I get this question every year. Why did my friend, neighbor, co-worker, relative, etc. get a bigger refund than I did? And the honest answer to that question is: I don’t know, I didn’t prepare their taxes. But here are some common reasons why some people might get a bigger refund than you do.
1. They withheld more. That’s the simplest explanation. Technically, you only get back if you overpaid your taxes. So, people who withhold too much, get refunds. If you get less, that actually means you win because you didn’t over withhold. (But trust me, I know. It really doesn’t feel like winning.)
2. They qualified for the earned income tax credit. EItC is one of those tax credits that you can actually receive even if you didn’t pay anything into the system. But—there are many requirements—most notably you have to have earned income. The EIC can make a huge difference in someone’s refund.
3. College tax credits—the American Opportunity Credit can be worth up to $2,500 on someone’s tax return. If your friend was attending school while you stayed home—that could be part of the difference also.
4. Different filing statuses—if you’re single, you could be in a higher tax bracket than your married friend. Or, if you’re married and your wife is also working—then you could be in a higher tax bracket than your single friend. Even though two people have the same job and earn the same amount of money—their circumstances outside of work could have a huge impact on their tax refund.
5. Different deductions—once again, it all has to do with things that happen outside of work. A person renting an apartment could be paying higher taxes than someone paying a mortgage because of the mortgage interest deduction—or any number of other deductions. There are just too many things to name.
6. Income—The more money you make, the more tax you pay. And people who make a lot of money have to pay the alternative minimum tax or AMT.
So, don’t waste your time worrying about your friend’s refund. The important thing is to think about what your goals are. Do you want a big refund? If so, how big of a refund do you want and what would you do with it?
Or would you rather take home more money with each paycheck? If so, what will you do with the extra take home pay?
But whether you choose a larger refund, choose larger take home pay, or maybe choose some middle ground; our job at Roberg Tax Solutions is to help you pay the least amount of tax while making smart decisions for yourself and your family. As long as you’re doing what’s best for you, it really doesn’t matter what your friends are doing anyway now does it?
The Jan Tax Plan
After two weeks of political conventions I thought I’d know a whole lot more about the tax plans for the Republicans and Democrats. Oh, I’ve heard some high minded ideal stuff—but not much in the way of nuts and bolts. If you’d like to do a comparison, you can check out the Tax Foundation’s website to see how they compare and how they compare to the Simpson Bowles plan too: http://taxfoundation.org/article/romney-obama-simpson-bowles-how-do-tax-reform-plans-stack
But since Romney and Obama didn’t give me what I wanted to hear, I decided to make up my own tax plan. To be honest, it’s more of a reflection of problems that I see with tax returns that I actually work on but these are the top changes that I would make if I were in charge.
1. Earned Income Tax Credit: First I’d reduce EIC payouts by 10% per year until it’s reduced by 30%. In order to claim EIC for a child, you’d be required to produce the child’s report card with passing grade. Why the cuts and why the extra requirements? First, the EIC credit is so high right now that it encourages fraud. Currently, the IRS estimates that between $12 to $14 billion dollars of EIC fraud occur every year. If the payout wasn’t so high, the temptation for fraud wouldn’t be so great.
The extra requirements would help ensure that the kids in our communities get a better education. Everybody gives lip service to more education, and parental involvement is key to kids succeeding in school. Well, if your kid is required to pass school in order to get the Earned Income Tax Credit, I think we’d have a whole lot of parental involvement. No report card, no money.
If the child is too young to attend school, a current immunization record would be required. It’s proof that the child is getting proper medical treatment.
One more thing on EIC—if a person is caught fraudulently claiming a child on his/her tax return, the penalty, besides paying back the tax, should be never being able to claim EIC again. Ever! I work with a lot of the EIC fraud victims, I think they’d really like that rule.
2. Self-employment income: If you receive 1099 MISCs and the total amount is less than $4,000—you should have the option to elect to count that as “hobby” income instead of automatically being taxed as self employment. Currently, if you receive a 1099 MISC, it’s counted as self employment and taxed an extra 13.3% on top of your regular taxes. For someone like me, that’s fine. I own my business, I write of my expenses—it’s the way it works. For many people, they have no clue they’re considered self employed. The small amount of income is a hobby or not a real business. $4,000 to me seems to be the break point between hobbyists and business owners.
I say, that if you elect to claim the income as “not self employment” then you can’t write off expenses. If you elect to claim that you’re in a business, you can’t go back later and call it a hobby in later years. That keeps people from jumping back and forth.
