I’m not sure why Uncle Sam waited so long to publish his tax guide for the newly unemployed.  The US unemployment has been above 5% for over a year.  We really could have used this last winter when the rate of new claims was at its peak.

And a note about manners, Uncle Sam.  I don’t expect you to be overly touchy-feely, but after all, the people reading this document will have just suffered a traumatic life event.  Couldn’t you have started a little gently?  Perhaps, something like “the economy is going through difficult times, and many individuals like yourself have temporarily lost employment.”    But nooooh.  Your opening line is:  “Severance pay and unemployment compensation are taxable.”  Ouch.  Harsh. Continue Reading »

On July 24th the Federal minimum wage will increase from $6.55 to $7.25 per hour.  Adjusted for inflation, the minimum wage is lower now than when I was in high school.  I’ve worked minimum wage jobs at a fast-food joint, a pizza place, and as a cashier in a chain drug store, but only during high school and college.  I can’t imagine trying to support myself, let alone a family, on those wages.

The wage increase won’t affect Massachusetts residents, as our state has a minimum hourly wage of $8.00.

Everyone, even those making minimum wage, will be affected by the increase in Massachusetts sales tax from 5.00% to 6.25% as of August 1st.  Sales tax affects lower income folks disproportionately, as they spend a greater percentage of their income on necessities.  Food is exempt from the tax, but other essentials such as toothbrushes, laundry detergent, and car parts are not.  If we have to raise taxes on the general population, I’d rather see an increase in the income tax.  Of course I’m amazed that a (normally) progressive state such as Massachusetts has a flat income tax.  The guy making minimum wage is paying the same rate as the hedge fund billionaire.  Except, of course, the billionaire can afford lawyers to find tax loopholes.

I guess taxes really are just for the little people.

The IRS will be holding a series of public discussions for input on establishing standards for tax preparers.  It’s about time, I say.

July 14, 2009:  The Internal Revenue Service today announced a series of public forums at which individuals and representatives of diverse constituent groups will be able to provide input on the development of tax preparer performance standards.  The public forums, a crucial part of an effort launched in June by IRS Commissioner Doug Shulman to help ensure tax preparers are qualified, ethical and provide a high level of service, will kick off on July 30 in Washington, D.C.

“These public meetings will be an important part of the dialogue as we move toward a set of comprehensive recommendations by the end of this year,” Shulman said. “We want an open discussion on how to strengthen the overall integrity of our tax system.”

Knock wood.  Tax preparation isn’t an occupation known for deceptive practices.  Sure there are problems but nothing as scandalous as “investment advisors” like Madoff, Harkless, or Stanford.  Nevertheless, tax preparers have your social security number and all of your investment account information.  Someone with bad intentions could do a lot of damage quickly.

Presently only three states require licenses for tax preparation:  California, Oregon, and Maryland.

I think a little accountability (no pun intended) would go a long way to increase consumer confidence.  Having a national standard would improve the overall quality of services delivered, even if the federal government leaves the responsibility of oversight to the individual states.

What do you think?  What qualifications do you look for in a tax preparer?

Tip ‘o the green shade to Kay Bell at Don’t Mess with Taxes for pointing out the IRS initiative.

Image credit: BeckyKP at Flickr.

One of the most interesting posts I’ve read recently is Frank Curmudgeon’s* The Roth Segregation Conversion Strategy.

Before we launch into Frank’s strategy, let’s cover the basics.

Recharacterization is the ability to move money that you put into your Roth IRA this year, into a traditional IRA instead.  It was created to enable people to correct their mistakes, such as funding a Roth IRA when their adjusted gross income is too high.  Recharacterization enables correction without penalty.

The basic Roth recharacterization tax-avoidance strategy goes like this:

• At the beginning of the year, you convert your IRA into Roth,
• At the end of the year, you recharacterize the Roth back into the IRA,
• If the Roth earns money during the year, you only have to recharacterize the amount put in at the beginning of the year, leaving the earnings in the Roth forever tax-free.
• If the Roth loses money, you only have to move back remaining amount into the IRA.  And you can try again next year

Mr. Curmudgeon takes it one step further,

• At the beginning of the year, you take your IRA, and divide it into two halves.
• Invest one half long and one half short (e.g. S&P 500 ETF’s), each in a Roth IRA.
• At the end of the year, one investment will be up x%, and the other will be down x%.
• Then you recharacterize both back into IRA’s.
• For the Roth that made money, you need only recharacterize the amount you originally put in, letting you leave the x% in the Roth, forever tax free.

