Author: Jan Roberg

Posted on by Jan Roberg

I Lost My Job, Now What? Tax Issues of Unemployment, Part 2: The 401(k)

Empty office building

Photo by Tomi Knuutila on Flickr.com

There are so many issues with losing a job that you hate to think about taxes, but it’s important to think things through. In the last post, I talked about severance pay. In this post I want to talk about your 401(k) and what to do with that money.

First and foremost—it’s important to get your money out of that company’s 401(k) program as quickly as possible. For most people I’m not recommending just taking the money out, I’m recommending what you call a direct trustee to trustee transfer into an IRA. You want to remember that term “trustee to trustee transfer” because that phrase will save you money.

Why take the money out of the 401(k)? Why not just leave it there and roll it into my new company’s 401(k) when I land another job? I get that question a lot. First, you have a lot more control over your money if it’s in an IRA than in a 401(k) so that’s very important. Second, many 401(k) plans are tied into the stock of their company—if your company is laying people off, then that’s a signal that the company’s stock probably isn’t doing so well either. Do you really want to leave your money in a sinking ship? Third, and probably most importantly, if you wind up needing to access that money before you land a new job the IRA is the better place to be as far as taxes are concerned.

What exactly is a trustee to trustee transfer and why should I do one? A trustee to trustee transfer is when you have the money in your 401(k) plan transferred directly to your IRA account without you ever touching the money. Your financial adviser will have you sign the proper forms to make this happen. If you’ve got one of those self-directed plans like in an E-Trade account you’ll be able to find the right forms on their website

But how does this save me money? Because, by doing a trustee to trustee transfer, there are no tax issues. Let me use an example: Let’s say you have $10,000 in your company’s 401(k). You’re in the 25% tax bracket, if you just take the money out, you’ll pay $2,500 in taxes plus another $1,000 in penalties for a total of $3,500 in extra income tax. That’s not good. A direct trustee to trustee transfer is just a tax free way to move your retirement money from one account to another.

Let’s say instead that you want to rollover the money into an IRA but you don’t want to do a direct trustee to trustee transfer. You have your company cut you a check for the full amount of your 401(k) and you’ll handle depositing the money yourself later (You have 60 days to do the rollover). What happens is they cut you a check for $8,000 and give $2,000 to the IRS for taxes. You deposit the full $8,000 into your IRA so you won’t be taxed on that, but you will be taxed on the $2,000 that went to the IRS. That means you’re going to be billed $700 for the $2000 that you gave to the IRS. ($500 for the 25% tax plus another $200 for the 10% penalty.) That’s got to be the craziest thing in the word! You just paid tax on your tax! Oh sure, they’ll refund you the $1300 but that $700 is gone! Zippo! And for what? Don’t fall into this trap.

But I lost my job! What if I need access to my retirement funds? Good point, that happens to a lot of folks. But unless your 401(k) amount is pretty small, I’d still recommend doing the trustee to trustee transfer first, and then only taking out money from your IRA only when it’s absolutely necessary.

Here’s a different example: Jill has an annual salary of $40,000. She gets laid off in December and cashes in her 401(k) which has $100,000 in it. Normally, her annual Federal taxes are just under $3,600, but with the 401(k) added her income taxes are over $40,000 (with the 10% penalty included.) Her taxes for the year would actually be more than what her regular annual income would be. She’s gone from the 15% tax bracket to the 28% tax bracket, and with the 10% penalty for people who are under 59 and ½ years old that’s a 38% tax rate.

But Jill could have done a direct trustee to trustee transfer and saved herself a bundle. Let’s say she does the transfer, but later she needs to access some of that money to make ends meet. We know that she’s been managing on $40,000 a year. Let’s assume that she gets $10,000 in unemployment benefits for the year so she only needs to access $30,000 out of her IRA to stay level. Her taxable income will still be the same so she’ll owe just under $3,600 in regular tax, plus she’ll owe another $3,000 in penalties for the IRA money giving her a total tax bill of $6,600. It’s certainly not a perfect situation; that 10% penalty is painful, but it’s definitely better than paying a 38% tax rate. In this situation, Jill still has food on the table, a roof over her head, and some money still left in her retirement plan.

