What You Learn if You Do Your Own Taxes

     Most of the people I know do not do their own taxes. They throw up their hands, decide it's too complicated and go to an accountant with their tail between their legs. Or they use H & R Block or Jackson Hewitt. A lot of people use electronic services such as Turbotax. This is kind of like doing it yourself, but the electronic process does hide some details of the tax system and how it affects you.

     I have always done my own taxes -- except for a couple of years when I tiptoed into an accountant's office and found out they don't necessarily do a better job, and they charge you a pretty penny for the service. I have also used Turbotax, but find that it doesn't always make life easier.

     In any case, while it does take some time, and the process is not entirely painless, doing your own taxes can be an educational experience. And I'm not talking about practicing your arithmetic skills. I mean you find out what the government encourages you to do, and what it penalizes. In short, you find out how the world really works, rather than how they tell you it works.

     For one thing, the federal tax system rewards saving and investing, and penalizes working. (Other financial forces may do the opposite ... but I'm talking taxes here.)

     For example, I recall for the year 2010, the government wanted us to work. IRS Form 1040 featured a Schedule M called "Making Work Pay" that allowed you to deduct up to $400 from your tax bill if you had earned income (the IRS term for money you earn by working).

     Apparently, the Feds are no longer quite so eager for us to get a job. There is no Schedule M for 2011. No $400 tax break.

     Working is about the worst way to make money in this country. The main reason we do it is because most of us don't have much of a choice. Getting a job is the only way we know how to make money.

     Speculating in the stock market is much more socially beneficial and is an activity to be encouraged and promoted ... at least according to the Federal government. Some of the money you make from capital gains -- the profit from selling a stock for more more than you bought it for -- doesn't get taxed at all. The rest is taxed at a lower rate than the money you make on your job.

     Your salary is also subject to an additional tax -- Social Security tax, aka the payroll tax. If you have a job, your employer pays half your Social Security tax; and takes the other half out of your salary before you even see it. You're still paying 14%. But it doesn't hurt so much; in fact, you're barely aware you're paying it.

     I myself do not have a job. But I do work. Like a lot of 60-somethings, I do some consulting and freelance work to supplement my retirement income. Nobody deducts any tax from my checks and nobody's paying half my payroll tax. So when I look at my tax form I can see that I not only pay a higher rate on the money I make from working, but I pay an additional 14% on top of that!

     Do you think that's fair?

     The dividends you make from owning stocks also get taxed at a preferential rate -- at the capital gains rate, rather than the earned income rate.

     I honestly don't see the rationale for taxing dividends at a lower rate than earnings. Except for this reason:  Retired people often have their nest eggs in stocks or stock mutual funds, and they rely on dividends to bolster their meager Social Security benefits. This is especially significant these days, when nobody makes any interest from a bank account or from a government bond.

     I think it's a good thing to give seniors a little bit of a break, when they've pinched pennies all their lives so they would have a financially secure retirement. But what about the millionaires?

     Some people in political circles have made noises about raising taxes on dividends and capital gains -- so rich people, stock speculators, wealthy heirs and heiresses pay their "fair share." I don't think that's a bad idea. But I do not think seniors should be penalized. So maybe the best way forward is to keep the tax preference for dividends and stocks, but only for a limited amount of income, say the first $20,000 or $30,000 a year. After that, dividends and capital gains could be taxed at regular rates.

      Here's something else I learned. Apparently, it's okay to discriminate against people on the basis of their advanced age. I tried to use some free e-file software this year. One site offered free e-filing if your household income is less than $57,000, and you're 25 years old or younger. Another site advertised free e-file if your adjusted gross income is $57,000 or less and you are 52 years old or younger.

     I'm over 25; I'm over 52; I'm out of luck.

     Here's one that absolutely amazed me. I live in New York, which is considered a high-tax state. I have a rental property in Connecticut, so I have to pay some Connecticut state tax as a nonresident. In doing so, I had to figure out what my total state tax would be if I lived in Connecticut. I don't know how it works for other people, but for me the state income tax is actually higher in Connecticut than it is in New York!

     Every year, after I figure my state tax, I start thinking once again about retiring to a state that has no income tax. Back in the early 1990s, Connecticut had no state income tax. But it does now! In case you're wondering, according to the IRS there are still seven states with no income tax:  Alaska, Florida, Nevada, New Hampshire, South Dakota, Wyoming and Washington.

     I did incur a lot of medical expense last year (fortunately, nothing serious ... a lot of dental expense added to a few extra medical charges), and I was heartened to see the IRS takes pity on those of us who are sick. You can deduct medical expenses over 7.5% of your income. If you have a business you can deduct the cost of medical insurance as well -- just like you do if you have medical insurance where you work. But you're out of luck if you're just an individual trying to pay for medical insurance -- no tax break for you!

     Apparently there are ways to deduct long-term-care insurance as well. This is something I've been thinking about getting for a couple of years now. I haven't bought any yet. Maybe I'll reconsider this year.

     There are plenty of other noteworthy items about the Federal tax form. The IRS offers tax breaks to save for retirement, to send your kid to college; to improve the energy efficiency of your house. Owning real estate is still a pretty good deal -- at least on paper, if the paper is Form 1040.

     The Federal tax code supposedly runs for some 13,000 pages, detailing all kinds of rules, regulations, breaks, penalties, advisories. Plus many more pages at your state tax level. I can't tell you about them all ... I just got an e-mail about a new job assignment, so I gotta go to work.

     I'll make about $3000 on this job -- and get to keep, maybe $1600 of it. But now I'm wondering, maybe I should spend my time checking out the stock market instead. I hear it's been doing pretty well lately.