No Tax Deduction for Lost Wages
Q. I work for a nonprofit organization that ran out of funds and was unable to pay me for four months this year. I continued working and do not expect those wages to be paid, even though I am now drawing my salary again. Is there any way I can treat my lost wages as a tax-deductible charitable contribution? My employer’s attorney would like me to sign a statement acknowledging that I was not paid to rule out any potential future lawsuit.-- L.L.
A. Unfortunately, there is no significant tax benefit for you from this situation; you are simply out the cash. The Internal Revenue Service does not permit taxpayers to deduct the value of their own donated labor, which is, in essence, what your forgone salary would be considered. However, there may be one small tax break available to you: a deduction for your automobile mileage and other uncompensated, out-of-pocket expenses associated with your four months of donated labor.
According to our experts, you may deduct 12 cents per mile for any work-related mileage you accumulated, including your commute to and from the office, during those four months, since your services were basically volunteered.
Perhaps you may have considered asking your employer to pay you for those four months of work with the understanding that you would turn around and donate the money back to the organization. Although such a move would qualify as a tax-deductible charitable contribution, there are several important issues you should consider before taking that step.
First, unless you donate the full amount of your gross salary, your organization would be out the amount normally deducted from your gross wages for your benefits and taxes. This probably would not make your employer happy. However, if you were to reimburse your employer for your entire gross wages, you would be forced to donate more than you actually received, possibly as much as 20% to 25% more. This may not make you happy.
Finally, any wages you receive--whether or not you donate them back to your employer--increase your gross income, potentially putting you in a higher tax bracket. A higher gross income also means a higher threshold for medical, miscellaneous and other deductions based on income, such as your $2,300 personal exemption.
Our experts recommend that, at least for the purposes of your tax situation, you consider your lost salary as exactly that: lost. However, before you sign any agreement giving up the right to sue for these wages, consult a trusted legal adviser. Perhaps there is some right to repayment you can reserve in the event your organization receives a huge windfall in the future. Or perhaps you can reserve the right to take extra vacation or paid days off when you need them.
Ratio Is the Key in IRA Withdrawals
Q. How do I handle distributions from my three individual retirement accounts when I turn age 70 1/2 and must make withdrawals? I have both tax-deferred IRA contributions and after-tax contributions in these accounts. May I withdraw the after-tax money first? If not, how do you figure the correct mix? Do I have to withdraw proportionately from each of my three IRA accounts?-- F.A.B .
A. The government wants you to think of your IRAs as having a taxable basis that is equal to the ratio of all your after-tax contributions to the total current value of all your accounts. And the government wants you to apply this ratio to whatever money you withdraw from your accounts, regardless of what account the withdrawal is made from. In fact, the government doesn’t care which account you take the money from; it only cares that the correct ratio is used when determining what percentage of that withdrawal is taxable.
Here’s how the ratio is arrived at, using simple round numbers. Let’s say your IRAs have a current total value of $800,000 and that $200,000 of this was contributed on an after-tax basis. This means that one-quarter of your first withdrawal would be tax-free and three-quarters would be taxable.
For your second withdrawal, you would calculate the ratio by dividing the remainder of your initial after-tax investment--the $200,000 minus whatever share of the first withdrawal is attributed to your after-tax funds--by the then-current total value of the investments.
Remember, only the initial after-tax contributions are withdrawn tax-free. The interest these investments have earned is still taxable; this is why you must always consider the total current value of the accounts when calculating the appropriate taxable/tax-free split of your withdrawal.
Investments Dictate Gift Tax Consequences
Q. I am giving my son the maximum $10,000 per year that I am allowed to give without triggering gift tax consequences. May I also loan him some money, possibly as much as $100,000, without gift tax consequences? --M.B.
A. The answer depends on two critical factors: the amount of interest you are charging your son and whether or not your son is receiving interest income on any investments. If your son does receive interest income from investments, your loan would have to carry an interest rate equal to or greater than the “applicable federal rate” for family loans for you to avoid both gift tax and income tax consequences.
If you charge less than the applicable federal rate, an amount that floats with the market and is set every six months, the forgone interest would be considered a gift from you and deducted from your lifetime gift limit of $600,000. You would also be required to claim as your income the amount of interest your son receives on his investments.
If your son receives no interest income from investments, you may loan him up to $100,000 and charge less than the applicable federal rate and still have no gift or income tax consequences.