If you’ve been laid off and have 401(k) benefits left in the company, talk to your tax person and your financial adviser to figure out a plan that’s best for you and your family. You don’t have to go it alone.

Posted on by Jan Roberg

I Lost My Job, Now What? Tax Issues of Unemployment, Part 1: Severance Pay

going out of business

Photo by timetrax23 on Flickr.com

First and foremost, I’m sorry for your loss. Losing a job is pretty hard to take and you’re allowed to have a mourning period, but you only get about a day because you’ve got work to do. This post is about taxes and timing —you really don’t want to get burned on your taxes in addition to losing your job.

The first issue I want to discuss is severance pay. If you’re getting any severance pay at all, be glad, so many people aren’t. To a lesser extent, in this category I’m including vacation pay and sick leave that’s owed to you as well. Here’s the important part: if you get laid off in the fourth quarter of the year, try to negotiate to have your severance pay paid to you next year.

Here’s why: let’s say you make an annual salary of $40,000 a year. Your company decides to let go of you right before Christmas (it seems to be a popular lay-off time.) On the plus side, they are giving you one year’s salary as a severance package which is pretty sweet. Here’s the problem—if you’re single and making $40,000 a year, your income tax is going to be under $3600. If your company pays you that severance package before January first, your tax bill won’t be $7200 (which would be double) it will be closer to $13800—over $10,000 more! In this scenario, moving your severance package would save you over $6,000—money that could be used for putting food on the table and paying the rent! Of course, if you’re laid off early in the year, take the money right away—you won’t have that tax problem.

Here’s another reason for moving your severance pay ahead—and this includes your owed vacation pay and sick days as well. That money is still considered to be “earned income” and you want earned income on your tax return. Given today’s economy, it’s possible for you to be out of work for an entire year. Unemployment doesn’t give you access to the Earned Income Credit, but wages do and severance pay is wages. You might not be familiar with the Earned Income Credit if you’re used to having a good job with a good income, but when times are tough it can be a blessing so you really want some wages on your next year’s return.

Will my employer agree to pay me later? I don’t know. The one thing I do know is that if you don’t ask, you don’t get. Here’s his side of it—he’s cutting costs by laying-off staff. If he pays you your severance now, that will reduce his taxable income for the year, so that’s his motivation for paying now—less taxes. But if cash is a little short, by paying you in January, it buys him a little breathing room. If he pays your severance in January, then it also postpones when he pays the IRS your payroll taxes as well. If cash flow is a problem for him, he might jump at the opportunity to delay your payment.

One important issue: if you think the company is going belly up—take the money and run! Pay the tax, deal with it. Realistically, belly up companies aren’t doing severance packages, they’re just paying whatever’s required by law. Get your money, cash the check and be done. Having less money to live on is better than having no money to live on.

Posted on by Jan Roberg

Cancelling Your Roth IRA Conversion

undo

Photo by voxtheory on Flickr.com

Whoa, that Roth IRA conversion you did last year seemed like such a great idea at the time didn’t it? I know I thought it was pretty wonderful. But things change and with the stock market tanking, your portfolio is probably not worth what it was back when you did the conversion. For some people, now might be a good time to – here’s the important IRS word: Recharacterize your IRA.

Basically, to recharacterize your IRA, you’re taking all the money that you “converted” and put it back into your Traditional IRA. You will need to talk with your financial adviser and fill out the proper forms to do this. You also have a deadline: you must complete the transaction by October 17th, so you don’t have a lot of time to work with here.

Once you recharacterize your Roth IRA, it will be like it never happened, so you’ll have to amend your tax return to eliminate the Roth conversion that you reported last April and claim a refund. But that might be the smartest tax move you ever made. Let’s take a look at an example:

Porky Pig is in the 25% tax bracket and he made a $10,000 Roth IRA conversion for tax year 2010. The cost of the conversion to Porky was $2500. But now, because of the stock market, Porky’s Roth IRA is only worth $8500. It’s like he paid $325 too much in tax. Is that enough for Porky to make a change? For me it is, but for some people it might not be.

