Coming Soon To A W-2 Near You!

One Word: Relax.

When you receive your W-2 in January, you’re going to notice that there’s some new information displayed there.  It’s going to be in Box 12 with the code “DD” and the amount shown would be the cost of your health insurance coverage.

This was the subject of some heart palpitations two years ago with the Affordable Care Act was passed by Congress.  Some less-than-trustworthy news sources declared that health care insurance was now going be considered taxable income by the government and that workers would have to pay taxes on “income” that they never actually received.

Scoundrels!

One Word: Relax.

Your health care benefits are not taxable income and the cost of your insurance is on the W-2 for informational purposes only.  For whose information, you may be asking?  Well….yours.

If I owned a crystal ball, I could tell you with some certainly how this whole health insurance issue is going to pan out in the future.  But I don’t, so I can’t.  But if I were a betting man, I would bet that many of us who had previously been covered under an employer-provided plan will probably be shopping for insurance on our own at some point in the future.

Is that a good thing?  A bad thing?  I don’t know, other than to say that it’s a Big Thing.

Purchasing insurance on the open market requires a certain amount of background information, and not least of that information is how much your current insurance costs, so you can decide if the insurance you’re buying is a decent value.  Most employees, however, only know how much their insurance costs them, and have no idea how much is being paid by their employer.

This change to the W-2 will give employees that information.  All you have as to do is look at the amount in Box 12 labeled “DD” and you know the street value of your insurance coverage.  Of course, the cost of premiums alone isn’t the whole story when it comes to purchasing insurance (let’s not forget deductibles and co-payments), but it’s a good place to start.

Remember that not all employees will see this figure on their W-2, and it’s not just because their employer doesn’t provide health insurance.  Many employers (particularly small businesses) are exempt from providing this information because it was considered to much of an administrative burden.  However, you can always consult with your Human Resources contacts at work to determine the total cost of your insurance.

Is your health insurance going to be taxed?  No.  Really.

Relax.

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 Tips for Fall

Happy Autumn!  Well, almost.

I hope you all had a pleasant summer and are enjoying the transition to cooler weather.  And how about those Brewers, eh?  The boys of summer look to hang around just a little bit longer, and that’s all right with me.

What’s going on in the world of taxes?  The President and Congress are girding their loins for the annual mud-wrestling competition that is the federal budget negotiations.  As this process grows more contentious every year, it means that the final tax laws won’t be written until the week between Christmas and New Years.  So stay tuned for that.

But now is a great to be taking steps to save on your taxes based on the laws we have in hand – at least until the end of the year.  

Charitable Contributions.  The cooler weather means it’s a great time to spend the weekend cleaning out the attic, basement, or garage and (finally) taking some of that old stuff off to the Salvation Army, Goodwill, Amvets, or whomever.  Remember that you can claim Fair Market Value for items that you donate, which roughly means what you would expect to get for the item if you sold it on Craigslist or at a garage sale.  Goodwill of SE Wisconsin has a handy guide available online and you can find it by clicking here.

Recharacterizing your Roth IRA Conversion.  Recent tax laws have made it possible for people to convert their Traditional IRA to a Roth IRA, but this required people to pay taxes on the amount of the Traditional IRA that was converted.  Now there are some circumstances where you might what to consider “recharacterization,” which basically means that you’re taking the money out of your Roth and putting the money back into your Traditional IRA.  It’s as though the conversion never happened – at least for tax purposes.

Why do this?  Let’s say you converted $100,000 in a Traditional IRA to a Roth, and so now you’re going to pay taxes on $100,000.  But if that $100,000 in the Roth IRA has declined to $50,000 you’re STILL going to pay taxes on the $100,000 you converted, and not the amount that it’s worth currently.  So in addition to being pushed into a higher tax bracket because of the conversion, you might wind up paying double the taxes based current value of the Roth.  You might want to just call the whole thing off by recharacterization. 

But you have until October 17^th to do this.

