Wednesday, December 5, 2012

Should You Do Your Own Taxes?

With tax season coming up, you might be wondering how your taxes will get done. In this post I hope to provide a little insight into whether preparing taxes by yourself is good idea or not.

I believe there are 3 ways to get your taxes done 1) by yourself, 2) "big box" tax preparers 3) your local CPA or other Tax professional.

1) By yourself -
If you don't have a particularly complex return I believe there are a few times you can skate by with preparing taxes yourself:
a) you are not in school (or if you are in school you are familiar with the education credits such as the lifetime learning credit, or the american opportunity credit and know when to appropriately take each)
b) you do not have kids
c) you only recieved income listed on a W-2
d) you plan on taking the standard deduction (i.e. you do not have substantial deductible expenses like a mortgage, charitable contributions, medical expenses etc).

If you fit into this category and feel somewhat comfortable with preparing your own taxes, than feel free to use whatever your DIY software you prefer. Of course your ability to prepare your own taxes depends on your competency level.

2) "big box" tax preparers -
Due to sheer volume of returns prepared, it is likely that I will offend someone by saying this, but I think this is the worst option. Last year I was offered a job at one of these "Big Box" firms (and denied) and I learned that thier hiring process is very poor. Most of the preparers go through a tax theory crash course and begin preparing taxes. It could be possible that your tax preparer is just working parttime to supplement his walmart paycheck.

After studying only a few years of tax accounting, it is nearly impossible for these people to be "professionals" after a few months crash course. I personally feel that one should never use this alternative (unless maybe you could do it yourself, but aren't up to the task)

3) Local Tax CPA
I believe that finding a trusted tax advisor is the best option for preparing your taxes. Dave Ramsey (a personal finance guru) recently put out an article highlighting that people who paid for a preparer typically save between $347-$841 on thier taxes. When you are likely to pay $100-$250 for an average return, you win here. (depending on your actual circumstances fees or savings can differ).

Keep in mind that not all CPA's are created equal, and that you should find a CPA firm that is most fitting for you. CPA firms are typically equipped to serve a certain type of client. For example a Big 4 firm usually is equipped to serve the largest of clients, like Microsoft, Amazon, Boeing and their executives. Some CPA's specialize in smaller businesses/individuals. Regardless of your choice of CPA keep in mind you are paying for quality advice and direction. When choosing a tax advisor find someone who:

a) "has the heart of a teacher". Regardless of how much you would (or wouldn't) like to know about your taxes, if your advisor has the heart of a teacher you know they aren't just in it for the money, but are willing to help and teach you.

b) plans to build a relationship with you. A good preparer knows that 2013 isn't the only time you need your taxes done. A good CPA wants to plan to help minimize your tax liability for the future, instead of leaving the tax return up to fate to decide.

c) is familiar with the portion of the tax code that pertains to your needs.

Lastly, I would like to highlight a personal experience to show the importance of using a quality accountant.

Last year I had a friend who wanted to me solve a complicated problem on his taxes in which he prepared online. After solving his problem I noticed he was neglecting to take a specific credit he did not know about. After filing the return he saved over $1,000 just by having me look over it.

There are two points to be made. First, you can't let webMD properly diagnose you with cancer and you can't let free online tax software properly diagnose your tax problems. Second, its not about what you know, its about what you don't know; as well as what you think you know, but actually don't.

Tax benefits of Children Part 2: Exemptions

Another benefit when you have children is the extra tax exemption.

Exemptions are basically deductions based on the size of your household. For each person there is a $3,800 exemption (in 2012). Every exemption can save you $380-$1330 in tax dollars depending on your income and what tax bracket you are in.

As a college student I have heard of parents trying to hang on to that exemption as long as possible, but the reality is if your student child is qualified to file on their own, there are situations when you might want to reconsider. Here is just one scenario:

Scenario: Letting the student child file their own return
(assuming a tax rate of 10%).

If a child is free to file their own taxes, they not only will get their personal exemption  ($380 value), but they will be allowed to take an additional standard deduction ($595 value).

If a parent is in a 35% tax bracket, they are not eligible to take the education credit. (The education credit's income limit for married filing jointly is $180,000).

If the student needs to acquire loans, or at least pay a partial amount for their schooling without scholarship, the value of an education credit could be up to $2,500. (education credits are not discussed in detail here).

Total potential savings = $2,145 = ($380 + 545 + $2500) - ($1330)
Total potential savings = (added value to student) - (parent forgoing the student's personal exemption)

I know not everybody's parents make $180,000+ but the analysis gets more complicated if I hadn't made that assumption.

Everybody's situation is different and each situation should be evaluated independently by your trusted tax adviser.

Thursday, November 29, 2012

Tax benefits of Children Part 1: EITC

This is the first post in a series of how having a child benefits you on your taxes. EITC, Child Tax Credit, exemptions etc.

I do not think planning to have more kids is a good tax planning strategy of course, but that bundle of joy gets you a few extra tax benefits along the way!

Credit General Information
In general, a credit is better than a deduction. Deductions reduce income, credits reduce tax owed.

Example: If you have a $100 deduction and a 28% tax rate, then your tax owed will be reduced by $28.
Likewise, If you have a $100 credit (regardless of tax rate), then your tax owed will be reduced by $100.