3. The Alternative Minimum Tax: This one is my pet peeve. The AMT adjustment was set in 1969 and hasn’t been adjusted. Right now, Congress basically votes for a “patch” every year. Why they wait until December to do it is beyond me. I say that we should adjust the AMT threshold for inflation and automatically adjust it every year to correspond to the rate of inflation. Normal people can’t plan their taxes without knowing about AMT. The fact that this has been going on for so long is ridiculous.
I could probably go on and on but these are my top three. What would you change if you could fix the tax code?
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.
If you’ve done your taxes and there’s an amount in box 45 for Alternative Minimum Tax (AMT), then you should read this because it might help. If the box is blank, you don’t have to bother with this post.
Also, this post is going to be a little more geeky and technical. If you’d like a basic introduction to AMT then you might want to check out my AMT for Dummies post first: http://robergtaxsolutions.com/2011/03/the-alternative-minimum-tax-for-dummies/
Now for the geeky part:
AMT is a pretty sneaky little tax. A lot of the issues with AMT revolve around what goes on your Schedule A-Itemized Deductions form. If you do your own taxes you can go in and play with the numbers to see what I mean. Let’s say that your real estate taxes were $4000. If you go into your tax software and change that number to $2000 or $6000, your final tax bill will probably stay the same. The AMT will rise and fall to adjust to the regular tax change. (Make sure you put your real estate tax number back to where it belongs.)
You can’t lie about what you put on your tax return, but sometimes you can choose which deductions you want to take. You may take a deduction for the state income tax that you pay on your wages, or you can take a deduction for the state sales tax that you pay. In most cases, the state sales tax is a smaller deduction, but if you’re using a computer program the computer will always choose the bigger deduction for you. The AMT can make your bigger deduction worthless, so in this case you want to take the smaller one. Why? First, if you claim sales tax instead of income tax as a deduction, you won’t have to pay income tax on your state tax refund next year. Second, in some states, like here in Missouri, although you can’t claim a deduction for your income taxes paid, you can claim a deduction for your sales tax that you paid.
So, the bottom line is you’re not changing what your total federal tax is. You are preventing taxable income on next year’s return and potentially reducing state income tax. For some people, this will do nothing at all because it depends upon your state.
The other category that has room for movement is your miscellaneous deductions; they wind up on line 27 of your Schedule A. For the most part, this includes your Form 2106 Employee Business Expenses. If you’re in the AMT category, you’ve already been dinged pretty hard by the 2% rule, because to claim a deduction here your expenses have to be more than 2% of your adjusted gross income. The AMT is like a double shot – first you lose part of the deduction due to the 2% AGI rule, and then the AMT takes the rest of the deduction away. A lot of people with AMT don’t even bother claiming their employee business expenses because of it. But don’t forget your state income tax return. Here in Missouri, your Schedule A deductions still carry through to the state tax return so you really should include your deductions even if they don’t help your federal return.
A suggestion for AMT payers with employee business expenses: If you’re in a sales position, or any job that has high employee business expenses, and you’re in a position to negotiate a salary increase. You might want to toss in having your business expenses reimbursed. Let’s say for example that you make an annual salary plus commissions of $200,000 a year and you average $10,000 a year in employee business expenses. You put those expenses on form 2106 and after the AGI limitation you only get a $6,000 deduction for it. (200,000 x 2% = 4,000. $10,000 – 4,000 = 6,000) But once you add AMT in there, your $6,000 is worth nothing.
So, by having your employer reimburse your business expenses on an “accountable plan” (that means you submit expense reports for your mileage and meals and stuff) then that money comes to you tax free. It’s a win/win for you and your boss: $10,000 tax free income to you and a $10,000 business expense write off for your employer.
Think about it, what would you rather have; a $10,000 pay raise that you have to pay state and federal income tax on or a $10,000 tax free reimbursement on money that you already spend anyway? I thought so.
AMT is a hard tax to manage. These little tips barely make a dent, but there’s not much there to work with. Hopefully it’s been some help to you.
I love tax-free income. The great thing about tax-free municipal bonds is the tax-free part. The downside is that they usually pay a lower interest rate than taxable bonds. For many people, tax-free trumps taxable every time—but you have to be careful because they’re not always the best deal for everybody. This is what you need to know:
1. While municipal bonds are tax-free on your federal return, they may be taxable on your state return. Usually, if the municipal bond is for your own state, then it’s not taxable. For example, here in Missouri, if I buy a bond from St. Louis County—that’s not taxable on my Missouri return. But if I bought a tax-free bond from New Jersey, then I’d pay tax on that interest. Buying at home gives you better bang for your buck.