Sounds like a great idea.  I can see why he enjoyed working in a hedge fund.  If you start with $200k, the market moves 10% in a year, and you’re in the 28% tax bracket, you’ll save $2800 in income tax, less transaction costs.  That’s only a 1.4% return on your investment, but it is risk-free.

Towards the end of his post, Frank gets cranked-up and starts optimizing the strategy through winner-take-all strategies.  You can minimize taxes by dividing your IRA investment into 37 Roths and (somehow) bet each on a different number on one spin of a roulette wheel.  One Roth will win, and it ends up with roughly 37 times its original amount, tax free.  All the other Roths are worthless.  The net result is to transfer the original sum into a Roth, tax free.  There’s the little problem that roulette bets are not a legitimate IRA investment option, but a reader proposed an option, if you’re interested.

I thought this all sounded quite interesting but just a little too good to be true.  Why would the IRS let me recharacterize only the original amount?

I began searching the IRS website.  The original IRS Code 408A(d)(6)(B)(i), clearly states that if you recharacterize, you must include the earnings.

If so, that blows the whole scheme.

There are legitimate uses of recharacterization, but use them sparingly to avoid the unpleasant glower of the IRS.  I think I’ll leave the roulette wheel to Frank.

* I love the nom de plume.

Image credit:  Flickr

Back in March I wrote a post on the marriage penalty — the fact that two working people tend to pay more in tax if they are married rather than stay single.  It received a comment from Terry Neese suggesting a terrific solution that I’d like to elaborate on.  Terry is a Distinguished Fellow at the Family Policy Center where she advocates on behalf of family-friendly initiatives and legislation.

Her simple proposal is to allow people to choose their filing status for income tax; that is, if a couple is married, but they would save income tax by filing as singles, let them file as individuals.*

How brilliant is that?

Simple. What could be simpler than checking off a different box on your tax form?  Not so simple: figuring out each year which filing status to choose, but isn’t that what Turbo Tax is for?

Flexible. You can change it from year-to-year, as your personal situation changes.  For example, you may decide to leave the workforce to stay home with your children or to return back to work as they grow up.  You could change your filing status, as best fits your current situation.

Universal. Applies to everyone, in any type of family situation.

Inexpensive. Well, inexpensive to implement; but someone needs to do a tax study on the impact to the Federal revenue stream.  I found several studies on the impact to individuals, but haven’t found one yet on the impact to Uncle Sam’s wallet.

Marriage is a societal institution worth supporting, even subsidizing.  If Pat and Alex formally agree to care for each other in sickness and in health, then that’s two fewer people who will need support from the government.  As a taxpayer, I like that.

It’s the same reason I support tax subsidies for homeowners (e.g. tax deductions for property tax and mortgage interest).  Communities are more stable when citizens are landowners rather than tenants.  I think Pat and Alex should get the homeowner’s tax break and the tax discount for marriage, too.  However, if marriage means higher taxes for them, I don’t want to discourage their public commitment.

Note that I didn’t specify whether Pat and Alex are one man and one woman, or two men, or two women.  It shouldn’t matter.  It’s not about their personal lives.  This proposal can be viewed strictly as a societal and financial benefit.  Every change that separates the sacred meaning of marriage from its secular ramifications is one step closer to a tolerant society that lets each citizen live a full and happy life.  There should be a different label for the state of being I associate with the person whom I have shared my life for sixteen years (married), from the state of being required to get discounted joint membership at Costco (married).

Any change that can be supported by both a liberal, like myself, and the relatively conservative, pro-family Family Policy Center must be good for America, right?

*Note that this is not the same as “Married filing separately.”  The best use of that category is for divorcing couples who are unsure about the legality of their soon-to-be-former spouse’s business.  You don’t want to put your signature on a joint return, if you think the numbers don’t add up.

Image credit: Flickr

When I posted recently on how to choose whether to fund your 401(k), Roth, or traditional IRA, I forgot to mention another category:  the Roth 401(k).  The Roth 401(k) rocks.  Like a Roth IRA, you put money in post-tax but then (in retirement) you take out the funds (plus appreciation!) without tax.  Unlike a Roth IRA, there is no income limit to be eligible to contribute.  For a Roth IRA, contribution eligibility phaseouts begin (for 2009) at $105k for singles and $166k for married folk.  Only about 20% of employers’ 401(k) plans offer the Roth option, but the percentage is growing.

