Is Your 401(k) Helping or Hurting You?
Jan's Frying Pan
I usually tell people that they should be putting money into their IRAs or 401(k)s to save for retirement. And while for many people I still think that’s a good idea, after this past tax season, I’m having second thoughts. Here’s why:
If you are not retired you should not be receiving income from your IRA or 401(k).
Now I understand life happens and sometimes people need to tap into those funds. But if you need to tap into your retirement funds for something other than retirement, then it means that you don’t have enough funds in your regular savings.
Here’s what happens—people tap into their 401(k) when they wind up in financial trouble. It doesn’t really matter how they got there, maybe its medical bills, maybe it was a tornado. The point is they needed money and the retirement fund was all that was available.
They get hit with taxes on the money they withdraw and they also get dinged with a penalty for early withdrawal of the funds. So they wind up being double taxed when they’re already in financial dire straits. Often, the withdrawal bumps them into an even higher tax bracket, making the hit even worse. If they would have had that money is a savings account that they could access—then there would have been no tax implications for getting at that money.
Okay I can hear you now, “Look, Sherlock, I already tapped out my savings account before I went to the IRA. I’m not stupid, I was desperate.” And yes, I do hear you. Where I’m coming from is that as a country, we all don’t put enough money into savings. We all, as a nation, are better at putting money into our IRAs and 401(k)s. We get tax incentives to do it. Sometimes our employers sign us up without our even realizing it. And it makes the IRS happy because they wind up getting more money out of us by giving us a tax break.
What’s that? Yes, the IRS makes more money off of us by giving us a tax break on our 401(k)s because we break into them so often. The sales pitch is put money into your 401(k) and you don’t pay tax on that money. Then, when you take it out, you’re supposed to be in a lower tax bracket so you “win”. The reality that I’m seeing these days is—people are putting their money into their 401(k)s while in the 25% tax bracket and taking it out while still in the 25% tax bracket and paying an additional 10% penalty on the money. The only winner I see here is the IRS!
So what’s the solution? Put money into a savings account. A real savings account—not a “this money is for our Disney vacation account“ — I mean this money is for “Dorothy and Toto blew away with the house and Auntie Em is in the hospital” account.
Savings accounts aren’t sexy. You don’t get any tax incentives to have one. Heck, you don’t even get a toaster anymore! (I still use a frying pan that my mom got for opening a bank account back in the late 40’s or early 50’s. It’s a great frying pan.)
But if it makes you feel better, think of your savings account as your way of cheating the IRS out of a little unearned bonus money. That might be all the incentive you need.
Filing an Extension for Your Personal Taxes 2012
Photo by david.ian.roberts on Flickr.com
Are you late filing your taxes this year? You’re not alone. It seems that many people are behind. Hey, it’s not really your fault—Congress changed a bunch of rules on us at the last minute. No wonder so many people are behind.
If you need to file an extension—that is, ask for more time to file your taxes, there are three ways to do it.
1. File electronically, using tax software. If you don’t have tax software already, you can use the 1040.com software on this website. Here’s a link: http://robergtaxsolutions.com/do-your-own-2011-taxes/
2. You can mail in a paper copy of the extension form. It’s called a 4868. Here’s a link: http://www.irs.gov/pub/irs-pdf/f4868.pdf
3. You can make a payment towards your taxes with a credit or a debit card. And that will give you an automatic extension for your taxes. (You can also use EFTPS, but if you don’t know what EFTPS is, it’s too late to use that option. For more information on EFTPS: http://robergtaxsolutions.com/2010/12/irs-electronic-deposit-rule-starts-january-1st/)
If you just want to make a payment, it’s pretty easy. You’ll start at the IRS website, and chose your payment provider from there. Here’s the link: http://www.irs.gov/uac/Pay-Taxes-by-Credit-or-Debit-Card
It’s important to know that an extension gives you an extension of time to file your tax return; it’s not an extension of time to pay your taxes. I think a lot of people want to file extensions because they owe and they think it will give them more time to pay. It doesn’t.
