What Happens to Me When the Government Shuts Down?

Good question.  Congress has to resolve the budget issue by March 5^th or technically the government will shut down.  Now, before I go on, I’d just like to get one nit-picky issue that really is bothering me out of the way:  As a small business owner, if I found out that my business would effectively be shut down in two weeks if I didn’t complete a project—I would be staying at the office until all hours of the night struggling to get the job done.  Congress, on the other hand, went home for a week.  I’m just sayin’…

Okay, back to topic.  What actually does happen if the government “shuts down?”  Social Security and veteran’s payments will still get made.  The post office will remain open.  Medicare and VA health care will still run as usual.  And of course our military will still be there to protect us.

So where will we experience problems?  National parks will be closed to visitors.  Close to ¼ of all federal workers will be staying home.  Federal contractors could be furloughed and that could really hurt some folks here in St. Louis.  But, there could be an exception for jobs relating to national security so we’ll have to see how that plays out.

And what about the IRS?  Income processing positions will remain open.  That is; if you owe money, those folks are still working.  Refunds, on the other hand, could be delayed.  The information hotline would probably be closed.  That’s right, it’s tax season, you need help and they send home all the help desk people.  It makes about as much sense as taking a one week vacation when you’ve got something really important to do.

By the way, Congress is deemed to be essential so it will remain open during the government shutdown.  I recommend that Congress and the Executive Branch work without pay until the budget is resolved.  Maybe it wouldn’t hurt many of them financially, but it would certainly make me feel better.

Crime and Taxes

In the Shawshank Redemption, Tim Robbins plays Andy, a banker falsely imprisoned for a crime he didn’t commit.  While in prison, he begins preparing tax returns for the prison guards which leads him to maintaining illegal books for the warden.  As Andy says to Morgan Freemans’ character, Red, “I never commited a crime until I went to prison.”

One of the more interesting aspects of the US tax code is that according to our tax law, you are required to report all of your income, even if it is from an illegal activity.  Anyone who’s seen the Untouchables knows that they got Al Capone for income tax evasion and not for any of the murders and other crimes he committed.  (Or am I supposed to say allegedly committed like they do on TV?)    Anyway, and I’m not making this up, the IRS  requires all thieves to report the fair market value of the items they stole on their tax returns.   Really.

But seriously, the crime I want to talk about is tax fraud.  In 2010, the number of fraudulent income tax returns increased by 50%.  That’s huge!  It’s estimated that 50,000 of those fraudulent returns were filed by prison inmates.  The IRS was able to catch about 4,500 of those forms because of falsely claimed Earned Income Credits.  EIC fraud is usually the easiest type of fraud to discover quickly because the IRS gets a conflicting tax return pointing out the fraud.  

Currently, state and federal prisons are not required to report the status of inmates to the IRS.  This makes it tougher for the IRS to catch the fraudulent prison returns and that hurts taxpayers who bear the tax burden while the fraud continues.   Of course, not all tax returns filed by prison inmates are fraudulent.  There are many legitimate tax returns that should be filed by prisoners.  For example:  a man is incarcerated in January but he had a full year of working on the outside and caring for his family before going to prison, that’s a very legitimate tax return. 

If the IRS had access to inmate status though, it would be much easier to determine which returns were for legitimate work,  and which returns were fraudulent.  While I’m not inclined to make life easier for IRS agents, this is one case where I think they deserve to have access to the tools that they need to do their job properly.

Tax Tips for Families with High School Aged Children

If you’ve got kids in high school, you know how expensive it can be—food, clothes, car insurance…  And of course, there’s that big expense coming up; college.   A little strategic planning right now could help you with your college expenses in the future.  Let’s take a look.

Senior year:  If your child is already a senior, you’ll be completing the FAFSA application soon.  You financial picture for the college process is already done so there’s not much you can do now.  Even if you don’t think that you’ll qualify for financial aid, you should complete the FAFSA anyway.  Should your financial situation dramatically change, you may be able to renegotiate your aid with the school.  You won’t be able to without a completed FAFSA application on file. 

