Q Dear Rick:
I have a tax problem that I would like your advice on. In 2013 I lost my job. I had worked for the company for a number of years and when I left, they gave me severance pay. The severance pay was equivalent to six months of earnings. In 2014, I couldn’t find a full-time job so I worked a number of jobs on a part-time basis. My tax issue is twofold. When I filed my 2013 tax return, I was told by a friend that you do not have to pay taxes on severance pay. He suggested that I attach a schedule to my return, which I did. The schedule basically was my W-2 less the severance pay. The net amount is what I reported as income. I recently received a notice from the IRS saying that I owe money. In addition to the amount of the tax they’ve also hit me with interest and penalties. I want to know the best way to contest the amount because I should not have to pay taxes on severance pay. Obviously, the schedule I attached was not sufficient. My second question deals with my 2014 tax return. In 2014, as I mentioned, I worked a number of part-time jobs. They claim that I did not report income from one of my jobs. I’ve also been told that I should not be taxed on the money since I did not receive a W-2. I did receive IRS Form 1099 but not a W-2. Hopefully, you can help me respond to the IRS.
A Dear Larry:
I hate to be the bearer of bad news, but I think when it comes to taxes you need to get some new friends. Unfortunately, in both cases the IRS is right and you are liable for the taxes.
First, with regard to the severance pay, there is a general misconception that the money is not taxed; it is. Just like receiving a paycheck, the IRS treats severance the same way. Therefore, the IRS was 100 percent correct and you are liable for the taxes on the severance. In addition, the IRS was correct with the assessment of interest. Interest is a function of time and since you did not pay your tax liability on time, interest is appropriate. The issue, however, is the penalties.
Penalties are meant to punish a taxpayer for not following the law. The IRS has flexibility with penalties that they don’t have in other places. It is very difficult or nearly impossible to have the IRS waive interest; however, it is possible to have them waive the penalties, particularly if this is the first time you’ve had issues with the IRS. In that regard, you can either petition the IRS on your own or you can hire a professional who has experience in trying to get the penalty waived. Of course, there are no guarantees they will waive the penalty and therefore, you need to keep that in mind when you consider hiring a professional.
With regard to your 2014 return, once again, you received bad advice. Whether you should have received a W-2 or a 1099 is a different issue. However, either way, that money is subject to taxes and should have been reported. Typically, the difference between a W-2 and a 1099 is that W-2s are for employees while 1099s are for independent contractors.
When it comes to taxes, the consequences can be substantial for those who do not properly prepare their tax returns. That is why I always say if you’re going to seek advice regarding taxes, be very cautious who you receive that advice from. If the person you’re seeking tax advice from is not in the business, which probably means they don’t have a commitment to continuing education and staying current on the tax laws, it’s probably a good idea to seek advice elsewhere.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at email@example.com