The penalty for paying late is ½ of 1% per month. So, let’s say that you owe $10,000 on your taxes. You file an extension, but don’t pay anything towards what you owe. When you actually file and pay in October, instead of owing $1000, you’re going to owe an extra $300. (.005 times $10,000 times 6 months = 300)
But here’s important news—I’m going to quote it because it’s that important:
“The IRS is providing late payment penalty relief to individuals and businesses who request tax-filing extensions and attach to their returns any of the “delayed” forms that couldn’t’ be filed until February or March.”
Here’s a list of the forms that are affected: http://blog.drakesoftware.com/2013/01/list-of-irs-forms-that-1040-filers-can.html
Granted, not everyone will be filing the “mine rescue team training credit” form, but lots of people will qualify with the education credits, or the depreciation form. Do check the list to see if you qualify for penalty relief.
No matter what, if you’re not ready to file your taxes before April 15th, do file an extension. Although the late payment penalty is ½ of 1% per month, the penalty for not filing (or filing an extension) is 5% per month. That’s ten times as much as the late payment penalty. You don’t want to have to pay that.
Seven Things You Need to Know About Claiming the Foreign Earned Income Exclusion on Your US Tax Return
Photo by mammal at Flickr.com
If you’re an American citizen working outside of the country, you may be able to exclude some (or even all) of that income from your US income taxes by using Form 2555, the Foreign Earned Income form. Here are some things you need to know about the form:
1. Currently, the exclusion for 2012 is $95,100. The exclusion for 2013 will be $97,600.
2. In order to claim the exclusion, you must have a tax home in a foreign county. You must also meet the bona fide residence test or the substantial presence test. Basically, if you work full-time inside a foreign country for the entire calendar year, then you’ll meet the bona fide residence test. If you work outside the United States for 330 days out of a 365 day period, then you’ll meet the substantial presence test.
3. If you are in a foreign country as a US government employee, then you are not allowed to claim the foreign earned income exclusion.
4. When reporting your foreign income, remember to convert any income and expense amounts into US dollars. You can get foreign currency exchange rates from the US Department of the Treasury: http://fms.treas.gov/intn.html
5. If your income turns out to be higher than the exclusion amount, your tax rate will be the higher rate, as if you had to pay tax on the full amount of income. For example, if you prepared your tax return and after claiming the Foreign Earned Income exclusion and any other deductions that you were entitled to, let’s say you have $5,000 of taxable income left. Normally for a single person, $5,000 of taxable income would mean $500 of tax—because that’s the 10% income tax bracket. But not in this case. It’s more likely to be $1400, because when you add back the excluded income, it puts that single person back into the 28% tax bracket.
6. If you are married and your spouse works, you may each claim an exclusion for foreign earned income.
7. If you claim the foreign earned income exclusion, you cannot take the credit for taxes paid to a foreign country on any income that was excluded. If your income exceeds the exclusion amount, it’s generally a good idea to run the numbers both ways to see which gives you the better tax advantage.
Expat taxes can be confusing. If you’re trying to navigate your way through the Form 2555, give us a call, we can help.
Is My Social Security Income Taxable?
Photo by Jan Roberg.
People often ask me if their Social Security income is taxable. No, sorry, I just lied. When I finish preparing a tax return for someone on Social Security I’ll often hear, “What do you mean my Social Security is taxable? ” People who say that are usually angry when they say it too. But, for many people, Social Security is taxable.
So how do you tell if your Social Security is going to be taxed? Here’s the quick and dirty way to figure it out. First, take half of all of the Social Security income you get and add that to all of the other income you get. If you’re single and the amount is over $25,000 you’ll start getting hit with tax. If you’re married filing jointly—then you’ll start getting hit at $32,000. If you’re married-filing separately and don’t live apart—then it’s all taxable.