Junior year:  This is the most important year for you as far as tax strategy.  If your child is a high school junior right now, then your 2011 income tax return is what will be used to determine your future financial aid.  It’s really important to think through any actions that may affect your income.  For example cashing out an IRA or 401(k) right now would increase your taxable income, and because of that would reduce your potential financial aid.  Cashing out stock for a capital gain—same thing.  On the other hand, cashing out stock for a capital loss would reduce your income.   Be sure to take advantage of any programs that would reduce your taxable income such as flexible spending accounts and adding to your 401(k) if possible.

Sophomore year:  This is the year before you’re working on the FAFSA.  If you anticipate that you’ll need to sell stocks, cash out 401(k)s or anything else that would raise your income, this is the year to do it in. While the parent of a junior would want to defer income, if your child’s a sophomore you’d rather claim the income during this year.  This is a little counter-intuitive.  A tax person is always going to advise deferring income, but this is the one year where that’s not the case because you really want to keep that junior year income down.

Freshman year:  Welcome to high school.  It’s hard to think about college when you’re still trying to adjust to Friday night football games and the concept of your child riding in a car with other kids.  In a perfect world, you’ve been saving for college since pre-school and you’re all set.  Unfortunately, the world isn’t perfect and life gets in the way.  Now’s the time to really think about money.  How are you going to pay for your child’s education.  While your student might not have a clue yet about what school to attend, you need to start thinking about it.  How much can you really expect to contribute to tuition?  How are you going to make up the difference?  You don’t need to solve all these issues now, but you need to do some serious thinking now, before you get to graduation without a plan.

Senior Small Business Owners: A Nice Surprise from the IRS

 

Let’s be real, how often do you get to hear the words “surprise” “IRS” and “nice” in the same sentence?  I know it’s rare, but a nice surprise is exactly what senior citizen small business owners are getting this year from the IRS.  For 2010, your Medicare payment counts towards the self-employed health insurance deduction.

This is brand new.  So new in fact, that people don’t seem to know where this new rule came from.  In the past, Medicare payments were never allowed to be used for the self-employed health insurance deduction.  The rule is not in the Small Business bill that was passed earlier this year, and it doesn’t seem to be hidden in the numerous pages of the health care bill either. 

So where can you find this new mystery tax ruling?  It’s right in the 2010 instruction book for the 1040 tax form.  It says: Medicare Part B premiums can be used to figure the deduction.  …For more details, see Pub. 535

 

Now if you go to Publication 535, you’ll find it says:  Medicare Part B premiums are not considered medical insurance premiums for purposes of the self-employed health insurance deduction.

 

Oopsies!  But according to the IRS, a new Publication 535 is being produced and it will say that you can make the deduction. 

So what’s it worth to you?  Depending upon your tax bracket – a few hundred dollars!  The average Medicare Part B premium is about $1200.   For 2010 only, you can use that $1200 to reduce your self-employment tax which would save you about $180.  Additionally, you’d reduce your regular taxable income by $1200 so you’d save even more.

Should you be worried about the conflicting rules?  No.  According to the IRS, the 1040 instructions are the rule to use. I don’t expect this rule to stick around for next year, but enjoy the gift while you’ve got it.

Why Your Take Home Pay Looks Messed Up

The number one question I’m getting these days (okay, besides how big will my refund be?) is “What happened to my take home pay?”  Hopefully, I’ve got some answers for you.

We’ve all heard that Congress voted not to increase our payroll taxes, but it looks like there’s more federal withholding being taken out of your paycheck.  What’s up with that?  Well, the income tax rate didn’t go up, but the “Making Work Pay” credit was taken out.  Because that credit it gone, your payroll withholding has gone up (somewhere between $400 and $800 per year depending on your filing status.)

The other change that we’ve heard about is that the Social Security withholding went down from 6.2% to 4.2%.  This makes your payroll withholding go down.  Depending upon how much you make, this might give you more take home pay than before, for others, it’s the opposite.  (Here’s a clue, the more money you make, the bigger this deduction will seem.)

