Tax Planning for Hobbits?

A local attorney and CPA whose firm specializes in advising clients who have accumulated substantial assets will be giving a breakfast talk Thursday morning with an intriguing title 

Financial Planning Association of NENY: An Unexpected Journey: A Hobbit’s Guide to Income Taxes

Thursday, Dec 20, 2012 7:30aWolferts Roost Country ClubAlbany, NYJoin us as Marty Finn, Esq. gives a spirited review of expired and expiring income tax provisions; new taxes, credits and reporting rules on the horizon; fiscal cliffs and other competing tax proposals and, most importantly, what to tell your clients right now about 2012 year end tax moves and planning for 2013 and beyond.

I am intrigued--but I am not going.  Mr. Finn's hobbit clients are so different from typical VITA site clients that it's hard to imagine I'll find out anything useful or relevant.  In general, tax advice for wealthy taxpayers is irrelevant (at best) or actually unhelpful (at worst) to low-income working families.

So much irony here, it's hard to know where to begin.  

Wolfert's Roost is a very fancy Albany country club named after a Dutch settler, Wolfert Acker, who built a small cottage in 1690, a humble but comfortable abode where a hobbit might indeed feel rather at home.  

In 1802, Washington Irving acquired Wolfert's modest estate and wrote his brother that he intended to make it over into a "little nookery" that would be "quaint but unpretending."  The picture below shows how those plans actually worked out into the grand mansion known as Sunnyside.

Wolfert's Rest Redux:  Sunnyside (image credit Wikipedia/Currier & Ives 1860)

Suffice it to say that the modern-day Wolfert's Roost Country Club looks far more like the grandiose Sunnyside than like the original Wolfert's Roost.   Indeed, both the country club and Irving's grand estate are as different from the original cottage as today's labyrinthine and complex tax returns are from the original  1913 tax return with its single page of instructions.

It's hard to imagine a humble hobbit (known for love of simplicity, their lack of materialism, and their modest lifestyles) being at home in a fancy country club learning about the ins and outs of how to take best advantage of an uncertain tax code.

But the hobbit analogy is certainly apt in that we do not have any clear map for the tax policy that faces us in the future--the fiscal cliff affords us little inkling of the financial consequences of many decisions high-income taxpayers have traditionally made in December.

But VITA sites like ours serve a very different population from the wealthier taxpayers whose decisions are likely to be the focus on Thursday morning's breakfast.   Mr. Finn's bio on his firm's website says that he specializes in "structuring business transactions" and "asset preservation," so clearly his business caters to hobbits who have accumulated assets to preserve or business transactions to structure.   

However useful Mr. Finn's advice might be for his hobbit taxpayer clients, it is unlikely to be of much help for typical VITA site clients.

With or without a fiscal cliff, VITA site clients have long faced extremely uncertain effective marginal tax rates (due to the income phaseout provisions for the various credits,  as well as the myriad of social assistance programs serving the poor, everything from SSI and TANF, food stamps, Section 8 housing subsidies, school lunches, to Medicaid.)  A few thousand dollars change in income in one direction or another can create wild gyrations in their marginal tax rates.   The tax code can be turned on its head for low-income taxpayers.  It is hard to know whether to give advice to go with a Roth vs. a traditional 401(k) if a taxpayer is uncertain about whether his effective marginal tax rate will be positive 95% (the rate recently estimated by Bloomberg News for some low-income taxpayers) or negative 40% next year, simply because he does not know what his income is going to be because he is not sure whether he will be laid off or how many hours of work his employer will be able to offer him or whether his precarious health will allow him to work.   And tax returns filed by low-income working families are far more likely to be audited than those of higher income taxpayers.

Even if low-income working families did have a clear roadmap of the tax policy horizon, it would be of little help.  Many VITA clients are "unbanked" with too little in assets to attract interest from traditional mainstream financial institutions and with very little control over their financial lives, little flexibility to move income or deductions or credits across years in order to game the tax system.  Most VITA clients are not homeowners.   The few VITA site homeowners may well be in negative equity positions due to an upside-down mortgage, and--in any event--they rarely realize much in the way of tax benefits from itemizing deductions.   Short of accelerating the birth of a baby due in January 2013 to late December (a move with potentially serious health consequences), typical VITA clients have few "year-end tax planning" strategies available to them.  

Their greatest concerns of typical VITA clients are not with *preserving* assets from taxes, but rather with just building up some assets in the first place and finding a financial institution which will not charge them large, confusing, or unpredictable fees for holding the very modest financial assets they do somehow manage to accumulate.