Let’s take a look at Porky’s friend Bugs Bunny. Bugs did a larger conversion; he rolled over $50,000 into a ROTH IRA. Bugs has a tax rate of 33% so he paid $16,500 for his Roth IRA conversion. Bugs also had a bigger portfolio drop than Porky, his Roth IRA went down by 20% to $40,000. Bugs paid $3,300 too much in taxes for his Roth conversion. I would think that $3,300 has got to be too much tax by anyone’s standards.

So what should you do if you made a conversion and your portfolio tanked? First, you’ll want to make an analysis similar to Bugs and Porky’s. What’s the true cost to you in terms of taxes? Don’t forget how much it will cost to amend returns and pay your broker fees. If it makes sense to recharacterize, then by all means, do so.

Don’t get me wrong, I’m still a big fan of Roth IRAs and I still think that the Roth IRA conversion is a great tool, especially for people whose incomes are too high to make regular Roth contributions. It’s just that if recharacterizing your Roth can save you a large amount of tax money, you really should consider doing it.

Can you do a Roth conversion again later? Yes, but you’ll have to wait for at least 30 days before you do it. You’d be reporting the conversion on your 2011 return (unless you wait until 2012.) You would not get the advantage of being able to split the tax payment between two years.

I hope this sheds a little light on the situation. Remember, the deadline to recharacterize your Roth IRA to a Traditional IRA is October 17. Don’t wait until the last minute, remember that your financial adviser will need time to process the paperwork.

Posted on by Jan Roberg

Audit Proofing Your Employee Business Expenses

20000

Photo by Kelly on Flickr.com

I recently attended the national conference of the National Association of Tax Preparers. It was easy to get to as it was in St. Louis this year. As much as I enjoyed taking the classes and meeting new people, sometimes the best information you get at these things is not in the actual classes, but in the scuttlebutt that you hear about what’s going on across the country. One of the issues that people were talking about was that the IRS has really stepped up the audits on Employee Business Expenses (Form 2106).

Just because certain types of forms might be susceptible to an audit doesn’t mean you shouldn’t claim legitimate deductible expenses on your tax return. If you are entitled to a deduction, you should take it. (Let me tell you, Warren Buffet’s not skipping out on his legal deductions). Just make sure you can back up your claims.

If you plan on claiming Employee Business Expenses on your tax return this year, the one thing you’re going to want is a copy of your company’s policy on employee reimbursements. If you get audited for your Employee Business Expenses, the first thing the IRS will ask you for is your official company policy on official company letterhead. If your company has a full reimbursement policy—you will automatically lose the audit. You may not claim a deduction for expenses that could have been reimbursed by your company.

Major companies like GM or Citibank will definitely have a policy. Smaller companies often don’t. To be honest, on more than one occasion I’ve written the reimbursement policy for a small company so they could submit something to the IRS when an employee was being audited. (Now that I think about it, I guess I should write one for my own company).

If you are claiming business mileage, you want to have a mileage log. This is the big IRS “gotcha” because so many people just guess a number and it’s wrong. For some reason, people seem to think that they drive 20,000 miles a year for business. Some people actually do. Some drive even more. But if you say that you drive 20,000 miles for business, you had better be able to back it up with a mileage log. For one thing, “20,000” is like a guaranteed audit flag. If you keep a mileage log, all you have to do is just whip it out and show the IRS agent and you’re done, end of story.

People who claim 20,000 miles and don’t keep mileage logs have a tougher sell. You’ll need outside proof, like your oil change statements to show your overall mileage, plus some type of record to show where you’ve been. Like hotel receipts to prove you drove to various places on business. I charge $100 an hour to recreate those statements for you and it takes time to recreate 20,000 miles. You’ll save yourself a boatload of money and a big headache if you just keep the log.

Don’t make up mileage numbers. I’m serious about the 20,000 being an audit red flag. One audit I worked on the gentleman asked me why I thought he got pulled for an audit. It was obviously his miles. Everything about his tax return had looked pretty normal, except for his 20,000 business miles. Hint: round numbers in multiple thousands look suspicious. He had no mileage log so I had him get me his odometer readings from his oil change company. Well it turns out, not only did he not have 20,000 miles of business driving, he drove less than 5,000 miles during any given year for the past three years!