Earned Income Tax Credit
The Earned Income Tax Credit is meant to provide a extra tax relief for working families and individuals.
The maximum credit for 2012  is $5,891 (Married, 3+ kids, earned income between $13,050-$22,300).

1. Income Limit: If your earned income* exceeds the limit, you are not eligible for the credit.

# of Kids Individual Married file jointly
0  $13,980  $19,190
1  $36,920  $42,130
2  $41,952  $47,162
3+  $45,060  $50,270

*Earned income includes: wages, tips, self employment earnings. NOT earned income: retirement income, unemployment, child support, interest & dividends.

2. Number of Kids: your Child is a child if it meets the following tests:
  • a. Relationship Test (child, stepchild, foster child, sibling, half-sibling, or a descendant thereof)
  • b. Age Test (<19, or <24 if a full time student, or any age and disabled)
  • c. Residency (they lived with you more than 6 months)
  • d. They aren't married, if married they don't file a joint return with their spouse (unless its for a refund).

3. Investment income: Cannot exceed $3,200 (interest, dividends, capital gains, some rents and royalties.)

4. You or your spouse must be at least 25, but less than 65 years old.

Credit Amount
Use the table to find your income amount, and how much your credit is worth!

The IRS has yet to officially release a table, but here is a link to a draft: Unofficial EITC Table

Note that this is a VERY watered down version of the credit rules.
Other considerations not mentioned in this post include:
  • Treatment of Scholarship/grant income
  • Income is actually your AGI number, which includes a series of deductions (including student loan interest deductions, moving expense deductions etc.)
  • Treatment of the credit if you have foreign investment income etc.

Thursday, November 15, 2012

Keeping the Mortgage for a Tax Deduction

Real estate is a favorite topic of mine. A question that often comes up is "should I keep my mortgage for a tax deduction?"

Most people are aware that there is a tax deduction for the interest paid on your mortgage every year. This often times will increase the likelihood of your ability to "itemize" your deductions (i.e. the ability to take more than your standard deduction amount of $11,900 if married filing jointly).

But is it worth it to keep a mortgage for the sake of a tax deduction? My answer is NO! but comes with complexity.

Here is why: Sure, that interest paid to the bank gets you a sweet tax deduction,  but it doesn't make financial sense to pay the bank $10,000 in interest to get a $3,500 cut on your tax bill. (calculated using a 35% tax rate, which is assuming you are rich and in the highest tax bracket, which statistically, most readers won't be!).

So that is it, we are all going to pay down our mortgages right? wrong! As much as I hate to admit, taxes aren't everything! Here is the minor complexity:

Generally speaking, you are likely to get more bang for your buck if you dump your money in that 401K, IRA, or some other investment. Most investments pay a better return than that rockin' 3.25% interest rate you are paying on the mortgage.

But, if you want a guaranteed return on your money, or you don't anticipate getting a return better than 3.25% (or whatever your actual mortgage rate is), then maybe paying down the house is a good idea.

(If you wanted to get real nerdy, you could dive deeper and calculate the after tax impact of paying down your mortgage, vs paying tax on your capital gains!)

Moral of the story: keeping the mortgage around ONLY for the tax deduction makes no sense. Its like asking for a quarter in exchange for a dollar.

(seeing as I do not have a mortgage, your experiences & criticism on this article are openly welcome)

Thursday, November 8, 2012

Why your taxes will likely increase in 2013

So this is a pretty popular topic in the tax world. I wanted to touch on how taxes will impact my close friends and family.

If Obama (I would be saying Romney here if he was elected) and Congress can't get something together, there are a few tax cuts that will expire.

-Payroll Tax - that amount taken out of your paycheck is currently 4.2%, it will be raised to 6.2%
Impact: All working taxpayers

-Tax Rates - the rates for ALL Americans (not JUST the rich, not JUST the middle class) will increase ranging from 3-5% across the board. (see the table below)
Impact: All taxpayers

-Standard Deduction for Married filing jointly will not be as beneficial.
Impact: Married taxpayers

-Married filing jointly 15% bracket will shrink (forcing many into a higher tax bracket)
Impact: Married taxpayers

-Child tax credit maximum will revert to $500 (currently $1000).
Impact: Lower income taxpayers with children

-Medical expenses will be more difficult to deduct (7.5% floor reverts to 10% floor)
Impact: taxpayers with crazy medical bills

Dependent care expenses - the maximum credit will decrease (from 3,000&6,000 to 2,400&4,800), as well as the portion of expenses counted as a deduction (35% percent to 30% of total dependent care expenses).
Impact: Lower income taxpayers with children

Earned Income Tax Credit (EITC) - Less Americans will be qualified for the credit due to more stringent requirements.
Impact: Taxpayers 25 years of age, lower income, working

Education Credits Expire - time to finish school, because the american opportunity tax credit will expire. This is the credit my student friends are getting (up to $2500) to subsidize our tuition. If you are a student, your tax return is likely to not look so nice when you file in april 2014.
Impact: All students (or parents with dependent students)

2013 Tax Rates:

Tax Brackets (2012 Dollar Amounts)Marginal Rate
Unmarried FilersMarried Joint Filers  
OverBut Not OverOverBut Not Over20122013