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Taxing Our Brains

Dan Smith

I SPENT A GOOD portion of my early adult life in neighborhood taverns. Back then, I sold beer for a living. You can imagine that I saw and heard some crazy things. Remember the sitcom Cheers? I knew doppelgangers for each and every Cheers character.

But the things I heard in those bars didn’t come close to the things I heard later when I worked as an income-tax preparer. No doubt other tax preparers and CPAs can add to my list. Here are my top 12:

1. Years ago, I asked a friend why she hadn’t refinanced her home loan after mortgage rates dropped sharply. Her response? She said she needed the bigger tax deduction. Even after I explained that she only saved 15 cents in tax for every $1 spent on mortgage interest, she still didn’t get it.

2. A client received Form 1099-C for the cancellation of credit card debt. She couldn’t understand why it was taxable, saying, “Why do I have to pay tax? It’s not like I got anything for it.”

I asked her, “What about all the stuff you bought and never paid for?”

The tax-code rationale: If one party can take a deduction, such as the credit card company for cancelling the debt, then someone else—my client, in this case—has to claim it as income.

3. A client with a fully depreciated rental property had the notion that, by using a mortgage loan to remove his home equity from the property, he could eliminate the taxable gain. This wasn’t an easy conversation.

The good news is, the client had been able to deduct a fraction of the price paid for the property each year. The bad news is, this process had reduced his cost basis to $0, not including the cost of the lot. Upon selling the property, the IRS recaptures all of those prior depreciation deductions in the form of long-term capital gains. And, no, the IRS doesn’t care how much you owe on the house.

4. Multiple landlord clients wanted to deduct uncollected rent from deadbeat renters or vacant units, or deduct the value of their time spent working on the property. Sorry, there’s no line on the tax form for that.

5. A client pulled all his money from his retirement account in early 2009. He was shocked that the distribution pushed him into the next tax bracket and cost him the 10% early withdrawal penalty.

Asked why he took out the money, he said it was because his account was going down in value. The market turned around in 2009 and has, for the most part, been going up ever since. Did I mention that he bought a beautiful new pickup truck with the money?

6. “My friend at work gets a bigger refund than me.” I got this comment frequently. There are lots of reasons this could happen, and it often has to do with how much tax was withheld during the year.

“In your case, I don’t know why you got less because I don’t do your coworker’s taxes,” I’d explain. “And even if I did, the IRS has its own version of HIPAA, the rules that cover medical privacy, which would prevent me from talking about your coworker’s taxes.”

7. A typical question from someone with a casino-issued W-2G for gambling income: “Why do I have to put that on my tax return? They taxed me when I got it.” Yes, they withheld tax, just like your employer does from your wages. But you still have to report those earnings on your tax return.

This situation is one of my income tax pet peeves. Slot machines and lotteries are programmed to keep a percentage of the money put into them. I don’t believe that the occasional lucky soul should be taxed at all on his or her winnings. Side note: Learn how to count cards at the blackjack table or become a really good poker player. As long as you aren’t in a tournament, where they keep track of your winnings, there’s no way for the casino to know your precise good fortune and issue the dreaded W-2G. I say this tongue-in-cheek: The winnings are still taxable, even when no W-2G is issued.

8. “I turned down the overtime because it put me in a higher tax bracket.” Ever tried to explain progressive taxation to someone? There are good reasons to turn down overtime, such as wanting to spend more time with family. But please don’t turn it down because of taxes. We’ll sort out the details at tax time—but, yes, you’ll be dollars ahead.

9. “Can I deduct as a loss my investment in Iraqi dinars?” I had advised the client not to buy the dinars in the first place. In this client’s case, his income wasn’t high enough to trigger income taxes, making the capital loss worthless to him.

10. Instead of a wage increase, a company increased its contributions to the defined benefit pension, thereby decreasing its unfunded liability. An employee insisted that he should be able to take a tax deduction for the amount of wages lost.

It’s hard for a lot of people to connect the dots between the money they receive for wages and the value of fringe benefits, such as their pension and health insurance. I can only imagine the outrage if all of a sudden people had to pay tax on the cost their employer pays for their family’s health insurance, which can easily be worth $30,000 a year.

11. “If I won the lottery, I’d hide the money in the basement so the government wouldn’t tax me every year.” If you have the money in a savings account, you’d make a little interest and still be ahead after taxes, plus the money would be safer from folks who know you’ve got a pile of cash in your basement. Like your tax preparer, for instance.

12. “I’m filing as head of household,” a client told me.

“You can’t be head of household,” I explained. “You don’t have any dependents.”

“Yeah, but I’m still head of my household.”

Beam me up, Scotty.

Are these comments from stupid people? No, they’re from all sorts of people, many with advanced degrees and highly technical jobs. It’s just indicative of how opaque taxes can be.

I don’t want you to get the impression that, now that I’ve retired, I’m happy to be done with these misinformed souls. I’m not. By doing their taxes, I got to know these folks. When I run into former clients now, I get a vigorous handshake or a warm hug. I miss them.

I also miss the days when, if someone asked me about E.D., they were talking about elective deferrals to their 401(k).

For 30 years, Dan Smith was a driver-salesman and local union representative, before building a successful income-tax practice in Toledo, Ohio. He retired in 2022. Dan has two beautiful daughters, two loving sons-in-law and seven grandchildren. He and Chris, the love of his life, have been together for two great decades and counting. Dan’s previous article was Beer to Taxes.

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