2. Even though your municipal bond interest isn’t taxable, it could make your Social Security income taxable instead. Say what? That sounds a little crazy, doesn’t it? Let’s say you’re a senior citizen with moderate income. You’ve got your social security check, a small pension, a little interest from a CD and a bank account, and most of your other cash tied up in tax-free municipal bonds. With social security income, you’ve got that funky formula where you take half of the social security and add it to the other income and if it crosses the threshold, then part of your social security benefits become taxable. Are you rolling your eyes yet? The computer does this all for you right? But – and this is the important part—your tax-free municipal bond interest gets added into that equation. If you’re one of those borderline seniors, that tax-free bond isn’t saving you as much money as you thought. You might want to look at other, higher return investments.
3. The dreaded AMT. If you’re a high income earner, tax-free income sounds like a great investment doesn’t it? But you’ve got to be careful if you’re dealing with the Alternative Minimum Tax. If you’re in the AMT zone, you want to stay away from what’s known as a “private activity bond.” A private activity bond is when a company like GM wants to raise money, but instead of GM issuing a bond itself, it has the local government issue a bond for it (for example for building a plant in the area). It’s still a tax-free municipal bond, but it’s actually for a private business so it’s called a private activity bond. If you’re an investor that doesn’t have to pay AMT taxes, you’re fine, you get all the benefits of tax-free income. If you’re paying AMT, then you’ve lost all the benefit of the tax-free income. Private activity bond income is taxable under AMT rules.
With the stock market going crazy and many people turning to bonds, it’s important to know the real tax effects of “tax-free” on your tax return.
Perhaps I should subtitle this: Who Are All These Rich People Who Don’t Pay Any Taxes and How Come I’m Not One of Them?
It’s frustrating isn’t it? You work hard for your money, you’re taxed at 28-35% federally, plus your state tax, real estate tax, sales tax, etc., and then you hear on the news about all these rich people who don’t pay enough in taxes. Makes you want to scream, doesn’t it? And I haven’t even mentioned AMT yet!
As a wage earner, you’re kind of stuck (The rich people with really low income tax rates aren’t wage earners like you, but I’m guessing you knew that anyway.) You’re going to receive a W-2 that reports your income and – let’s face it – it is what it is. But that’s a good thing, be glad you have a job that earns you good money. But the goal here is find ways to reduce that taxable income.
Easy one first: max out your 401(k) plan. This one is so basic I wouldn’t even think to say it, but I’m shocked and amazed by the number of high income wage earners who don’t do this. Those of you who work for companies where you get kicked out of the plan because not enough lower income employees participate are exempt from this scolding-that’s a whole other problem that I don’t have a cure for. But if you’re making enough money to be reading this post, then you need to maximize your 401(k) contributions. For 2011, the maximum amount you can defer is $16,500. (If you’re in the 33% tax bracket, then that’s over $5,000 in tax savings!) If you’re over 50, you may defer $22,000.
Cafeteria plans: These are those other services that you can set aside money for—tax free, to be used later to pay for health care or child care expenses. Some companies have a huge selection of these benefits, but health and child care are the two most common ones. There’s a hitch with cafeteria plans though, it’s use it or lose it so don’t put aside more money than you intend to spend.
People often ask about the tax credit they can get from paying for day care service and don’t they lose the credit if they pay for day care through their work. That’s true. But look at the reality—at your income, the best you’re going to get in a tax credit is 20% of what you spent on daycare. By paying your child care expenses out of your cafeteria plan, you’re saving whatever your tax rate is so you’re better off. Any child care money that wouldn’t qualify for the child tax credit will be regular taxable income to you.
As a high income earner, you’ve probably already met my not-so-good friend Mr. Alternative Minimum Tax. The AMT winds up costing you many of the deductions that other taxpayers usually claim, but this is a tip that’s important for you to know. While the AMT may eat away many of the deductions that you could have claimed on your Schedule A form, it’s still a good idea to do the paperwork anyway. Depending upon what state you live in, you can often claim your itemized deductions in your state even though they were lost on your federal return. Not all states do this and you might need to play around to see what works best for you.
For example: here in Missouri, you can’t claim a deduction for your state income tax paid, but if you substitute state sales taxes paid on your schedule A then that’s still a deduction. For most people, state income taxes paid is a much bigger deduction than state sales tax. But if you’re dealing with AMT then claiming the lower state tax amount paid doesn’t change your federal taxes—you’ve still got the same tax liability either way. So, in Missouri you’ll want to claim the sales tax rate instead of income tax so that you get the larger deduction on your Missouri state taxes. Also, by doing this it makes your state refund not taxable for next year, and let’s face it, you don’t need any more taxable income.
Many of the tax programs give you updates on how an item on your tax return affects your federal taxes. If you’ve played around with this you’ve probably given up claiming certain deductions, (like state income tax and employee business expenses.) But make sure that you check the value that these deductions have on your state return, you don’t want to miss out on anything that you can possible claim.
