"Believe what ya like. Think what ya like. You'll be judged for what you do."
-- Tim Minton, Eyrie

Friday, March 30, 2012

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.


Dr. Kathy McCoy said...

Fascinating, Tom! You're right: doing taxes on your own sure opens your eyes! Here I was feeling quite proud of myself for using TurboTax instead of an accountant (after years of complicated Schedule C's), but your way is better! I learned so much just by reading your post!

stephen Hayes said...

Mrs.Chatterbox was once a tax consultant and she prepares our taxes. I just sign on the dotted line. I was surprised when the last return she asked me to sign said to not resuscitate me.

schmidleysscribblins,wordpress.com said...

Srephen's comment is too funny. David does our taxes using Turbotax. As you know the work you do before you use the Software is the difficult part. Why take it to H.R. Block if you already organized your paperwork?

Nice write-up. I have noticed for years our income is in the wrong bracket, i.e. earned income.

You didn't go into the subject of all those folks who don't pay any taxes at all. Of course, some are like my son who makes $16,000 per year as a Special Ed teacher in Southern VA (he is a contract worker in a Right to Work State).

My son files taxes every year and gets a refund. He also gets by on the kindness of strangers.


Rosaria Williams said...

You make it sound so easy! Well, for some people. I have never done my taxes; my hubby does, and keeps me up to date, and taught our children to do theirs too. I better learn too.

Arkansas Patti said...

How nice you and Mitt pay the same rate:))
Luckily (or not) I am old enough and poor enough that I pay nothing. Even my real estate taxes are frozen since I hit 65 and I pay nothing there after exemptions. If it weren't for personal property tax and sales tax, I could finally be a free loader after 45 years of working.

Tom said...

I WISH I enjoyed the luxury of a spouse who did my taxes!

I've heard about all those people who don't pay taxes. I don't know who they are. I know some people with low incomes don't pay any Federal income tax, but they still pay Social Security tax, state tax, real estate tax, sales tax, etc.

I must confess, taken altogether, I do pay a lower rate than Mitt Romney. Still ... I'm definitely in favor of him paying more, and me paying less!

Catch Her in the Wry said...

I been preparing taxes for over 35 years and some of your commentary is not correct. I don't want to take up your comment section with corrections though.

H&R Block and similar franchises charge outrageous fees because only a portion of that fee goes to actual tax preparation. The rest goes to the national franchise to pay franchise fees and national advertising. You'll find a local accountant/preparer will normally be much cheaper because of that. My fees are ridiculously low compared to my competitors, because I charge by my time, not by the number of forms in the tax return. No matter how complicated, if it tax me a half hour to do the return, I charge a half hour rate.

Starting this year, all tax preparers (except CPAs and attorneys) are required to take a competency test. Many of those temp preparers at the franchised offices will not be able to prepare taxes in the coming years -and that is a very good thing for the consumer.

Turbo Tax is a good sofware program for the average taxpayer. I will say, however, that it doesn't give you all the little details that add up to saving you money. Just this week I redid a tax return a client had done with Turbo Tax and got him an additional refund that more than paid for my fee. His comment: "TurboTax didn't tell me I could do that." But I did and it wasn't something illegal or even in a "gray" area.

By the way, I am a big proponent of eliminating the income tax system and inplementing the only "fair" tax - every man, woman and child should pay the same amount (i.e. $2000) and be able to keep all their money over that amount. People would spend, save, invest the balance and the economy would roll. It would also be a deterent to having children out of wedlock to get the bonus refund of earned income credit.

Joanna Jenkins said...

I've long since stopped trying to figure out my own taxes-- I leave it to my husband, the accountant :-)
It's just to complicated and the rules keep changing.

#1Nana said...

I don't think that Texas has state income tax, but they have high sales tax. Here in Oregon we have state income tax, but no sales tax. Best of both worlds would be to live in nearby Washington and do all my shopping in Oregon.

schmidleysscribblins,wordpress.com said...

You certainly generated a lot of discussion. Re your question to me. No I don't like the Individual Mandate in the new Health Care Law. Big government overreach in my book. A better way would have been to use Paul Ryan's idea which was to give those (like me) who buy health insurance a tax break. Anyone wanting the break would buy insurance or not. This should take care of the free riders. Or not. It's complicated.

Very afraid of the 'preexisting condtion' idea. Does this mean any old thing or will it cover items like Cerebral Palsy? Need more specificity.

I want to see the extension for kids to age 26 preserved, and let parents and/or employers pay the insurance premium increase.

Also, extending Medicaid to cover single adults who are not already covered by Medicare should help.

These two changes would cover most of the uninsured without wrecking what we already have in place.

Hopefully, when the law is determined unconstitutional the powers that be will go back to the drawing table and fashion something sensible.

Take it away from the Feds and let the states do it I say.


Linda Myers said...

I've been doing my taxes forever and I have to admit I enjoy it, whether by hand or by Turbotax. But then, I was a systems analyst when I worked for money, so it's how my brain is wired.

You're right - Washington State has no income tax. But where I live the sales tax is 9.5 percent instead.

JHawk23 said...

Agree! And stock sales and dividends are just the beginning. For many years living overseas, we had the extra complexity of accounting for our home, which we rented out - learned all the ins and outs of several different kinds of depreciation, etc. Now we're retired but my wife has a small business and again, the intricacies of that yield not only understanding, but a useful mental challenge.

One year, back in the 1980s, I had a triply complicated tax situation and little time to deal with it. I went to a "pro." Not only do you have to organize everything for them, leaving them the easy part, but he just put my data into Turbotax anyway. Oh, and when I examined the "final" return, I found two or three arithmetic errors, including several thousand in deductible interest that was entered as only several hundred. Never again!

Kathy Gregory said...

I applaud you for having the diligence to do your taxes yourself. It does take quite a bit of determination to look at the numbers and equations and just figure out what you have to do with them. That’s a good observation you made regarding saving and investing. That is why a lot of people say that the big money is in investing and in playing with stocks. Because you’re essentially getting good money with virtually no deductions waiting for you.

Lauren Padilla said...

I remember the first time I experienced paying my taxes by myself. I was a bit nervous that time. It's like walking in a dark path with no idea on where to turn to. Luckily, there was this old colleague of mine in that area. He helped me to get familiar with the procedure. I also learned that I can make monthly installment payments.

Winston Sutton said...

This is really a splendid story, Tom. It seems like it’s too easy for you to handle the tax on your own. Doing taxes are too complicated, which ’s why a newbie must consult a specialist for this kind of task.