Increase (or Decrease) Your Tax Refund!

In a previous post, we talked about why it is that some people – even those with identical incomes – can have wildly differing refunds.  The person in the cubicle next to you, who makes the same salary, is always crowing about his $8,000 refund and you’re barely getting anything back at all.

What gives?

As we discussed earlier, a host of life situations can have an effect on your income tax refund.  Putting money into an IRA can significantly decrease your tax liability – while taking money out of an IRA can significantly increase it.  One person might have big capital gains in the stock market and another person might have capital losses that are just as big.

But one of the fundamental things that effects your income tax refund is the level of withholding on your paycheck.  It’s really the baseline that determines your refund, yet many people know little or nothing at all about how it works.

That is until today, because I’m going to explain it.

You’re welcome.

All right.  Back when you were first hired at your job – however long ago that may have been – you filled out a IRS Form W-4, which looks something like this.  The Form W-4 was part of that stack of papers you had to fill out on your first day, and so most people don’t remember it.  

What this form does is determine the number of exemptions that you’re going to claim for the purpose of payroll withholding.  And I emphasize that this is just for the purpose of payroll withholding and doesn’t necessarily reflect how many exemptions you’re going to claim on your actual tax return.  But more on that later.

The worksheet is pretty self-explanatory.  You enter a “One” on the worksheet for every situation that applies to you.  One for yourself.  One if you’re Married and the sole bread-winner in your family.  One for each dependent.   One for this.  One for that. 

Based on the W-4 Worksheet, if you were filling this out as Ward Cleaver – those of you under the age of thirty can ask your parents about that reference – your total would come to Five.  If June Cleaver had a job outside the home (like that would ever happen) and the Cleaver’s were paying for tax-deductible after-school care for the boys, the number would rise to Six.  If the Beaver ran off to join the circus and was no longer a dependent, the number would drop to Four.

So what do these numbers mean?  When the folks down in payroll are determining how much federal tax to withhold from your paycheck, they use a table provided by the IRS to every payroll department in the country.  Based on the number of exemptions you claimed on the Form W-4 and the amount of your paycheck, this table determines how much to withhold.

For example, if you made $500 per week and had just two exemptions (you were single with no kids), the payroll department would withhold $40 in federal income tax.  If you were Ward Cleaver and had five exemptions and $500 per week, the withholding would be only $11.  At seven exemptions, there would be no withholding at all.

So as you can see, the number of exemptions that you claim on the W-4 makes a huge difference in how much is withheld from your paycheck every week, and that effects how big your refund might be at the end of the year.  The larger the number of exemptions, the less the payroll department will withhold, and the smaller your refund will be.

So if it seems like you wind of writing a check to the IRS every April 15^th because you still owe taxes, a very simple solution would be to decrease the number of exemptions that you’re claiming; this will increase the amount that’s being withheld throughout the year, and that should take care of any shortfall.

By the same token, if you’re ending up with a whopping huge refund every year and are tired of giving the federal government a zero-percent loan (remember that a refund is your money), then you might want to increase the number of exemptions, which will decrease how much is being withheld.  You’ll have a smaller refund at the end of the year, but more money in your pocket on payday.

Increasing and decreasing the number of exemptions on the Form W-4 is often a perplexing concept, because taxpayers feel that the have to be withheld based on their actual number of dependents claimed on their taxes.  That’s simply not true. 

In fact, the instructions for the Form W-4 (which rank right up there with those airplane safety guidelines in the seatback pocket in terms of “Documents That Nobody Ever Reads”) includes instructions on how to increase your exemptions because you have large itemized deductions.  It would not be far-fetched for our friend Ward Cleaver to have 10 exemptions on his W-4.

If you haven’t done it for a while, and especially if your refund is larger or smaller than you’d like it to be, I would urge you to go fill out the Form W-4 and see what number turns up.  If it’s different from what they have down in the payroll department, you can change it.  Just sign the form and hand it over.  It’s that simple.

As always, if you have any specific questions, you can find me at jeffrey.ritchie@yahoo.com or follow me on Twitter at http://twitter.com/#!/MilwaukeeTaxPro

Tax Credits for Education

The day your child has been waiting for since kindergarten has finally arrived – GRADUATION DAY!!

Woot!  Woot!

The day you have been dreading since kindergarten is now on the horizon – FOUR YEARS OF COLLEGE TUITION!!

Woot?

I hope that you started planning for your child’s college education before now, but if you’re a little late to the game, there are still some tax-related options available.  If your child is still a few years away, keep this stuff in mind – and do start planning today for the future.

Let’s start with the best-case scenario in which your child has received scholarships and other forms of financial assistance.  The most common question I get in that regard is whether scholarships are considered taxable income.  And the answer is that most of the time, they are not taxable.

If you’re attending an accredited school for the purpose of obtaining a degree, then scholarships that pay for tuition, fees, books, supplies and equipment are not taxable.  Only amounts that go for room and board, optional equipment and incidental expenses are considered taxable.  Any amount that your child receives for services rendered (that would be a student job on campus) is also considered taxable income.

Regarding any taxable portion of your child’s scholarship, remember that as of last year, the first $5,700 of your child’s income will be eliminated by the standard deduction, so even with $3,000 in income from a job and $5,000 in taxable scholarship money, your child’s taxable income is going to be $2,300 with a tax of only about $230.