Unemployment Compensation.  Unfortunately, the job market continues to struggle and many people who have never filed for unemployment compensation before and getting a taste of what that’s like.  Here are two things to remember.  The first is that unemployment compensation is taxable income, so if you’re not having anything withheld from these checks, you could face a tax liability next year when you file.  

The second thing to remember is that job search expenses are deductible as a Miscellaneous Deduction (that’s the one where the deduction has to be at least 2% of your income before you can take it).  You probably won’t have deductible expenses for routine things like printing resumes and such, but if you’ve hired an employment consultant or are traveling out of town to job interviews, those costs are significant and could be deductible.

Sale of Your Home.  The U.S. housing market continues to be a challenge, but if you’ve sold your home recently, here are a few things to remember.  If you’ve lived in your house for two of the past five years, then you may be able to exclude some or all of the capital gains from the sale of the house.  A capital gain is defined as the difference between what you paid for the house (including closing costs) and what you received after closing costs when you sold it. 

The IRS allows you to exclude $250,000 in capital gains ($500,000 for married couples) from the sale of your home, so if you bought several years ago and the value has appreciated over time, most if not all of the gain in value on your home will be tax free.  But more relevant to more recent home buyers and sellers, you cannot deduct a loss on the sale of your primary residence.

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

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

Rent or Buy?

It’s been a rough few years. 

I’ve dealt with more clients in bankruptcy and foreclosure since 2008 than I have during my entire professional career prior to that.  I’ve had clients with multiple foreclosures, with the financial consequences dragging out for years.  So it should come as no surprise that many people are wondering if owning a home is such a good idea these days.

The case against ownership is based on what you see going on around you every day.  As of last fall, the total value of residential real estate had fallen by (wait for it) SIX TRILLION DOLLARS.  That’s a staggering amount of lost equity, and if you’re a homeowner, some of those losses belong to you.

Owning a home can also be problematic in another way.  The modern economy is based on mobility – the tradition of a recent college graduate working for the same company for thirty years and then retiring is deader than disco.  According to the Bureau of Labor Statistics, the average worker is going to change jobs ten times during his or her lifetime – and sometimes that’s going to require a change of address, as well.

But when you own a home, you’re financially tied to the community where you live – even when that community has been devastated by layoffs.  You’re stuck trying to find a job where no similar-paying jobs may exist.

Not Surprising Fact Department:  The cities with the highest rates of home ownership (prior to 2006) are also the cities hardest hit by unemployment.  Workers in these cities (think Detroit) are less nimble with regard to where they live – they can’t just move to where the new jobs are.

All that being said, the depressed real estate market and extremely low interest rates make a compelling case to invest in a home.  The laws of supply and demand would indicate that real estate values are likely to increase long term, and inflation is likely to rise as the economy recovers, but a fixed rate mortgage at today’s lower rate will protect you from that (a little).

But there’s more.  As people have been foreclosed upon, they’ve become renters rather than homeowners, and so in some markets we’re starting to see a shortage of quality rental properties.  What happens when a commodity becomes scarce? You got it – in some markets the price of rent has gone up by double digits during the past two years.

So should you rent or buy?

I’m not here to answer that question for you, but I can give you a couple of things to think about as you make the decision.

Are you dug in?  If you were born and raised in Metropolis and that’s where all your family and friends live, you may have decided that you’re in for the long haul.  If that’s the case, then making a long-term commitment might be right for you.

But if you’re committed to moving up in your company or your profession, and moving up might require relocating to a different market, you might want to think twice about owning a home.  The rule of thumb is that, all things be otherwise equal, it takes about five years for owning a home to start paying off. 

Is buying a good deal?  As I said in my first blog post, run the numbers on your mortgage and then run them again.  Now is the time to snatch up some incredible bargains on real estate – but don’t be a fool and decide to buy more house than you could have afforded otherwise, and then lock yourself into a bigger mortgage than you need. 

The rule of thumb here is that your mortgage and escrow payments should not be more than 28% of your monthly income.  This is all about cash flow – your mortgage payments should be low enough that you’re still able to be making your other obligations AND…AND…AND still be saving for retirement.