So this can totally mess up your tax rates. For example—let’s say you ‘re currently in the 15% tax bracket and you haven’t crossed into “Taxable Social Security Land” yet, but you’re right on the border. You want to take a really nice vacation and it’s going to cost you $10,000. How much money do you need to take out of your IRA to go on vacation and pay the income tax?
Well, you know you need 15% more for the tax so let’s say you take out $12,000.
$12,000 X 15% = 1800
That means that you’ll have $10,200 for your vacation, right? (12,000 IRA – 1,800 income tax = 10,200 vacation money)
Looks good, except it’s wrong. See, if you’re on that border, then half of the $12,000 is going to go into the taxable Social Security pile. So instead of paying 15% on $12,000 you’re paying 15% on $18,000; that’s another $900 in taxes. ($18,000 X 15% = $2,700 and $2,700 – $1,800 = $900)
Now you don’t have enough money to pay for your vacation. You’ll need to be taking more out of your IRA and then even more of your Social Security will be taxed.
Because taking that distribution makes your Social Security Taxable—your real tax rate is 22.5% instead of 15%.
$2,700 tax divided by $12,000 distribution = 22.5% tax rate
For lots of people, there really isn’t much you can do. If your income is high enough, you’re stuck with your Social Security being taxed and there’s no way out. But for some folks—you can plan ahead to avoid this bumped up tax—or at least try to reduce it. You’ve got to know about the tax though if you’re going to plan ahead for it. If you want help figuring out if your Social Security is taxable, give us a call.
Olympic Tax Bill
Photo by SouthEastern Star ★ on Flickr.com
It seems that Congress is falling all over itself trying to make the prize money that our Olympic athletes win in London tax exempt. They’ve had a week to watch the games, think about it, and propose legislation. Pretty fast work for our political leaders. I guess Congress cares about your tax bill if you’re an amazingly great athlete—but they don’t care enough about the rest of us to finish the work for settling the tax code for our 2012 taxes. Yes, I’m talking about this year’s taxes!
Seriously, we’re hearing all of the candidates talk about what they want to do with our taxes for 2013—next year. But as of this date (August 2012) there are several tax issues that still haven’t been decided about your taxes for this year. Did you know that?
Here’s the big thing we don’t know yet:
AMT, the Alternative Minimum Tax. Right now, the exemptions for AMT have fallen to the old 2001 levels. If you were married filing jointly in 2011 and made less than $150,000, your AMT exemption would be $74,450. Using the 2001 rules, the exemption is $49,000. Now for most people, talk about Alternative Minimum Tax sounds like a bunch of mumbo jumbo—but to put things in plain English—if our people in Washington do not settle this issue, 20 million more Americans are going to get hit with the AMT tax this year. Most of those people have no idea this is coming. You could be one of those 20 million and not even know it. And I’m talking about 20 million people who will be added to the AMT rolls; people who already pay the alternative minimum tax will be paying even higher AMT taxes than in previous years. Thousands of dollars more!
Now, in fairness, the Senate does have a bill on the floor that would actually increase the exemption by $4,300. I expect it to pass (I hope), but not until much later this year, like in December. There’s something fundamentally wrong with not knowing what you should have to pay on your income taxes until after you’ve already earned your entire year’s salary.
Some other tax issues for this year that are still up for grabs include: deducting state and local sales taxes instead of state income taxes, the classroom teacher deduction of $250, allowing senior citizens to transfer IRS funds to charity tax free, the tuition and fees deduction for college expenses, and a whole host of business related tax incentives. How can you make a move if you don’t know if you don’t know if you’re allowed to do it or not?
Congressional inaction on current tax issues means that many people will have their refunds delayed next year. That’s not fair to you or to me.
But back to the Olympic athletes: I’m an Olympics junkie. I love watching the games and I admire our athlete’s accomplishments. And when NBC does its little heart tugging stories on our athletes’ struggles, I understand wanting to give them all a break. But how much of a tax break do we really need to give folks like Serena Williams, Michael Phelps, and LeBron James? They’re already making millions of dollars a year. Here’s the thing—if Congress were to pass the new AMT exemption—it would essentially make Serena’s gold medal prize money tax free, while at the same time helping millions of other Americans who could probably use the tax break a little more than Serena does.