If you get a pension, and not wages, the increase in the withholding will hit you harder because you don’t have social security withholding.

Now for many people, the payroll tax changes were not set up correctly for their first paychecks of the year.  Please don’t blame your payroll department; the changes came so late in the year, that computer programs were not programmed for the new rules.  This made for some crazy adjustments that showed up in later checks.  Hopefully, by now, your paycheck should be normal.

It’s always a good idea to check to make sure your payroll withholding is right.  The IRS has a withholding calculator that you can use to see if you’re on target for next tax season.  You might want to wait another week or so to make sure that all of the payroll adjustments are done and that you’ve got a “normal” check to look at before running the numbers through the calculator.  If you use a check with “adjustments” in it, the numbers will be crazy so make sure you’ve got at least two checks in a row that have the same withholding numbers in them.

Tax Tips for Persons with Different Abilities

I received a notice from the IRS about  “Tax Benefits for Disabled Taxpayers” and the first thing it mentioned was an increased exemption for blind taxpayers.  I found it a little odd because in other parts of the tax code, blind doesn’t constitute a disability so go figure. 

In IRS speak, disabled generally means you can’t work and are unable to care for yourself.  But, there are plenty of people who are in wheel chairs, deaf, blind, or with some other “disability” but are perfectly capable or working and fending for themselves.  Confused?  Me too.  This blog post is going to cover tax issues for persons with any type of physical or mental impairment.

So first,  blindness:  there is an additional standard deduction for being blind or partly blind.  If you are partly blind, you must get a certified statement from an eye doctor stating that your corrected vision is not better than 20/200 in the better eye, or that your field of vision is not more than 20 degrees.  Keep the statement in your records.  Of course, if itemizing your deductions gives you a better return, do that instead.

 Disability related payments:  certain disability related payments such as Veterans Administration (VA) disability benefits and Supplemental Security Income (SSI) are excluded from gross income on your income taxes.   If you receive employer provided disability payments, those are taxable. 

Impairment Related Work Expenses:  If you have a physical or mental disability that limits your employment; you may be able to claim business expenses in connection to your workplace.  This is different from the regular employee business expense deduction because you don’t have to meet the requirement that the expense exceed 2% of your gross income.  An example of this kind of expense would be a special computer screen for someone with a vision impairment.  The key requirement here is that the expenses must be necessary for the taxpayer to work.

Medical Expenses:  If you itemize your deductions, you may be able to deduct your medical expenses.  This is true for anyone whether they have a disability or not.  What’s important here is that you can include costs for making your home more accessible as a medical expense.   An example of this would be installing ramps or widening doorways to your home.  If the improvements you make increase the value of your home, they are not deductible as a medical expense.  An example of something that probably wouldn’t be deductible would be a heated spa; while it would be beneficial to have the heated spa to alleviate pain, the spa would also increase the resale value of the home and therefore couldn’t be claimed as a medical expense. 

Earned Income Tax Credit:  EITC is available to disabled taxpayers as well as to parents of a child with a disability.  If you retired on disability and receive taxable benefits under your employer’s disability retirement plan, that’s considered to be earned income for purposes of the Earned Income Tax Credit until you reach retirement age.  EITC not only reduces your tax liability, but it may even result in a refund.

It’s important to know that EITC has no effect on certain public benefits. Any refund you receive because of the EITC will not be considered income when determining whether you are eligible for benefit programs such as Supplemental Security Income and Medicaid.  

 If you have a disabled child, there is no age limitation for EITC.

Also, taxpayers who pay someone to care for their dependent or spouse so they can work or look for work may be able to claim the Child or Dependent Care Credit.  There is no age limit to this credit if the child or spouse is unable to care for themselves.

For more information about tax benefits for persons with different abilities, check out IRS publication 907 http://www.irs.gov/publications/p907/ar01.html

What To Do If You Don’t Have Your W2

It’s important to have your W2s before you try to file your income tax return.  If you take your taxes to a professional, it’s against the law for us to file a return without having a copy of your W2 in our files.  So what do you do if you don’t have yours yet?