I’m good at what I do, but this guy wound up paying the IRS some money. I asked him, why did he claim so much in mileage when he only drove 5,000 miles altogether. He said that was what the other guys in his office claimed. Don’t do that! Use your own numbers.

The other thing that gets a lot of IRS attention is the meals and entertainment expense. This trick is so easy it’s ridiculous. Let’s say you take John Smith to lunch to talk about him buying your product. The waitress brings you the check and you get out your credit card. She brings the receipt back for you to sign and add the tip. You also write on the top copy: John Smith sales widgets. Or you may write Jane Doe, advertising; or Fred Bird IT consulting; or whatever. The bottom line is that this note tells you who you were with and what the meeting was about. The receipt itself gives the date, time and place. The waitress may wonder why you wrote about Jon Doe and the widgets on the receipt, but that’s fine, (she’s seen it before.) But by writing on the top copy of the sales receipt, you made the yellow copy a time recording stamp. As the yellow copy of your sales receipt ages it changes color. This shows that you wrote your note a long time ago – remember that an audit will be two or three years after the fact. This proves to the IRS that you were – time for the big word here—contemporaneously recording your business expenses. It gives you street cred with the IRS agent. You took care of business, back when you were supposed to instead of trying to make up stuff after it’s too late.

Bottom line, if you want to audit proof your employee business expenses, you want a copy of your company’s expense reimbursement plan, a solid mileage log, and notations made on the top copy of your meal receipts.

Posted on by Jan Roberg

How to Call the IRS

A mysterious phone call

Photo by rocketace on Flickr.com

Because of my line of work, I spend more time on the phone with IRS agents than anybody else I know. When I used to work for a big tax company, my co-workers joked that my real reason for calling the IRS so much was because I liked their hold music and I should just buy a radio instead. But the truth is, the IRS is a scary organization for many people to deal with and not everyone can hire someone like me to do it for them. These are my tips for calling the IRS if you’re going to try it yourself:

  1. The most important rule in the book is to remember your good manners. No matter what you may be thinking, no matter how angry you are about the situation, you absolutely must remember your good manners that your mother taught you.
  2. You are most likely going to be on hold for a long time. Be someplace where you are comfortable and have something else to do while you’re waiting. Even with my special “Bat Phone” that I get to use for the IRS, I still have to wait on hold. You’re going on a regular civilian line and the wait can be very long.
  3. Make the call someplace where you won’t be disturbed. I have a home office and a work office. You would think that my home office is the perfect place for making IRS phone calls, except that my dog hates the IRS. I do not understand her problem—she’s a dog, she doesn’t pay taxes; but every time I’m on the phone with the IRS she begins barking like a crazy beast. In my line of work, this is not a good thing. I now make all my IRS calls from work. You probably don’t have the luxury of a designated IRS calling place, but just do your best to limit your distractions.
  4. You have to make the call yourself; you can’t have your daughter or neighbor call for you. If you can’t call for yourself, you need to be in the room. The IRS agent will want to talk to you personally, confirm your identity, and then you will have to give permission for the IRS to talk to the other person. Even after you give permission, you still have to be in the room.
  5. If you have a letter or notice from the IRS, have it with you when you call. Call the phone number on the notice that they provide. If you don’t have a phone number, the main IRS phone line is 1 (800) 829-1040—but only use that if you have no other phone number, you’ll wait on hold even longer.
  6. Be prepared to get transferred and put on hold again. (I find that dark chocolate M&Ms have a calming effect on the stress of being on hold. Just a suggestion.)
  7. Finally, the moment will come when a real live IRS agent will pick up the phone and will actually be able to assist you without sticking you on hold and forwarding the call again. Ta Da! By now, you could be really frustrated with the hold music and all, but you will remember your good manners and pleasant voice and say, “Hi, I’m ________________, and I’m calling about a notice that I’ve received from your office.”

And now the real conversation begins. The agent will need to identify you, she will ask you questions about your name, birthday, social security number, phone number, etc. Basically, she’s trying to make sure that you really are the person you say you are. Don’t be offended by that, it’s actually for your own protection.

