Saturday, April 6, 2013

10 Lessons You Learn By Doing Your Taxes


     Most people do not do their own taxes. They throw up their hands, decide it's too complicated and run to an accountant or H & R Block. 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.

     While it does take some time, and the process is not entirely painless, doing your own taxes can provide an educational experience. I'm not talking about practicing your arithmetic skills. I mean you find out what the government is really encouraging you to do (despite what it says) and what it really penalizes.

     In short, you find out how the world really works.

     Here are ten lessons I learned in doing my own taxes over the last couple of weeks.

     1. The Federal tax system penalizes workers. Not only do you pay the highest rates on the income you earn, but you also pay Social Security (aka payroll) tax of about 7% on yor salary. Your employer pays an additional 7% -- which means, at least theoretically, they could pay you 7% more if they weren't giving that money to the government. But wait ... the government likes you if you make a lot of money -- once you earn more than $113,700 a year, the government no longer takes its cut of 14%.

     2. The Federal government wants you to invest in the stock market. 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. Most stock dividends are taxed at a lower rate as well.

     3. You're a sucker if you have a savings account, or buy a bond. The interest rate you receive from a corporate or government bond, or a regular savings account, is the lowest it's been in decades. It's below the rate of inflation, which means you are actually losing money. The IRS doesn't care. It taxes the little bit of interest you earn at its regular rate, meaning you lose even more money.

     4. The IRS can't make up its mind about real estate. Real estate investors can take advantage of certain tax breaks, such as depreciation; but are excluded from others. Rental income is taxed at the full rate, as opposed to stock dividends which get preferential treatment. Bottom line: Investing in real estate can be a good deal, but it's not for everyone.

     5. Or owning a business. Again, many tax breaks are available to people who work for themselves, such as deductions for "travel and entertainment." But there are drawbacks as well. For one, you have to pay both the employer's and the employee's part of the Social Security tax. And the tax-filing process can be confusing and complicated, requiring obsessive record keeping and mind-numbing calculations.

     6. But it does want you to save for retirement. The government offers a wide (some would say overly complicated) array of options -- such as the IRA, the Roth IRA, the SEP IRA, the 401(k) plan – which allow you to escape, or at least defer, taxes on your retirement savings.

     7. It wants you to get health insurance through your business, but not on your own. The IRS doesn't tax the income you use to pay for health-insurance premiums, but only if you get medical insurance at your workplace or through your own business. If you buy medical insurance on your own ... no tax break for you!

     8. And the government will cut you a break if you're sick. You can deduct out-of-pocket medical expenses that exceed 7.5% of your income.

    9. The government wants you to go to college. There are several ways to deduct a portion of college tuition on your Federal tax form, and many states offer tax breaks for educational expenses as well. The 529 College Savings Plan is a relatively simple and easy way to avoid taxes on money you put aside for college. 

   10. The government really doesn't want you to do your own taxes. The Federal tax code reportedly runs 70,000 pages or more (people can't even agree on how long it is), and details all kinds of rules, regulations, breaks and penalties. Plus many more pages at your state level. And if you ever get audited, the government will want to inspect all your records and backup materials. The whole process is way too complicated for the average person. The IRS really wants you to pay an expert, who is more likely to get it right, and who will do it electronically.


21 comments:

DJan said...

I paid to have my taxes done every year when I was working, and now that I'm retired, it's an easy option to have my Social Security and retirement annuities added up. I use the AARP free service at the Senior Center, and it takes the person about ten minutes! :-)

Anonymous said...

Excepting since retirement (Hunky Husband does both of our taxes using software & e-filing, now), I have always done my own taxes. I understand everything you posted except this statement: "The IRS really wants you to pay an expert, who is more likely to get it right, and who will do it electronically."
The Feds do want electronic filing; but, I've seen no evidence that they wish me to pay an expert. Obviously, at least to me, our tax code is complicated because our legislators keep giving breaks to those to whom they are beholding.
Cop Car

Anonymous said...

P.S. I do recall, back in the early 1980s, filing taxes for a year in which I had moved, in which I had rental property, in which IRAs started, in which I expensed an auto, and a few other things happened, the sheaf of papers that I submitted to the IRS ran about 30 sheets. The only complaint the IRS had was that I failed to send the last sheet to them - my having left it in the copy machine!

BTW: I failed to congratulate you on a posting well done!
CC

John said...

