Some people do a little victory dance when that tax refund check comes in the mail. But truth is, in the long run there’s nothing really to celebrate.
"Getting a refund check for $5,000 or more each year is like an addictive habit for some people. They get a rush from a big check arriving in the mail like they hit the lottery. Unfortunately, it’s just their own money they are getting back," says Jon Ulin, founder and managing partner of Ulin & Co. Wealth Management.
"We advise our clients to pay in only enough in federal income taxes from their paychecks throughout the year to come as close to breaking even on their federal income tax liability as possible. Do not overpay your federal taxes," says Ulin.
At the end of the year, if you’re a bit short on your federal income tax obligation, you simply just send a check to the IRS. If you’re getting more than $1,000 back in refunds from the IRS, then this proverb applies to you, "To Uncle Sam, you will neither a borrower nor a lender," says Ulin.
when you get a refund, it means you gave the IRS an interest-free loan for the year
Maybe you convince yourself that the refund money will be used to pay for a vacation, knock off some debt, or make house or car repairs. But when you get a refund, it means you gave the IRS an interest-free loan for the year. "Anyone else, even a bank, would pay you interest on the money. But not the IRS, it returns only the amount you overpaid, regardless of how much money you gave or how long you ‘loaned’ them the money," says Richard Reyes, a certified financial planner with Wealth & Business Planning Group.
Short-term gain can mean long-term regret
Your money being held by the IRS is not liquid. If you have a job loss or personal emergency, you can’t just call up the IRS and ask them to send you your money when need it most.
Instead of giving Uncle Sam a loan, you could be investing that money or paying bills. Take for example, if you have a credit card debt charging you 18% per year, you would save yourself $900 in interest payments by paying off your debt, rather than overpaying your federal income taxes, says Ulin.
Then too, if you defer less in federal income taxes and put your money to work in a before tax retirement account, such as your employer sponsored 401(k), you could end up saving a decent amount of money in federal income taxes based on your personal blended tax rate, adds Ulin.
How to get your withholding right
Estimate how much in federal income taxes you will owe for the year and then divide that amount by the number of paychecks you expect for the year. If your income and deductions do not change much from year to year, you can simply look at what you owed in federal taxes for last year and allocate the same amount for this year but increased for inflation if your income is adjusted up as well, says Ulin.
Most people pay the bulk of their annual tax bills through payroll withholdings. Through this process, a percentage of your pay is taken out each pay period and sent to the IRS where it is credited toward your final tax bill. Review your employer W-4 withholdings at least once a year. Many circumstances can affect the amount of tax you’ll eventually owe, says Ulin.
The IRS has a withholding a calculator that can help you figure out how much should be taken out. However, "Most times it will still have you withholding too much. My bias is to work with a professional to get it within the right range," says Chris Hardy, managing director of Paramount Tax and Accounting.
Also, once you complete the withholding calculator and you find that you are between exemptions, you can choose a lesser exemption amount and add a flat dollar amount on line 6 of the W-4 before turning it in to your employer.
If you’re getting substantial refunds each year, talk to a tax professional to make sure you’re claiming all the exemptions you can.
"I recommend that you increase the number of exemptions you claim by 1 for every $2,000 of tax refund you get back. Then when your deductions change, take the extra money and put part of it in a savings or investment account. At the end of the year, you will still have the money and you will have earned interest on it," says attorney Edrie Pfeiffer, an attorney with Hampton Roads Legal Services.
Another source of help, says Jayson Mullin, CEO of Top Tax Defenders is the IRS’ "lock in" department at 855-839-2235. "They may be able to walk you through how many allowances you should be able to take. If the agent is wiling, they can access your past year tax returns and use this information to calculate a reliable allowance amount."
Finally, points out Hardy, "The majority of people focus on preparing their tax return, not tax planning. Tax planning is where you can get the biggest ROI for your money. April 1 is not the time to be tax planning for the prior year."