Let me say that once more, because while your home is an investment, it should NEVER be your only investment.  Don’t swap mortgage payments for contributions to your 401(k) or your IRA.

My last bit of advice is to simply know yourself.  Buying vs. Renting is as much about lifestyle choices as it is about finances.   If you really hate yard work, for goodness sake don’t go out and buy yourself a yard to work in.  Makes sense, right?

Thanks for reading.

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

It's Never Too Early...

Here’s the problem with tax planning. 

For the first three months of the year, people are so stressed out by reading instruction booklets and looking for those lost receipts and then filling out their tax forms for the previous year that they want to go at least two months without EVEN THINKING ABOUT TAXES after the filing deadline.

Then before you know it, summertime is here.  Family vacations, baseball games, cookouts on the patio and a long snooze in the hammock – and really – who can think about taxes with all that fun stuff going on?

Well I sure can, gosh darn it.  And so before this year is more than half over – and by then you’ve already missed out on some good opportunities to save on your taxes – we’re going to talk about tax tips and strategies for 2011.

The tax legislation passed last December (which effects income earned in 2011) was not much more than a placeholder.  The leadership in both parties was simply not willing to engage in the knock-down, drag-out partisan brawl that some members of their respective parties wanted, and so there wasn’t a lot of change from 2010 to 2011. 

But there are some changes, and you need to know about them.

Big Thing #1 is that the lower capital gains tax rates are still in place.  So if your income is relatively low this year – either because you changed jobs, just graduated from college or just retired – you might want to consider cashing in some of those capital gains this year.  No promises as to what’s going to happen in 2012.

If you’re in the 15% tax bracket or lower, you don’t have to pay ANY capital gains on assets held long term.  What does this mean?  Let’s say you were laid off this year and your income has taken a significant hit.  If you’re married and your combined income for 2011 is less than $69,000, then you might want to cash in the Apple stock you bought back in 1983 because you won’t have to pay any taxes on the capital gain.

It’s free money. 

Big Thing #2 is the Residential Energy Tax Credit.  Despite some speculation that this credit would be dropped at the end of 2010, it has lived on to give taxpayers credit for home energy efficiency for another year.  But there are two big warning flags with regard to this credit.

The first is that while the credit survived, it’s been significantly scaled back from previous years.  In 2009 and 2010, you could receive 30% of the installed cost of certain energy efficient home improvements back as a tax credit, up to a total of $1,500.  The new credit is much smaller.

For improvements like replacement windows, the credit it limited to 10% of the cost and is limited to just $200.  The credit for installing a high efficiency gas furnace is just $150 – I had several clients who received the entire $1,500 credit for just a furnace alone.

The second thing is that the new credit has a total lifetime limit of $500, so if you have already received $500 or more from the previous energy credit, you’re completely out of the running to take advantage of the new credit.

Keep this in mind when you’re pricing home improvements, because the odds are that the guy at Home Depot isn’t a tax expert and he’s going to tell you all sorts of incorrect things about your potential tax savings.  The fact is, you’re going to save money on your energy costs (no small thing these days) but you’re NOT going to save a lot on your taxes.

For more information on the energy credit, go to www.energystar.gov.

Big Thing #3 is the American Opportunities Credit.  I don’t know why this isn’t getting more attention because it’s a whopping huge credit that probably won’t last forever, so you really should take advantage of it.  Simply put, it provides a $2,500 year tax credit for every child that you’re putting through college. 

Every year.  For four years. 

Let me do the math – That’s $10,000 in assistance to pay your kid’s tuition.  You say you have twins?  Make that $20,000. And if you don’t have a tax liability large enough to need your annual tax credit, the American Opportunities Credit will actually create a refund where none had existed before.

Sweet!

We’ll take more about ways to save on your taxes in 2011 as the year goes on, but these three can provide some big savings if you’re able to take advantage of them.

Thanks for reading.

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