Well first, your employer has until January 31^st to send your W2 out.  By now, you really should have it.  If it’s still missing, here’s what you need to do:

Call your employer.  That’s the easiest solution.  Give them a reasonable amount of time for it to arrive in the mail, but usually that will take care of the problem.  It doesn’t matter if he doesn’t like you or you left under bad circumstances, he has to give it to you—it’s the law.

 If calling your employer doesn’t help, and you have not received your W2 by February 14^th, then you need to call the IRS.  You’ll be calling the main line at 1 800 829-1040.  They’re going to ask a lot of questions so be prepared to give them your name, address, city and state, zip code, social security number, and phone number.  Then, you’re also going to give them your employer’s name, address, city and state, zip code and phone number.  Plus, you’re going to need to give them your dates of employment, an estimate of the wages you earned, the federal income tax that was withheld, and when you worked for that employer during 2010.  Basically, you’re going to get that information off of your final pay stub.  The numbers are going to be off of the “year to date” column.

 After you’ve done steps one and two, then you can file your tax return.  You’re going to use a form called a 4852.  It works as a substitute for your W2.  All the information that you called in to the IRS, is going to go on the form 4852 again.  Warning -your refund will probably be delayed until the IRS can verify the payroll information provided.  (This is why it’s so important to try to get the W2 from your employer first.  If you’re getting a refund you don’t want it to be delayed.)

 Sometimes, people receive the missing W2 after they’ve filed the form 4852 and the information is different.  If that happens to you, you need to file an amended return (form 1040X.)    This doesn’t happen all the time, I just mention it so that you know in case it does happen to you.

 One thing that’s important to remember is that you are supposed to report all of your income, even if you didn’t receive your W2.  You can’t just take a late W2 and put it on next year’s taxes.  It can get you into trouble if you try that so please don’t.  Also, you might not receive your W2, but the IRS probably did.  If you file a return without your missing W2, but the IRS does get the W2, then you could get a nasty little letter from them about why didn’t you report all of your income?  And what’s even worse, in my opinion, is if filing the W2 would have gotten you a bigger refund.  The IRS usually doesn’t bother you if they owe you; it’s usually the other way around.  So be sure to have all of your paperwork before you file, you don’t want to miss a thing.

Sub-Chapter S Corporations: Paying Yourself Enough?

Are you paying yourself enough?

Owners of Sub-Chapter S Corporations often pay themselves a salary and take the rest of the company profit as passive income.  It’s a pretty popular tax reduction strategy.  You don’t reduce your overall income tax rate, but you do save some money on the payroll taxes which amount to around 15% of your income. 

But it’s really important to make sure that the salary you pay yourself in your Sub-S Corporation is relevant to what you really should be paid.  Recently, the IRS won a case against an accountant, with 20 years of experience, in Iowa for only paying himself a wage of $24,000 while receiving distributions amounting to over $200,000.  According the IRS, a first year accounting grad can be expected to receive a salary of around $40,000.  They determined that the accountant should have paid himself a salary of $91,044.  (Okay, I know you’re thinking $91,044?  I can understand the $91,000 but how’d they get the $44?  Don’t ask me, I haven’t a clue.)

You may be wondering, why bother paying a salary out of the S Corp and taking the rest of the profits as a distribution in the first place?  Isn’t it all just profit anyway?  Well yes, but there’s a difference.  In the Iowa case, the man paid himself a wage of $24,000 plus he had distributions of $200,000.  In essence, his company had a profit of $224,000.  (I’m rounding, okay?)  If he were to receive all of that income as self employment income, he’d pay regular income tax on the $224,000 (less his deductions of course)  plus he’d pay 12.4% social security tax on $106,800 of that income, plus another 2.9% on the whole $224,000.  That’s $19, 739 over and above his regular income tax.  By paying himself a wage of $24,000, his employment taxes are $3,672.  Although it doesn’t work out that cleanly, he basically saved himself about $16,000 in taxes.  That is until the IRS stepped in.