A full year of tuition, room and board paid for, and it cost $230 out of pocket.  Complaints?  Anyone? 

Bueller?

Now let’s assume that scholarships didn’t cover the whole cost and you’re paying out-of-pocket for your child’s college education.  When that’s the case, you have several options available to you.

The best is the American Opportunities Credit, which can provide up to $2,500 per year (per student, if you happen to be the parent of twins) who are attending college.  The American Opportunities Credit covers “Qualified Education Expenses.”  What’s a Qualified Education Expense?  For nearly all tax credits and deductions a Qualified Education Expense includes tuition, fees, and supplies but doesn’t include room and board.

Bear in mind that the American Opportunities Credit was part of the Obama Administration’s stimulus package, and there’s no telling how long it will last.  It’s scheduled to expire on December 31, 2012 and if it does, it will like revert back to its previous incarnation, the Hope Credit.

The Hope Credit is similar to the American Opportunities Credit, with the biggest difference being income eligibility.  The Hope Credit phases out at $80,000 whereas the American Opportunities Credit doesn’t phase out until income reaches $160,000.   In addition, the American Opportunities Credit is good for all four years of undergraduate education, where the Hope Credit is only good for two years. 

When you’ve maxed out the Hope Credit, the next option is the Lifetime Learning Credit.  This credit is often overlooked, but can be quite beneficial.  For a fulltime student, you can receive a credit of up to $2,000 per year – but it’s also available to graduate students and people taking only a single class and not pursuing a degree.

The final option available is the Tuition and Fees Deduction.  This deduction (not a credit) reduces your taxable income – potentially both your federal AND state taxable income, by up to $4,000.  Remember that this is a reduction in taxable income, so the amount that you actually save will be a percentage of that amount based on your tax bracket.

The last resort, of course, is taking out a student loan.  There are two quick things to remember here.  The first is that people often exclude Qualified Education Expenses paid by using student loans because they feel that it’s somehow “not their money.”  You’re paying that loan back with interest, so it’s your money, all right.  And the second thing is that once you’re out of school and paying back that loan, the interest is tax deductible – don’t pass up that deduction!

Congratulations to the graduating class of 2011 and to those parents who made all this possible.

Have a great summer, and if you have any tax questions, drop me a line at jeffrey.ritchie@yahoo.com and don’t forget to follow me on Twitter at http://twitter.com/#!/MilwaukeeTaxPro

Summer Tax Tips

Ah Summer Time….

The time when the flowers are in full bloom and we all enjoy family activities like dragging the kids to the swimming pool and then off to baseball practice but then they start to whine incessantly about how they’re so bored and that there’s NOTHING to do…

Ah Summer Camp….

A few weeks respite when the kids can be entertained by trained professionals and we can relax and enjoy the season.

One question I get a lot from my clients is whether the cost of summer camp is tax deductible.  Many of them have their children in daycare or after-school programs during the school year and receive the Dependent Care Credit, so isn’t summer camp more of the same?

Well, sort of.

Let’s review the basics of the Dependent Care Credit first.

If you (or both you and your spouse) are working or seeking work, attending school fulltime, or are permanently disabled, you can usually deduct a portion of the costs you pay for child care.  While this person is usually your own dependent child under the age of 13, the credit might also apply to other persons, such as an elderly parent, who lived with you for more than half the year.

To claim the credit, you need to calculate how much you paid for child care and then subtract from that amount any dependent care benefits that you received from your employer.  This is typically a pre-tax deduction that you sign up for every year, but not every employer offers it.

Once you’ve figured the out-of-pocket expenses for day care services, you then check your Adjusted Gross Income (that’s going to be the figure on the last line of Page 1 of your Form 1040). 

Based on your Adjusted Gross Income, your credit will be a percentage of your out-of-pocket costs. This could be anywhere from 35% for very low-income workers to a maximum of 20% for people earning $43,000 or more.  To see the tables, go to http://www.irs.gov/pub/irs-pdf/p503.pdf.

Caveat:  You cannot claim child care expenses paid to your spouse, the child’s parent (if not your spouse), or to anyone who you claim as a dependent on your tax return.

Other Caveat: The person who provides the day care must report this income.  The Form on which you claim the Dependent Care Credit (Form 2441) asks for the Social Security or Tax Identification number of the person (or company) that provides the services.

If you’re paying “under the table” for child care, then you can’t claim the credit.

OK.  So what about summer camp?

The basic rule is this – any summer camp that does NOT provide overnight accommodations is considered daycare the same as any other daycare provider.  So if you have your child enrolled at a number of summer camp programs through the YMCA or other organization, these costs are deductible the same as your regular day care costs.

However, camps where your kids spend the night are NOT considered daycare and don’t qualify for the Dependent Care Credit.  Bummer.

But you really have to look at it from the government’s perspective.  If the cost of overnight camps was tax deductible, you could send your kids to “camp” at Disneyland for two weeks and then claim a tax credit.  And if you think that nobody would be so foolish as to even attempt such a thing, you need to read some of the whoppers that turn up in court on a regular basis.

So have a good summer, and if you have a tax question, drop me a line at jeffrey.ritchie@yahoo.com and I’ll do my best to answer it.

Thanks for reading.

Follow me on Twitter!  http://twitter.com/#!/MilwaukeeTaxPro