The next part of the conversation will be about why you’re calling. Is the notice wrong? How do we fix it? Is the notice right and you want to find out how to pay the tax? Or maybe the notice is right but you don’t have the money to full pay and need to make arrangements. This is the nuts and bolts of the phone call where you find out what’s needed to end your problem.

I’d say that 95% of the IRS agents who man the phones are actually decent people and they really do want to help you. They might not be able to—they have rules and laws that they must stick to—but most of them genuinely want to be helpful.

So what if you get one of the other 5%, or what if the IRS agent just can’t solve your problem? You don’t have to settle the issue right that instant. Let’s say you get a notice that says you owe $20,000—you can’t pay and when you call the IRS you can’t come to a resolution on the phone. You very politely say, “I’m going to have my representative call you next week.”

If you can’t settle the issue on your own, then it’s time to hire someone like me (an enrolled agent), but at least you’ll know that you’re not wasting money on something you could have handled yourself.

Posted on by Jan Roberg

Excerpts from the Facebook feed during the President’s LinkedIn Discussion about the Jobs Act

barak-obama

Photo on Flicker by Jose' Lui's Agapito

I recently watched President Obama’s LinkedIn townhall meeting on Facebook.  Talk about a double dose of social networking media! 

 I haven’t really blogged about the tax proposals because quite frankly, I prefer to wait until something is actually the law before I  post about it.  But I found the comments that people were making about the economy and their concerns were pretty relevant and important.  If you’d like to read the comprehensive fact sheet, here’s a link to that right here:  http://www.whitehouse.gov/the-press-office/2011/09/08/fact-sheet-and-overview

This certainly isn’t every Facebook post from the meeting, I couldn’t keep up with all of them and I did omit items that were off topic.  But I found that these posts reflected issues that are certainly facing people today.  And I felt they were worth sharing.

• Charles B
I agree that best way to keep Social Security is raise the salary cap. I would recommend a tax rebate, and reinstating the consumer loan interest tax deduction. This would be more effective than deducting the amount going into Social Security using the payroll tax cut.

• Morrie E
How about coming up with an export program that supports already successful small to medium US manufacturers ship their products to the international markets? This takes companies that are already having success and expands their market so they will have to hire more people to meet the increased demand.

• Daisy H
When we have 14 – 26 million Americans unemployed and only 3.5 million jobs available; as Jeff of LinkedIn previous stated, it is obvious, that we need to put lots and lots of resources into helping Americans to create small businesses and hire each other.

• Wendy D
Mr. President: I have been looking for a permanent job fo 15 months. I have found that employers are reluctant to hire the long term unemployed. Can an incentive be given to employers for hiring someone who has been searching for a long time as opposed to hiring someone who alreayd has a job? Thank you.

• Morrie E
Why can’t growing small businesses like mine access the SBA for small working capital loans. Without a good FICO score, the banks will not underwrite the loan. Of course, many small businesses are just recovering from 2008 and now the business owners personal FICO score is now being used instead of the D&B for just the business even if your business is a C corp.

• W Reynolds W
It is a known fact that employers discriminate the unemployed. Even if legislation is passed trying to ban discrimination, the legislation won’t be worth the paper it is written just as it has been ineffective to control discrimination based on race. We need a universal employment policy that is based on economic reality.

• Norman Wade P
When the times are tough, you take care of home first. America is our home, take care of schools, manufacturing, construction, medical invsestment, transportation, environment.

• W Reynolds W
The President has been pushing infrastructure repair as part of his American Jobs Act bill. He would be wise to focus on repairing employment legislative infrastructure to stimulate true jobs growth.

• Shashank M
The guy who has obviously made tons of money in Silicon Valley business stands up and wants his taxes to be raised. Fine – do that. Why wrap the rest of us in it. Not all of us have minted money so we can afford to be “unemployed out of choice”! And no – you did not invest in my education. I paid every dollar out of my earnings.

• Susan S
What is the point of all this discussion when we all know the rep are never going to allow your reforms. I have been out of work for 2 yrs due to medical issues and am still waiting for a hearing with SSD I will lose my home before I even get to Hearing after owning my home for 25+ yrs. whats fair about that after paying into SS all these years They are dragging their heels long enough to lose it after all these years

• Vickie T
Mr. President, I have been laid off for almost two years. Working in the IT world. I need the immediate training and now!!! Not next week! Now!

