Can you slip into Tax Debt America and if you do, can you get out?
An article (and quiz) at the New York Times by Emily Badger & Margot Sanger-Katz asked the question – Could you manage as a poor American? I began to think about this question with respect to tax debt – how does one can fall into tax debt. Tax debt isn’t a situation I would wish on anyone – obviously it’s a financial condition and in many cases just unfolds suddenly. Would you make the same mistakes that cause people to owe the government? Here’s a short quiz to figure out the effect from what might appear to be a harmless stumble.
- Have you experienced a large once-in-a-lifetime type of event? Winning a lottery or receiving a large sum of money from cashing out retirement all at once.
- Relied on someone you trust to “handle” your tax affairs?
- Had to make “rob Peter to pay Paul” type of decisions about your expenses and other obligations?
Here’s a couple stories where people think they are on the correct path – only to be blown up by an unexpected tax debt.
Jim Snodgrass of Wichita, KS had retirement on his mind. After 33 years working at the large agricultural company in town, he could see a light at the end of the tunnel. The company was offering to buy-out long term employees by offering an early retirement plan. Jim would get a severance package which would double his income this year – even though he only worked 6 months!
Though he wasn’t yet 59 and a half, Jim figured he could pay off his house and truck and live comfortably off the rest of the money until he was able to collect social security. It seemed like a reasonable enough plan until he received a large and unexpected tax bill!
This was Jim’s once-in-a-lifetime type of event. With his regular income, his severance and his retirement money, for the first time in his life, Jim reported income that placed him in a never seen before tax bracket – and resulted in a tax bill for the first time in his life.
He had already spent the money paying off his home, his car and some credit card debt. A little was left over – but Jim still had regular (albeit diminished) living expenses like food, utilities, insurance. What to do? His plan for retiring early was falling apart.
Mike Olenfeld from Manketo, MN drives a truck to make his living. Over three million people do the same supplying our familiar Walmart, Target, Home Depot or local grocery store. Truck driving can often require driving long-haul where a trip can take several days and a driver will have to stop to rest somewhere before continuing. Being away from from home makes doing things at home rather difficult.
Financially related tasks are pretty tough to complete unless you have someone you trust to help. Usually that person is your wife whose life is tied up with yours and generally, both you and your wife are pulling in the same direction. Mike was married and likes to joke that he’s allergic to paperwork. He can get his loads to and fro’ but don’t ask him about how much he made or what his tax bill is – he’ll just say ask my wife.
Alice wasn’t married to Mike and definitely wasn’t happy. She had been planning to leave for a long time. She didn’t like being alone for long stretches of time when Mike was on the road. She hated being his accountant and bookkeeper. When Mike arrived from a two-week haul, he would present a plastic bag full of truck stop receipts to Alice. Her job was to sort and organize them for the accountant when it came to prepare their taxes. Alice was also supposed to make estimated tax payments – the current estimated tax due quarterly.
Alice stopped making estimated tax payments. Alice stopped filing. And then Mike was surprised to come home to an empty house. Alice was gone and took everything with her. The financial impact was severe. Utility bills were past due. So was the rent on the house. Alice had been stockpiling Mike’s cash so that she could escape.
All of his sudden, Mike found his world upside down. He was broke, alone and nearly homeless. It took him three years to figure out the IRS said he owed $80,000.
The divorce was finalized. Mary would get the house and the two kids. John would have to pay child support. Then there was the matter of the retirement money. Mary would get some of that too.
He and Mary were doing pretty good financially. Together, they were earning over $100,000 which put them in the top 15% of income in the US.
Regardless of why the divorce happened, John’s finances took a triple whammy. He went from filing married filing jointly with 2 dependents and being a homeowner with its associated tax breaks, to a single person who now rented an apartment with no dependents, and a child support obligation. On top of that, he was forced to give his wife, part of this retirement savings and since he was not 59 and ½ yet, he had to pay income tax and penalties.
The quick change to his financial position meant John had to improvise with respect to his finances. He could no longer cover all his bills so he instructed his employer to send less of his income to the IRS. This helped in the short-term but made his tax bill much worse.
All of these stories illustrate the speed at which tax debt can happen. I’m reminded of the quote, “how did you go broke? First slowly, then all at once.” The same idea rings here. Tax debt can happen quickly and unexpectedly and then grants people a place in Tax Debt America where fixing the debt isn’t so easy and can often take years.