A final note about 2011: Last year, I wrote about itemized deductions and charitable contributions as being a great way for high income earners to reduce taxable income. Charity deductions are not affected by AMT so it really was an effective tax deduction. For 2011, itemized deductions are once again limited due to income and Congress is talking about limiting charitable contributions even more. Although 2010 was the best year to make a charitable contribution, that’s past. A charitable contribution in 2011 will not be as helpful to your bottom line as it was in 2010, but it’s quite possible that it will be much more beneficial to you than a contribution made in 2012. This is one of those “watch Congress” issues to see which way the wind blows, but if you’re a charitable giver, it may make sense for you to “double up” in 2011 instead of spreading it out over 2011 and 2012.
Okay, first, if you’re paying Alternative Minimum Tax, you’re probably not a dummy. Most people who have to pay the Alternative Minimum Tax (AMT) are highly paid employees. If you were really a dummy, you wouldn’t have a job that makes you pay AMT. That said, AMT taxes are really confusing and can make you feel like an idiot. I’ll try to make some sense of it here.
Why do we even have the AMT? Good question! Our tax laws have benefits for certain kinds of income and special deductions and credits for certain expenses. For example, you don’t pay tax on the interest from a munincipal bond and you get a tax deduction for paying mortgage interest on a house. If a person plays his cards right, he could drastically reduce his tax by taking advantage of these deductions. Congress created the AMT in 1969 so that high income taxpayers who claim lots of deductions still wind up paying income tax. That was the intention of the law—to make things fair.
Why is AMT such a pain in the behind now? For one thing, the AMT wasn’t indexed for inflation. What was considered to be wealthy in 1969 is fairly middle-class in 2011. People who were never originally targeted for the AMT are now subject to AMT taxes. Congress passed legislation last December for an “AMT patch” to adjust for inflation. The patch will be good for 2010 and 2011, but if they don’t make some type of permanent adjustment, we’ll be dealing with this over and over again starting in 2012.
Who has to pay AMT? Using the IRS definition: You may have to pay the AMT if your taxable income for regular tax purposes plus any adjustments and preference items that apply to you are more than the AMT exemption amount.
How’s that in plain English? For most people, if you don’t itemize your deductions, you probably won’t have to pay AMT. If you do itemize, one big deduction people lose has to do with employee business expenses—like when sales people take a deduction for their mileage, those people get hit with AMT. If you’re a salesperson who claims employee business expense deductions on your tax return, you’re much more likely to be hit with AMT than a person who doesn’t.
Other AMT hot spot issues are your state income taxes that you paid, and mortgage interest expense. With your mortgage, you can deduct the interest on the money that you used to purchase your home or improve your home. But if you refinanced your home to pay off a credit card, that part of your interest payment won’t be a deduction for you on the AMT form. Also, if you had enough medical expenses to claim a deduction on your regular return, it will be reduced or eliminated when calculating the AMT.
There are lots of items that affect the AMT, but those are ones that I see regularly when I’m doing tax returns with AMT. There are things like mining costs, intangible drilling costs, and research and experimental costs. I’m sticking with the issues that are fairly common.
If you’re using tax software, it will calculate the AMT for you automatically. You’ll notice that if your AMT is lower than your regular tax, you don’t get your taxes lowered. You only get to see the AMT tax if you owe more. (Doesn’t seem quite fair does it?)
If you’re still doing your return by hand, or just want to estimate of you will have to pay AMT for next year, you can use the AMT assistant on the IRS website. http://www.irs.gov/businesses/small/article/0,,id=150703,00.html
The idea of tax deductions for high income earners must sound preposterous, especially if you’re a high income earner. You know how it goes, you try donating money to charity or taking advantage of any of the other tax deductions only to find that your deduction is “limited due to your income.” So what’s the point?
Well this year, there is a point. Itemized deductions and exemptions aren’t phased out for high income taxpayers for 2010. Last year, if you earned over $166,800 you started to lose out on your deductions. The higher your income, the less valuable your deductions were. Only for 2010 are you allowed all of your itemized deductions. You also get 100% of your exemptions also.
But what about the Alternative Minimum Tax or AMT? Won’t that get us anyway? Well, yeah. AMT is a problem for high income earners. But, and this is important, charitable deductions aren’t eliminated in the AMT calculation. AMT dings you for your state tax payments, miscellaneous deductions (like employee business expenses), and some types of mortgage payments. Your charitable contributions still count as a deduction in the AMT calculation. Even if you’re stuck paying AMT, you’re still better off having that charity deduction on your tax return.
Bottom line: If you are a high income earner, there has never been a better time for you to make a charitable contribution.