For Subchapter S owners, this issue of an appropriate wage for self employment tax isn’t going to go away.  Last year Congress tried to make all Sub-S income from personal service firms (lawyers, accountants, and consultants) taxable as self-employment income.  The issue failed, but I suspect it will return again. 

So how should you value what you pay yourself?  The IRS doesn’t give us any firm guidelines.  Although some accountants suggest that any personal service provider should claim 70% or more of his or her S-Corp income as wages, the IRS only revised the accountant’s self employment wage to about 40% of his income.  That leaves us open for some interpretation.

One guideline I like to use for people who remain in the same career, but start a new business is what did they make performing the same service at their old company?  What would you get paid if you were to be hired today at a different company for the same job?  It’s a good way to substantiate that what you’re paying yourself is a legitimate wage. 

To read more about the case of the accountant in Iowa, check out the Wall Street Journal link here:  http://online.wsj.com/article/SB10001424052748703951704576092371207903438.html?mod=sf2tw

Tax Tips for Single People

If you’ve skimmed through my other blog posts, you might notice that I have lots of tips for people with children, people who are old, or people with various family situations.  What you don’t see is much about people who are single and working.  This post is for you.

If you’re a young adult out on your own, earning wages, and living in an apartment, you’ve probably noticed that you don’t have many tax deductions to work with.  The three most likely things you might qualify for are the student loan interest deduction, the IRA deduction, and the retirement savings contribution credit.  Other than that, unless you’re ready to buy a home, you usually don’t have much to work with.  But let’s take a look at these three items.

Student loan interest deduction:  if you’ve finished college, or are at least temporarily out, you’re probably paying student loans.  The most you can claim per year for this deduction is $2,500—now that’s for the interest you pay, not the principal.  I often find people trying to claim everything they paid and that won’t fly.  You can only use the amount on your form 1098E that you get in the mail. 

Now if you’re single and you make less than $60,000 per year, then you can claim the full amount of your deduction.  If you make over $75,000 you lose the deduction completely.  For those of you inbetween, you’re in what’s called the phaseout range.  It’s a funky equation, bottom line, the closer you are to $75,000, the less you’ll be able to claim. 

IRA deduction:  My Dad always used to lecture me about saving for retirement.  Now that I’m older, I just recycle his lecture. (I’m sure he doesn’t mind.)  If you don’t have a retirement plan at work, you can put up to $5,000 into a traditional IRA and that money will not be subject to income tax.    Let’s say your income was $50,000 a year.  With just your standard deductions, your total tax would be $6,350.  (Now hopefully you’ve been withholding all year and you wouldn’t have to pay in that much, that would be your total tax liability.) 

But if you put $5,000 into an IRA, then your tax liability would go down to $5,100.  By saving money for your retirement, you’d also save $1,250 off of your tax bill.  That’s a pretty good bang for your buck.

If you do have a retirement plan at work, you can just reduce your taxable income by putting money into your 401(k) plan there.  It works a lot like the traditional IRA.  One thing to remember, if you do have a retirement plan at work and you make over $66,000 then you won’t be able to claim a deduction for an IRA contribution.  You can still claim a full deduction if you make less than $56,000, and anything in between puts you into that “phase out category”.

Retirement Savings Contribution Credit:  Putting money away for retirement can be especially helpful taxwise if you qualify for the Retirement Savings Contribution Credit.  You can only claim this credit if you income is $27,750 or less though and you cannot be a full time student.  So, if you graduated in May and started working in June you wouldn’t be able to claim the Saver’s credit this year.  (But then we’re looking at the Education credit so that’s usually a better deduction anyway.)

The credit is worth between 10% and 50% of your retirement savings contribution.  The maximum contribution you can claim is $2,000—so even if you put $5,000 into your IRA, you could only claim $2,000 towards the credit.   The percentages work like this; if you made less than $16,750 you can claim 50% of your contribution.  Up to $18,000 you claim 20%, and over that you get a 10% tax credit.