Tom,
I'm one of those who pays a "pretty penny" for having my accountant do my business and personal tax returns....mainly because doing the accounting is boring for me.
Also, I don't care to keep up on all the IRS rules that will continue to change as time goes bye.
John

schmidleysscribblins,wordpress.com said...

This year as last, we will use our "Retirement Savings" to pay our Federal taxes. Will it never stop? I don't mind paying my taxes if the money is used wisely. Listen to Senator Tom Coburn (Senator Proxmire's heir) a while and you learn Fed $$ is wasted like crazy.

One reason I hated working for the Feds at times, was owing to the waste fraud and abuse I witnessed every day...even during a Republican administration. Many of these folks do not understand basic economics. Dianne

Barb said...

Tom, I do deduct my premiums that I pay for medical insurance annually as I do not get it through work. I do my own taxes but through turbo tax and the like.

Lorna said...

I pay to have my taxes done and am dismayed at what you said about bond funds in item #3.

Anonymous said...

Since my first home purchase in 1978 I educated myself in all the various legal ways of reducing Uncle Sam and his buddy Mr State cut of our income using tax deferred retirement savings IRAs and pretax 401K during our higher tax bracket years. Early retired, we kept the tax bill low by tapping different accounts taxable, tax deferred withdrawals and pension to cover our expenses. But now that I started to collect my railroad pension (Tier 1 is Social Security equilvalent) at 60 I look at March as my Tax Freedom Month. I no longer pay taxes I am just giving their money back and they are discounting what I am getting from the calculations they had given me. It is my task to educate myself on taxation so I can use all legal methods to minimize that discount and to get them to pay the taxes owed from my tax deferred IRA withdrawals from their check. It comes to a tax of less then 2% on money I set aside when the dual was charging me 32%. 30% return is not bad!

Chris said...

Bingo. I think the savings penalty is so staggering at the moment that I really don't understand how it will be restored to proper perspective and proper benefits to the individual saver. Thanks for the comments.

Galen Pearl said...

#10 is so true! Even when I go over my return prepared by my accountant, I can't follow it. I could never recreate it! So I will learn my lessons vicariously through you! Thanks for sharing them.

gigihawaii said...

David uses TurboTax, and he is an accountant. Too bad we no longer have mortgage interest to deduct.

Stephen Hayes said...

So much good information here. I haven't gotten around to doing our taxes yet. I better get busy.

Olga said...

I did our taxes for years and years until I went into a clinical depression. Houseplants and taxes were the two major things I could no longer handle. I have gotten over the depression, but I never went back to doing the taxes or trying to keep houseplants ali ve. We got a rebate from the Feds and had to pay the state a whopping
$3. We did pay a quite a bit for the accountant to do our taxes, but it seemed worth it.

Douglas said...

I have Faye. Not only a wonderful wife but a tax preparer extraordinaire as well as an IRS Enrolled Agent. I would be lost without her.

Kay Dennison said...

I have always done my own taxes.

Bob Young said...

Great simple tax advise for filling out your own tax return.

http://www.mindrmobile.com

Linda Myers said...

I've done my own taxes for decades. I use Turbotax, keep a list of questions, and have lunch with my accountant friend in April. It's like a puzzle.

Dick Klade said...

Always have done my own taxes. Was audited twice, and actually gained a few dollars in the process. Both auditors were very professional and the encounters were painless. If you hire someone to fill out the forms, you still are responsible for retaining records.

Wystan Dale said...

When you don’t have any idea about the benefits of doing your tax, you’ll end up messing up with it. You’ll never be interested of paying your taxes and it may sound like a burden to you. It’s important to know that taxes are an investment for the future, a way for the government to be able to give back to you. It also serves as your social security. It’s better to fix your taxes now before the Fed tax system penalizes you. :)

Lauren Padilla said...

I don’t like doing my own taxes either because I don’t want to go through all the hassle of accounting and many other things. I just want to get it over with. But it is good to know all of these things and be aware of the benefits you can get from paying taxes and where each deduction is allocated.

Lauren Padilla

Kathy Gregory said...

I actually take time to do my own taxes because I like knowing how much of my hard-earned money goes to taxes and where it is allocated. I also take note of how much I am able to benefit from them like for my kids’ education and the health services I am able to avail of. That somehow makes me feel that my taxes go to good use.

Kathy Gregory