• Ben K
In the current economy, a lot of people, myself included are working as contract workers, and not employees and receive limited or in some cases no benefits, and are part of what has come to be called the Permanent Temporary Workforce and have been for a year or longer, as I have been. What is your plan to help companies hire contractors and other temporary workers as employees?

• Wendy D
Retraining will work for most. But there are many like me, 60 yrs +, who don’t have time to retrain. We need jobs now, in our areas of expertise, or we are domed to living in poverty as we age.

•Connie L
Mr. President , take the debt off the backs of the American not the big corporations and banks, have a good day!

•Joseph G Jr.
I don’t have problems finding work even though for the past 10 years it has come in the form of contract work but finding a permanent job or starting my own business is my motive though I can’t seem to make enough money to make my business grow and getting a small business loan is out of the question in this economy. I’m a contractor in the Information Technology field who badly wants to start my own business and I’m full of ideals and have a deep passion for technology and a desire to lead and help others, how can I get the funds I need to grow, hire employees and compete in today IT industry without going into financial ruins getting business loans? 

•Peggy H
Education is important but at this point and time it is secondary until we manage to keep jobs in the US. Also we can’t all be in management. We need the blue collar worker too.

Back to me again.   Here’s a link to the White House Press Release about the event.  http://www.whitehouse.gov/blog/2011/09/26/president-obamas-town-hall-linkedin-we-are-thing-together?utm_source=092711&utm_medium=blog&utm_campaign=daily   It has the video and the written transcript if you’re interested.  Thanks for reading.

Posted on by Jan Roberg

Paying Someone “Under the Table”

Day 4 - Paying off debt

Photo by Quazie on Flickr.com

I was talking with a small business owner the other day and she told me this story:

I have a friend who’s really hurting. She lost her job about six months ago and she just can’t make ends meet. She’s having a hard time even putting food on the table. I wanted to help her out so I had her come help me with a project at my business and I paid her under the table. The thing is, she really did a good job and I could really use some more help but I can’t afford to pay her under the table any more.

Let me make one thing perfectly clear: Never pay anybody under the table!

First, it will come back to bite you in the behind one way or another. Trust me, I do a lot of audit work. “Under the table” doesn’t help anybody. You don’t get a deduction for paying “under the table” and the person you paid can wind up getting audited and get stuck paying tax on that money anyway. It’s a lose/lose situation.

If you really want to help someone out, but you can’t officially give them a payroll job, hire them as a contractor. Do the whole thing, have them fill out a W-9 form, and explain that you’re hiring them as contract labor. Tell them they’ll have to pay taxes on the money: 13.3% for self employment tax plus any additional income tax for their tax bracket.

Hiring someone as a contractor gives you a “triple good” effect. First, by making your friend contract labor, you can write off the money you give her as a tax deductible expense. If you’re paying 40% on your self-employment income, that $100 you pay is really only costing you $60. Plus, you’re getting a benefit out of it too because you’re getting the benefit of her labor. And third, your friend has a job. It might not be a full time job, it might not pay all the bills, but it’s something to put on the resume to show that she’s working. News reports are saying that employers won’t hire someone who has been out of work for over six months. That contract labor job gives her a better chance at finding real work. Plus, it allows her to use you as a reference. (Okay, I guess that makes it four benefits, not three. That sort of makes me the accountant who can’t count. Maybe I should hire someone to help me with that.)

But what about all the reporting requirements? With contract labor, all you have to do is prepare a 1099, which is due in January. You can get the forms free from the IRS. It’s easy. You only have to submit 1099s if you pay someone over $600 so if you’re just helping someone a little, you don’t even have to worry about that. I’ll make a how-to post in late December, so you can do it yourself. (My fiendish plan to get people to come back to my blog.)

