined.

89 days and 6 hours ago.

Reply

Thank you Merlo. I understand.

He says that he will be taking a loss this year and won't need to pay any taxes.

Posted by Merlo 89 days and 6 hours ago.

Answer

He will still owe the early withdrawl penalty of $4,000, even if it ends up he actually has no taxable income. But he would still come out ahead when averaging the two years.

Disclaimer: Information in questions, answers, and other posts on this site ("Posts") comes from individual users, not JustAnswer; JustAnswer is not responsible for Posts. Posts are for general information, are not intended to substitute for informed professional advice (medical, legal, veterinary, financial, etc.), or to establish a professional-client relationship. The site and services are provided "as is" with no warranty or representations by JustAnswer regarding the qualifications of Experts. To see what credentials have been verified by a third-party service, please click on the "Verified" symbol in some Experts' profiles. JustAnswer is not intended or designed for EMERGENCY questions which should be directed immediately by telephone or in-person to qualified professionals.

Tax

Have your own Tax question?

Related Tax Topics:

Question

Optional Information

Country/State/Province of question: US/IL

Answer

Reply

Accepted Answer

Reply

Answer

Reply

Thank you very much Merlo!

Answer

Thank you Karl, and good luck in getting this worked out.

Reply

Answer

Answer

Karl,

Your brother is correct that a SEP contribution can be made up until October 15th if he has an extension. Merlo is correct on IRA accounts but different rules apply to a SEP.

See page 6 "Time limit for making a contribution" - http://www.irs.gov/pub/irs-pdf/p560.pdf

Answer

Bill is correct that the extension does apply for the SEP IRA. However, your brother will still owe tax and penalty in 2009 when he makes the withdrawal, and not just the 10% penalty.

Sorry for the confusion.

Reply

Yes. That is what I thought. He will own the tax on $40,000 plus the penalty.

Will the tax that he owes on the $40,000 be at his 2008 tax rate? This year he is making very little money and will be at a different tax rate.

Answer

Reply

Thank you Merlo. I understand.

He says that he will be taking a loss this year and won't need to pay any taxes.

Answer

He will still owe the early withdrawl penalty of $4,000, even if it ends up he actually has no taxable income. But he would still come out ahead when averaging the two years.

Tax

Have your own Tax question?

Related Tax Topics:

Question

Optional Information

Country/State/Province of question: US/IL

Answer

Reply

Accepted Answer

Reply

Answer

Reply

Thank you very much Merlo!

Answer

Thank you Karl, and good luck in getting this worked out.

Reply

Answer

Answer

Karl, Your brother is correct that a SEP contribution can be made up until October 15th if he has an extension. Merlo is correct on IRA accounts but different rules apply to a SEP. See page 6 "Time limit for making a contribution" - http://www.irs.gov/pub/irs-pdf/p560.pdf

Answer

Bill is correct that the extension does apply for the SEP IRA. However, your brother will still owe tax and penalty in 2009 when he makes the withdrawal, and not just the 10% penalty. Sorry for the confusion.

Reply

Yes. That is what I thought. He will own the tax on $40,000 plus the penalty. Will the tax that he owes on the $40,000 be at his 2008 tax rate? This year he is making very little money and will be at a different tax rate.

Answer

Reply

Thank you Merlo. I understand. He says that he will be taking a loss this year and won't need to pay any taxes.

Answer

He will still owe the early withdrawl penalty of $4,000, even if it ends up he actually has no taxable income. But he would still come out ahead when averaging the two years.

Related Tax Questions

Karl,

Your brother is correct that a SEP contribution can be made up until October 15th if he has an extension. Merlo is correct on IRA accounts but different rules apply to a SEP.

See page 6 "Time limit for making a contribution" - http://www.irs.gov/pub/irs-pdf/p560.pdf

Bill is correct that the extension does apply for the SEP IRA. However, your brother will still owe tax and penalty in 2009 when he makes the withdrawal, and not just the 10% penalty.

Sorry for the confusion.

Yes. That is what I thought. He will own the tax on $40,000 plus the penalty.

Will the tax that he owes on the $40,000 be at his 2008 tax rate? This year he is making very little money and will be at a different tax rate.

Thank you Merlo. I understand.

He says that he will be taking a loss this year and won't need to pay any taxes.