Friday, March 27, 2015
Thursday, March 26, 2015
Tuesday, March 17, 2015
There are few Americans who do not dread the hassle of filing their taxes, but while it can be a headache for some, it can be an absolute migraine for those who are self-employed. There are more than 800,000 self-employed Americans, according to the Bureau of Labor Statistics. And while they can enjoy setting their own hours and take pride in being their own boss, they are also responsible for taking the tax preparation reins.
As in all things tax-related, what one doesn’t know (not to mention slipshod or incomplete recording keeping) can cost you. Here are some tax tips for the self-employed:
- Self-employment income can include pay you receive for part-time work you perform out of your home. This could include income you earn in addition to your regular job.
- You must file a Schedule C, Profit or Loss from Business or Schedule C-EZ if your expenses are less than $5,000 with your standard 1040.
- Use Schedule SE to figure your self-employment tax, which must be paid in addition to income tax. Self-employment tax includes Social Security (12.4 percent) and Medicare taxes (2 percent).
- People typically make estimated tax payments quarterly to pay taxes on income that is not subject to withholding. There are penalties if you fail to do so or if you underpay.
- Be sure you are taking all the deductions to which you are entitled. If it relates to your business, it’s deductible. Among what the IRS deems “ordinary and necessary” expenses you can claim are: mileage, gas and tolls; equipment, postage, business meals and entertainment, and subscriptions to appropriate publications.
- If you pay cash, keep receipts. Record all transactions, including bad business debt. Putting money into a retirement plan is not only good planning for the future. It also affords a tax break if you make salary deferrals up to $18,000 this year.
- In addition to your 401(k), you can also deduct your health insurance as well as benefits paid to employees.
- For those to whom the process is daunting, perhaps the most welcome write off might be for tax preparation software or professional assistance.
Monday, March 16, 2015
Sunday, March 15, 2015
The main difference between a C corporation and S corporation
A potential S corporation hiccup: ownership allocation
The upcoming S corporation deadline
Saturday, March 14, 2015
In the beginning of March, our thoughts turn to the (unpleasant) tax-filing season. This necessary evil goes with the territory of being a wage-earning citizen, and it has its pros and cons. Our taxes contribute to the great lives we inhabit here in the U.S., providing us with clean water, good roads and public schools for our kids.
Even though we file our taxes annually, it never seems to get any easier. In fact, if your salary goes up and you earn a bit more money, filing your taxes may become more difficult.
Before you begin to get your records in order and complete the paperwork (or ship it off to a tax preparer), take a moment to review your tax forms and avoid these top 10 tax filing mistakes.
1. Sign your return and double-check your Social Security number, name and address. Countless returns are delayed or sent back for careless errors. Double check to make sure your Social Security number and those of your spouse and children are correct. Sign your return before filing. Always review your return before sending it out. And while you’re at it, double-check your math. It’s so easy to plug in $520 when you meant to type $250.
One of my least favorite tax duties is checking my accountants work. That’s right, even if you hire someone to do your taxes, you still need to check it. Tax preparers are human, very busy and make mistakes, just like you and I.
2. Understand the new tax law changes, each year. I know this sounds like an ominous task. But most years, the tax requirements change a bit, and you are responsible for being aware of the changes. That means that if the standard deduction increases, and you don’t know about it, you could be leaving a lot of money on the table. Years ago, I used to order all of the IRS tax booklets and review them. Other years I might just buy the updated J.K. Lasser book (this year's book is titled, "J.K. Lasser's Your Income Tax 2015: Preparing Your 2014 Tax Return"). Now, with the internet, the IRS.gov website can be your best resource.
Use the search function for questions, and check out the changes for this year's section of the site. The government does an excellent job of explaining the tax laws on their website.
3. Include all of your income. It’s easy to file your taxes if you just had one job, and your employer issued a W-2 form with your wage and tax withheld information. But what if you and your spouse each had a job, and each of you earned a bit of income on the side as freelancers or consultants? Some of your clients may issue a 1099 form and others may not. It’s your responsibility to include all of the income you earned, whether you received a 1099 form for that income or not.
Even with interest rates at rock bottom, you may have received some interest and dividend payments. Don’t forget to include them on your return. Financial institutions are required to inform the IRS about the interest and dividends you receive.