I get it, the Olympics is news and talking about them gets our politicians some media exposure. (Guilty as charged, I’m blogging with an Olympic theme myself.) But there are some very real tax issues this year for the rest of us that Congress hasn’t addressed yet – and we deserve to have our leaders settle the issues sooner, rather than later.
PS: As far as the medal earnings for the athletes that are not already millionaires is concerned—any decent accountant will be able substantially reduce the tax on Olympic winnings, and in many cases reduce it down to zero. From a serious tax standpoint, it shouldn’t even be an issue.
Does the New Health Care Bill Have a 3.8% Sales Tax on Selling Your Home?
Photo by therichbrooks at Flickr.com
I received a question from Laura who asked:
“I just received an email from a friend that said that there will be a 3.8% tax on all home sales after 2012 and that this tax is part of the Health Care bill. Do you know anything about this and can you clarify it? Thanks.”
I’ve heard that one too, but it’s not exactly true. Last week I wrote about a 3.8% Medicare tax on investment income which includes long term capital gain transactions of real estate—and that’s the rule that people are referring to when they talk about a sales tax on selling your home.
Let’s sort this out so you know exactly what’s going on.
Bottom line: if you sell your house after you’ve lived in it for at least two years, $250,000 of the profit is excluded from capital gains tax. ($500,000 if you’re married.) Let’s say your house cost $200,000 (this is usually referred to as “basis” in the tax prep world) when you bought it and you sell it for $400,000, that’s a gain of $200,000. You’re not even in the running for paying the 3.8% Medicare tax because all of that gain was excluded from your income. For you, this Medicare tax would not be an issue at all. None of the proceeds from the sale of your home in this instance would even show up on your tax return.
Now let’s say you live someplace where the property values have gone up astronomically. (Clearly you don’t live in my neighborhood if they did. Our values just seem to drop while our property taxes go up. Sorry, I’m whining.) Okay, let’s say you live someplace where real estate values have increased way more than they have here in Missouri—then you could have an issue.
Let’s say you bought your house for $100,000 and sold it for $800,000 so that you’ve got a profit of $700,000. A $700,000 profit is a good thing! Assuming that you’re married, you get to exclude $500,000 of that gain from the capital gains tax so you would only pay tax on the extra $200,000.
Let’s do the math: $800,000 sales price – $100,000 purchase price = $700,000 capital gain.
$700,000 capital gain – $500,000 capital gain exclusion = $200,000 that you have to pay capital gains tax on.
A transaction like that will kick you into a high enough tax bracket to pay that extra Medicare tax in addition to the capital gains.
For most normal folks—we’ll never have to pay the Medicare tax on the sale of our homes.
If the value of your home has increased so much that you have to pay that tax—then to quote Charlie Sheen, “Winning!” Seriously, you’d have gained $700,000 on the sale of your home. That would be awesome. And you’d only have to pay capital gains tax on $200,000 of it.
Right now—the capital gains tax for 2013 is scheduled to be 20% (who knows what Congress will say before the year is out but that’s what it’s scheduled to be.) And the extra Medicare tax will be 3.8%. So—let’s do the math on that:
200,000 taxable gain x .2 capital gains tax = $40,000
200,000 taxable gain x .038 Medicare tax = $7,600
So the total tax on that gain would be $47,600. As bad as that sounds, remember we’re looking at a $700,000 gain to begin with so you’re really only paying 6.8% (or 47,600/700,000 * 100) tax on that amount. Granted, we’re talking about one little example with crazy numbers—but remember—that’s for someone who has enough gain to have to pay in the first place. Like I said earlier, for most of us—we’re looking at zero tax money spent on the sale of our homes.