So let’s say you made $25,000 and put $1,000 into an IRA.  You’d qualify for a $100 tax credit (1,000 times 10% is $100.)  Another cool thing about this credit is that you can mess around with it.  Let’s say that you make $28,000—oops, you can’t get a Saver’s Credit.  But wait, if you put $1,000 into an IRA now your income is only $27,000 and you do qualify. 

You don’t get a lot of tax savings options when you’re working and single, but it’s important to know what is available to you and how to make to most out of what you’ve got.

Is it Taxable?

Click here for more Late Show.

 Have you ever watched the David Letterman show when he does the “Will it float?” routine?  They pick some ridiculous item and drop it into a huge tub of water to see if it will float.  It’s probably the singularly most stupid thing on television, but I can’t turn it off.  I don’t think they do it anymore, but I loved it when they used to have it.   As a child, my best friend and I would fill up the sink and test all sorts of stuff to see if it would float or not.  I guess Dave was just doing the same thing (on a much bigger scale!) 

Anyway, that’s how I feel about taxable versus non-taxable income.  Will it float?  Do I gotta pay taxes on the money or not?  For me, most of the time, I already know the answer, it’s what I do for a living.  But there’s always some new challenge, something I haven’t seen before.  Figuing out if various types of income are taxable or not is my personal little “Will it Float?” contest.  And let’s face it; I always like to find money that you don’t have to pay taxes on.

Here’s a list of some of the things you do not have to pay taxes on:

• Child support payments
• Gifts, bequests and inheritances—you may have heard of estate taxes, but if Uncle Joe dies and leaves you cash money, you don’t pay tax on that.  If Uncle Joe dies and leaves you his IRA, those distributions are taxable, it’s different from just being left cash.
• Workers’ compensation benefits
• Meals and lodging for the convenience of your employer – let’s say your boss sends you to Chicago for a business trip and you put the trip on your credit card.  Your boss reimburses you for your hotel stay and your food, you don’t pay tax on that.
• Compensatory Damages awarded in a lawsuit.  Compensatory damages are to “make you whole.”  Let’s say you sued your neighbor because he ran over you with his car.  If the damages awarded to you are to cover your hospital costs, that would be compensatory damages and they wouldn’t be taxed.  If you sued for lost wages because you couldn’t work, that would be a different type of damages and that part of your lawsuit award would be taxed.  I’ve worked on tax returns dealing with lawsuits that awarded several different types of income from damages.  We’d have to split them into the correct categories for tax purposes.
• Welfare benefits are not taxed.
• Cash rebates from a dealer or manufacturer.
• Adoption expense reimbursements for qualifying expenses are not taxed either.

Some things are kind of iffy, they’re taxed in some cases and not in others.  Here are some examples of “maybe yes, and maybe no.”

• Life insurance- if somebody dies and you are paid death benefits, that’s not taxable.  If you surrender a life insurance policy for case, any proceeds that are more than what you paid for the policy will be taxable.
• Scholarship or Fellowship Grants- If you are a degree candidate, then you can exclude from your taxable income amounts that you receive as a qualified scholarship.  If you get one of those super scholarships where they pay for your room and board, that doesn’t qualify as tax free and you will be taxed on that part.

Most other items count as taxable:  wages, salaries, tips, unemployment, self employment, pensions, interest, stock sales, etc.

There’s an IRS publication that goes into complete detail of what is and isn’t taxable.  It’s 43 pages long and it goes into some serious detail over what is and isn’t taxable.  For example:  did you know that death payments for astronauts dying in the line of duty after 2002 are not taxable?  That one was new to me, I just learned it now trying to pick up the link to the website.  The alphabetical list of types of income and whether it’s taxable or not begins on page 31.  http://www.irs.gov/pub/irs-pdf/p525.pdf

When in doubt, it’s probably taxable.  There’s actually a line in the tax code that says, if something isn’t specifically listed in the tax code as being not taxed, then it is taxable.  (They don’t actually phrase it that way, to be honest, if you read the actual paragraph you may not even know what they’re saying.  I took some liberties with the language, but the meaning is head on.  If you discover a new type of income, and there’s no mention of it anywhere, then by default the IRS taxes it.

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