4. Take all of the deductions you’re entitled to. Especially if you earned some side income, you may be able to deduct a host of expenses. The main aspect to consider is, what did you need to spend in order to earn the extra income? Did you have to buy certain supplies? Did you use a dedicated room in your home as an office? What about advertising costs? Review the Publication 501 tax booklet and Publication 529 and claim all of the deductions for which you are eligible. It could save you lots of money.
5. Remember to deduct all of your charitable gifts. Do you donate clothes, furniture and household items to Goodwill, the Salvation Army or other nonprofit charities? Don’t forget to deduct their fair value. Check out the Publication 526 tax booklet to see if you qualify. You may be surprised to find out the value of these gently used items. Some tax planning software even values your charitable clothingand donations for you. Cash and check donations are deductible as well.
6. Don’t miss credits for which you are eligible. Credits are even better than deductions. A credit is deducted right from total of taxes owed. There are credits for children, low-income credits and educational credits. Study all of the available “credits” on the IRS.gov website.
7. Don’t forget the date. Your return must be postmarked or filed electronically by April 15. If you miss the deadline, you will owe penalties. If you fear you may not be able to make the filing deadline, there is an out. You can receive a six-month filing extension on your tax paperwork by completing Form 4868 by April 15. This will give you an extension to file until Oct. 15, but you still need to pay the full amount owed by April 15. The extension doesn’t apply to money owed, only to sending in your tax forms.
8. Make a copy. Don’t forget to keep a copy of your tax return. In the future, you may receive a letter from the IRS describing an issue regarding your return. If you don’t have a copy, you’ll have to order a copy of your return in order to handle the problem. It’s so much easier to make a copy for your personal records in the first place.
9. Attach all relevant schedules and mailing information. Some tax items require separate forms. If you have self-employment income, did you complete and attach a Schedule C? After completing the forms, make sure to attach them in the correct order. Use the numbers on the upper right hand corner to properly order and attach them to your 1040 form. Finally, after checking your return, make sure to mail it to the correct address and put on the proper amount of postage. A simple mistake can mean extra work later.
10. Use the IRS website to help keep your return free from common errors. Visit the IRS Topic 303 website for a list compiled by the IRS of the most common filing mistakes. The government informs you of pitfalls and errors of other tax-filing citizens. A few minutes reviewing your return for potential errors can save you headaches and time in the long run.
Friday, March 13, 2015
Americans may hate the annual tax-filing season, but they certainly welcome the refunds that are issued each year.
In fact, more than half of those who participated in Bankrate's March Money Pulse survey say that they expect to get or have already received their IRS tax refund from the Treasury Department.
That's not surprising. The IRS reports that most taxpayers do get money back each year when they file their returns.
What is surprising is that this phenomenon continues, despite the best efforts of tax and financial advisers to teach the public more efficient money management skills.
Many interest-free loans to Uncle Sam
Money managers regularly counsel taxpayers against having too much income tax withheld from paychecks. While this will produce a refund upon filing, it means that taxpayers surrender use of their own money for months.
The worker essentially provides the federal government a 12-month (or longer) interest-free loan.
"Most people think getting money back is a good thing, a windfall, but you're simply getting your own money back," says CFP professional Douglas Boneparth, vice president at Life and Wealth Planning in New York City.
The average refund amount so far this year is around $3,000. "That's $250 a month you could have used throughout the year for saving or spending," says Boneparth.
Refunds preferred across all income levels
The desire for a refund is strong at all income levels. More than half of respondents in the Bankrate Money Pulse poll say they prefer tax refunds to breaking even at filing time or owing Uncle Sam a bit.
And nearly 4 in 10 (38 percent) of all Americans say they would like a big IRS tax refund.
Preferences for a refund by income category
|Preference||$75,000+||$50,000 to $74,999||$30,000 to $49,999||Less than $30,000|
|Total who want some amount of refund||53%||63%||62%||57%|
Bankrate.com Money Pulse survey, March 12, 2015
Only 27 percent of Americans say they want to hit that tax sweet spot of not getting a refund, but not owing Uncle Sam any money when they file their 1040 forms.