If your employer offers a both a 401(k) and a Roth 401(k) and matches both, you might consider dividing your contribution equally between the two, to hedge against future changes in your tax rate.  Your tax rate might change if you make a lot more (or less) money or because Uncle Sam decides to change the rules.  Either way, it’s a good idea not to have all your eggs in one basket. Continue Reading »

So did ya get a big tax refund?  Yeah?  Wooohooo!

No, wait.  Hmmmm… Maybe not so good.  Wait a minute, do you mean that I let Uncle Sam have all that money all year?  When it could have been (at least) slumming in my savings account?   Hey, maybe I should fix that.

If you had a large tax refund, then your employer is likely over-withholding from your paycheck.  Your employer’s calculation assumes that you’ll use the standard deduction, so if you itemize, you’ll probably want to reduce your withholding.  The larger your itemized deductions (as a percentage of your income), the less you’ll want withheld.

Now I agree with Nina, over at Queercents, that it is nice to get a refund at tax time — much better than having to write Uncle a check — but you don’t need to drive your refund to zero, just bring it down a notch or two.  It’ll help your cash flow throughout the year.  Bonus points will be awarded if you set up an automatic investing plan to invest the tax savings every paycheck to take advantage of dollar-cost-averaging. Continue Reading »

If you pay estimated taxes, remember that the 1Q 2009 bill was due 15 April 2009. With everyone focusing on finishing 2008 taxes, it’s easy to overlook this deadline for the current year’s obligations.

If your primary income is from an employer that withholds sufficient tax, so that when you file your income tax you either get a small refund or a small bill — generally less than $1,000 — then you don’t need to file estimated taxes.

If you have significant other income, for example, from investments, then you need to calculate the additional tax you will owe, and send it in.

If you own or participate in a small business, then you need to calculate the business’ quarterly profit. The profit is distributed to you (if you are the sole proprietor), or to the partners (if it is a partnership). You must pay self-employment tax of 15.3% plus income tax on your income from the business.  If your business is a corporation, then consult the relevant regulations.

If you are self-employed as an independent contractor, you might not think about income tax until you start receiving 1099-misc’s at the beginning of each year.  Turns out that you really do have a small business — the business of you — whether you think about it that way or not.  And, yes, you should pay estimated taxes, including the self-employment tax.

“Taxes are the price we pay for a civilized society“  Oliver Wendell Holmes, Jr.

1040-ES:  Estimated Tax for Individuals

Photo credit: stock.xchng

An index fund is a mutual fund that owns all the stocks in a particular index.  The index could be the S&P 500, the NASDAQ 1000, the MSCI EAFE, or any of a hundred other indexes.  If you want your portfolio to have 80% domestic stocks and 20% international, then you could invest those proportions in two index funds.  This would instantly give you diversification across hundreds of underlying stocks.  Exchange traded funds (ETFs) are essentially the same thing, but they are considered slightly differently for tax purposes.  They are considered baskets of stocks instead of many individual stocks.  To me this is splitting hairs, but I’m sure it’s making investment companies buckets of money.  Let’s see if an ETF does us common folk any good.

Let’s compare two scenarios: investing $10,000 in an ETF vs. and index fund.

(Warning: Plot Spoiler: A good index fund is as good as an ETF; however, not all index funds are made the same.) Continue Reading »

April 15th is fast appoaching, and we all need to reconcile our accounts with Uncle Sam.  And Uncle doesn’t like to be kept waiting.

One strategy is to hide your stack of paper deep in your desk drawer and hope that the tax fairy will come along one night.  Surprisingly, this doesn’t work very well.

If you don’t have your return ready to file, it’s really quite easy to request a six-month extension.  Just be aware that it only allows you to file your return late — you still owe your tax on time.  If you don’t pay your tax by April 15th, you may owe penalties and interest.

You can file Form 4868:  Application for Automatic Extension of Time to File US Individual Income Tax Return.  The form is pretty straightforward — you enter your best estimates of tax owed and tax already paid.  If you think you will owe more, then send in a check or pay by credit card.

Interest and Penalties: You’ll owe interest plus a penalty on any tax not paid by April 15th.  The annual interest rate is 5%, but subject to change quarterly.  The penalty is 1/2 of 1%, up to a maximum of 25%.   If you do not file your return on time and do not file for extension, there is a minimum penalty of $135 or 100% of the unpaid tax, whichever is smaller.