(Note from editor: So I checked the web and saw that many people were receiving emails claiming that there was this 3.8% sales tax on the sale of your home. However, what these emails failed to explain was the exclusion amounts (250k single or 500k married) that are shielded from tax. They later went on to criticize the health care bill and our current president. Since it is an election year, you are probably more susceptible to emails or messages like this to try to get you to vote a certain way. Do your research and keep checking in with this blog for the most recent and accurate information.)
The Government Imposes Taxes to Make Us Behave the Way it Wants Us To (An Editorial)
Photo by Tom Lohdan on Flickr.com
The Government imposes taxes to make us behave the way it wants us to. Whew! That sounds like something one of my “nutjob government conspiracy type” friends would say, not me. Except that it’s true. If you don’t believe me, just take a look at the so called “sin taxes”. You know, the extra taxes imposed on cigarettes and liquor.
The federal government taxes each pack of cigarettes by a $1.01. Add to that the state taxes, here in Missouri, we have the lowest cigarette tax in the country at 17 cents a pack, but Washington State has a tax of $3.20 per one single pack of 20 cigarettes. You really gotta want a cigarette to smoke in Washington.
Beer, on the other hand, only brings in 5 cents per 12 ounce can to the feds. But a bottle of tequila will fetch $2.14 cents in taxes. And that’s before adding in the state taxes!
So maybe you don’t smoke or drink, you might think these taxes don’t apply to you. But it’s not just our sins that the government is trying to control; it’s our shopping behavior as well. Think about the First Time Home Buyer Tax Credit–a nice chunk of change of up to $8,000 for buying a new home. The energy tax credit–for making our homes more energy efficient. And of course the energy efficient vehicle tax credit–for buying an electric or fuel efficient car. All of these tax credits were intended to help various industries.
So maybe these programs didn’t apply to you either, but here’s one that probably did: The Economic Stimulus Act of 2008. Maybe you remember that’s the year that everybody got an extra $300 check in the mail. The idea was that if everyone in America got an extra $300, they’d go out and spend it and that would jump start the economy again. Unfortunately, that didn’t work. A large percentage of the population used that money to either pay down their credit cards or add to their savings accounts–we didn’t get the consumer bang that the government wanted. You might remember we later got the “Making Work Pay” credit, which basically gave us an extra $400 but it was doled out in our paychecks in tiny increments over the course of the year. People hardly noticed the increase in their paychecks, so the money just got spent.
The analogy that I think of here is that it’s kind of like having a $50 bill in your wallet. I don’t get 50 dollar bills very often, so when I do get one I tend to hang onto it for awhile. “I’ve got a $50 dollar bill, it’s special, and I don’t want to spend it!” Now give me a $5 or a $1 bill and it’s gone. My nephew calls it “blowing your money away.” (He actually uses a slightly different phrase but I’ve been edited for my G rating.) You understand though, it’s much easier to let small amounts of money slip through your hands than larger amounts. So these little tax games have made us spend more money–without us even being aware of it.
And I have a problem with that. I don’t like the idea of being manipulated for one thing. But more importantly, I think our tax code sends a message about American values that I don’t think we as a country should be sending. As a nation we talk about the importance of marriage and of children being raised in a two parent family–and then we pay a premium to unmarried parents through the Earned Income Tax Credit. I don’t think it was intentional, but that’s what happens. Young married families with two incomes get phased out of that tax credit, but if you don’t get married–then you get the money. And it’s huge! We’re talking thousands of dollars a year. That’s a big incentive for not getting married. Why are we doing that?
There’s already been lots of talk from the politicians about changing the tax code. “Tax the rich”, “don’t tax the rich” those arguments can go on for hours. But what I’m not hearing, and what I’d really like to hear, is where should our country be headed? How do we get there? How much is it going to cost? And how are we going to pay for it over the long haul? These quick-fix one-year only tax incentives aren’t the way to run a country. And while the rich are very concerned about their taxes (and rightly so, they seem to have the most to gain or lose during this election) the tax code affects everyone; rich, poor, and middle class. We need long range planning, long range goals, and a long term tax plan. Let’s bring the grownups to the table, drop the manipulation games, and get to work on a real solution.