What about all the new tax incentives for hiring that the president has proposed? So what about them? Right now, that’s all they are—proposals. Congress may or may not pass some or all of them. We have to run our businesses and our lives in the present tense. I’ve tried waiting for Congress to pass bills before—it’s bad business. Hiring someone as contract labor is a good quick fix for your staffing problems and it’s a good quick fix for someone who may need to eat.

Who knows? Maybe that contract laborer you hire will be the key to you making big profits.

Posted on by Jan Roberg

Dirty Little Secrets about Your Tax-Free Municipal Bonds

Calculator and Money

Photo by TaxBrackets.org. You can check out their website by clicking on the photo.

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.

Posted on by Jan Roberg

Tax Tips for High Income Earners

Luxury Tax

Photo by youraddresshere on Flickr.com

 

UPDATED 2013

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 2013 and 2014, the maximum amount you can defer is $17,500. (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 $23,000.

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.

 

Posted on by Jan Roberg

When Can I File My 2011 Tax Return?

stopwatch

Photo by Julian Lim on Flickr.com

I’m posting this in September of 2011—that means we have over three months before the year is even over. If you’re asking this question now, it means you’re expecting a refund—which is good—but the bad news is you’re not going to see it for quite a while.

Hopefully, here are some answers you’re looking for.

Although the IRS hasn’t posted any official dates yet, generally, the first day that you can e-file a return will be the day after Martin Luther King, Jr. Day—basically the middle of January. Please don’t hold me to that, Congress can always come in and mess things up, but that’s usually the earliest you can e-file.

Last year, because Congress had slowed up the e-filing for lots of people’s returns, folks asked, “Can I just mail my form in before the e-file date if I’ve got everything done?” The answer is “No, don’t.” The IRS will just toss your mailed return in a corner and not open it until they’re allowed to and your return will get processed slower than the e-filed returns so you really don’t want to do that.

What about those loans you can take against your refund? When do they start and who has them? That’s a really good question. Last year, the IRS changed its practice of providing something called a “debt indicator.” If you filed a tax return through a company that issued Refund Anticipation Loans, the IRS would send back information saying whether you had a federal tax levy against you or not. If there was no “debt indicator” then it was safe to assume that the bank issuing the Refund Anticipation Loan would get its money. If a taxpayer had a debt indicator flag, then they wouldn’t get the Refund Anticipation Loan.
The problem is that the IRS refuses to issue a debt indicator anymore so banks aren’t willing to take the risk. Refund Anticipation Loans have virtually dried up. Last year, only one tax business in my area offered a Refund Anticipation Loan but it was limited in scope.

The Advance Refund Anticipation Loans or Christmas Refund loans were pretty much based on the same principal. As of this writing, I know of no one who is issuing advanced money for the 2011 tax year. If anyone is, it’s doubtful they’ll offer that program anytime before Thanksgiving.

Is there anything I can do to get my hands on my tax money? In 2011, probably not: Congress repealed the advanced EITC law which used to allow you to claim your EITC in your paycheck. If you have federal income tax withholding taken from your pay (not Social Security and Medicare, but federal income tax) you can change your withholding so that you get more take home pay. There’s a calculator on the IRS website that can help you figure out how many exemptions to claim. http://www.irs.gov/individuals/article/0,,id=96196,00.html
You’ll want to have your most recent pay stubs and your last tax return handy as you fill in the answers. It’s a pretty good indicator of what your refund will look like come tax season and if changing your W4 could benefit you.

A word of caution: The IRS clamped down on Refund Anticipation Loans because it felt that those loans were harmful to consumers. They basically put the big tax companies out of the loan business because they have to follow the rules. Sometimes, shady guys slip through the cracks. So here’s the warning—if you find a tax business that does refund anticipation loans ask a lot of questions. How long have they been in business? What happens if there’s a problem with your return? How will you get your money? How long will you have to wait for your money? What are the charges for the loan, for the tax preparation, etc.? If you don’t feel safe, if your questions aren’t answered to your satisfaction, then walk away.

You can get free tax preparation from VITA or the IRS. If you have a bank account, you can have your refund direct deposited within two weeks of filing. You’re already going to have to wait for a few months anyway, if you can hold out for just a little bit longer you can save yourself hundreds of dollars—money that you can spend on you, your kids, your rent, etc. Good luck.