Laurie Ziegler, an enrolled agent with Sass Accounting in Saukville, Wisconsin, is not surprised about the refund preference.
"I do encounter it a lot," says Ziegler, who is working her 23rd filing season as a tax preparer. In fact, one of Ziegler's clients is getting a five-figure refund because the filer doesn't want to owe the IRS.
When it comes to taxes, says Ziegler, people typically want to err on the side of caution.
Forced tax-savings accounts
Many taxpayers also use their annual refunds as forced savings accounts.
That's somewhat understandable, considering interest rates on most liquid savings instruments are so low. But you also limit your access. "You can't go to (the) IRS to get money to replace the furnace," says Ziegler.
Still, many taxpayers apparently are comfortable with leaving their money in Uncle Sam's hands. "We're creatures of habit," says Ziegler. "If it's not broke, don't fix it. But it is broke."
"Is (forced savings) a good excuse? No, it is not. There's no excuse for improper planning," says Boneparth. "From a financial perspective, the reality is that it's an inefficient, inferior way to save."
Dealing with debt
What is surprising and a bit more encouraging from a financial standpoint is that more than a third (34 percent) of tax refund recipients plan to use the money to pay down debt.
Another 33 percent plan to save or invest the tax cash. About a quarter of poll respondents say they will spend their refunds on necessities, such as groceries or utility bills.
What will you do with your tax refund?
|Plan to use tax refund to||February 2015*||March 2010|
|Pay down debt||34%||30%|
|Save or invest||33%||28%|
|Spend on necessities (food, utilities)||26%||26%|
|Splurge (vacation, shopping spree)||3%||7%|
|None of above/don't know||3%||9%|
*Based on respondents who expect to or have already received refunds.
Source: Bankrate.com Money Pulse survey, March 12, 2015
Source: Bankrate.com Money Pulse survey, March 12, 2015
Retailers will be dismayed to learn that only 3 percent of taxpayers plan to splurge with their tax refunds.
Overall, taxpayers this year are a bit more conservative with their refunds than they were when surveyed five years ago.
"People are still very, very nervous about the future," says Tim Gagnon, a tax attorney and accounting faculty member at Northeastern University in Boston. "They had to take on more debt and see a refund as an opportunity to get some of it down so they won't be so leveraged."
That's a laudable goal. Still, Gagnon would like to see taxpayers get their money throughout the year.
Those who wait for an annual lump-sum refund not only waste use of their money while interest charges on debt grow, Gagnon says, but they also run the risk of not getting the money when they expect or need it if they encounter tax return processing delays.
All taxes are local
When asked what programs they would be most willing to pay higher taxes for, Americans narrowly favored higher education. Not surprisingly, the free tuition option was particularly popular among 18- to 29-year-olds, chosen by 43 percent in that age group.
Tax planning beyond refundsWhile the general lack of tax planning is disconcerting, Chris Browning, an assistant professor of personal financial planning in the department of personal financial planning at Texas Tech University in Lubbock, Texas, is somewhat more sanguine.
Browning says there actually is some planning behind getting a refund. The problem is that many taxpayers don't go beyond that.
"There generally is too little understanding of the trade-offs between getting a tax refund or not," says Browning. "What you plan to do with a refund is what you could have done anyway with your money earlier."
And, says Browning, many people don't realize that tax planning is not just fancy financial maneuvering. Something as simple as filing a new W-4 to adjust withholding is tax planning. It's a way to be more proactive in how to receive your money, says Browning.
Still, the receipt of a large refund that's used for generally sound financial purposes could be viewed as the optimal suboptimal situation, says the Texas Tech professor.
"The optimal thing would be for people to have a zero tax refund and zero tax liability, to plan it right to maximize their money for optimal consumption over a set period, such as a tax year," Browning says. "But if saving through a tax refund leads to people having money to set aside for saving, paying down or paying off debt, it's not the optimal, but it could be the suboptimal solution."