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

Disaster Scenario

First of all, I want to send my prayers, condolences and best wishes to those in the Deep South who have been ravaged by an unprecedented series of natural disasters from tornadoes to massive flooding.  Have courage and rely on your faith and each other to get through this.

It’s probably not surprising that as a tax guy, this morning I found myself thinking about the Casualty, Disaster, & Theft Loss tax deduction that is available to taxpayers on Schedule A of the federal Form 1040.  Can it help in this situation?  Sort of.

As I often tell my clients, the Casualty, Disaster &Theft tax deduction is something I hope they will never need.  Qualifying for the deduction isn’t easy because the IRS doesn’t allow the deduction for comparatively minor losses, so qualifying means that you’ve taken a serious and really significant financial hit during the course of the year.

For openers, any loss that you might experience – such as damage from a tornado or a flood – must be an uninsured loss.  You can’t claim the deduction for losses to the extent that you are being compensated by somebody else because, at least in the financial sense of the word, you haven’t really experienced a loss.  So if replacing the hail-damaged roof of your house is going to cost $15,000 and your insurance will pay the whole thing, you don’t have a deductible loss.

On the other hand, if you experienced $20,000 in flood damage and your insurance specifically excludes flooding (and many policies do – check yours today) then you have a $20,000 loss that is potentially deductible. If your insurance only paid a portion of the damages, then the portion not covered by insurance is also a potentially deductible loss.

Potentially.

Potentially.  Because here’s the catch – you’re not going to be able to claim the whole amount.  Let’s say that your car was stolen and subsequently wrecked.  To calculate your deductible loss, you would take the Fair Market Value of your car on the date it was stolen and then subtract from that amount whatever you received from the insurance company in addition to any amount that you received from the salvage company that towed your wrecked car to the junk yard.

After you deduct the amount of any insurance compensation and salvage value, you then deduct $100 from the remaining balance (don’t ask me how or why the IRS settled on this figure) and then you deduct 10% of your Adjusted Gross Income that appears on from Line 37 of your Form 1040.

And that’s what makes qualifying for the Casualty, Disaster, & Theft tax deduction so difficult.  It’s the reduction by 10% of your AGI that will most likely take “routine” losses off the table for the purpose of receiving a tax deduction.  If your Adjusted Gross Income is $75,000, it would take an uninsured loss of more than $7,600 (10% of your AGI plus $100) before you could even start counting your losses against your income. 

All of which is not to say that people don’t sometimes suffer catastrophic losses like what we’ve seen in Mississippi and Alabama this week.  What happens then?  Let’s use this scenario:

Your home and its contents are insured for $150,000.  A tornado basically destroys everything, and the claims adjuster places the total loss at $300,000.  You receive a check for $150,000 from the insurance company and are able to salvage $5,000 worth of property from the wreckage, so you have a total casualty loss of $145,000. 

Your Adjusted Gross Income for the year was $80,000 and so that reduces your deductible loss by $8,000.  Combine that with the $100 IRS-designated reduction, the amount you can claim on your Schedule A for a Casualty, Disaster & Theft loss is $136,900.  

Now with only $80,000 in Adjusted Gross Income and $136,900 in deductible losses (that’s not including the usual itemized deductions for income taxes paid and so forth), clearly you’re not going to owe any taxes this year because your deductions are greater than your income.  What’s more, the IRS will allow you to carry back these losses up to five years.

What does that mean?  Let’s say that your modified Adjusted Gross Income – this is your AGI minus other itemized deductions and exemptions – comes to $60,000 for the year and you have a $136,900 casualty deduction.  Subtract the $60,000 from the $136,900 and you have zero taxable income for the year, along with $76,900 left over.  This is what’s called a Net Operating Loss or NOL.

You can then carry that Net Operating Loss back to the previous year and amend your tax return to claim this as a loss for the previous year.  All things being equal, you’re probably not going to owe any taxes for the previous year and will get back whatever you had originally paid.  If there’s still a remaining Net Operating Loss, you can carry it back to the next preceding year until you’ve used up the entire amount.  

In the scenario I’ve described, you would realize a savings on your taxes of a less than $20,000 when all is said and done – the actual amount will depend on a host of other factors that would effect your final tax liability.  That’s a good thing, of course, and after a disaster you need whatever help you can get.  But it hardly makes up for the loss of your house and all your belongings.

So as I said earlier, I’m glad that the Casualty, Disaster & Theft tax deduction is out here, but I pray that you’ll never need it.

Thanks for reading.

Filing an Extension? Here's What To Do!

It’s that time of year.  The snow has melted and the flowers are starting to bloom.  And now the tax deadline is looming and you’re just not ready to file.

Maybe this is the year that you file an extension, so let’s talk about that today.

The first thing you have to understand is that filing for an extension on IRS Form 4868 does not give you an extension of time to pay your tax liability.  If you need more time because you owe the IRS big bucks and you just don’t have the money, an extension isn’t going to help you, but more on that later.

People typically file an extension when they have business or investment interests that require more time to calculate gains and losses for the year.  Another common reason to file an extension is because you’re living outside the United States or serving in combat as a member of the armed forces (but those have special rules that we’ll talk about in a future blog).  

In order to file an extension, you have to complete your annual tax return to the extent that you have actual data available, and then use your best estimate for everything else.  The safest thing to do with regard to those best estimates is to use last year’s data, unless you know for certain that there are going to be significant changes.  In any case, filing an estimate really does require you to complete a “draft” version of your tax return and pay what you owe.

So you file the Form 4868 and send in your estimated tax payment, and then you file a complete tax return sometime before October 15^th.  But that’s for when you owe money to the IRS.  Can you use the Form 4868 to claim a refund?

Three Words: Not Bloody Likely.

Actually, it’s really just one word: No.

The IRS and most states expect you to file a return by the April 15^th deadline regardless of whether you owe a tax liability or you expect a refund. However, there are no penalties for filing late when you have a refund coming, and although the IRS will never say this out loud, if you have a refund coming, they don’t care if you never file your tax return.  They’re happy to keep your refund, thank you very much.

OK.  So that’s what you do when you need more time to file your return.  But what about when you owe the IRS thousands in tax liability but just don’t have that kind of money?  The most common response from taxpayers is to not file a return, under the mistaken impression that the IRS can’t collect the balance due until you actually file.

Wrong, wrong, and wrong!

Not only can the IRS collect from you, they’re going to collect a heck of a lot more because of the penalties-and-interest smack down you’re about to experience.  Failing to file a tax return (when there’s a balance due) results in a penalty of 5% of the balance due each month, up to 25% of the total.  So if you owe the IRS $5,000 and wait until December 31 to fess up, your Tax Liability + Penalty = $6,250.  But that’s not the end of it.

There is a monthly penalty for Failure to Pay a tax return that is separate from the Failure to File penalty.  Failure to Pay is .5% each month for as long as it takes you to file a return.  In the example above, you’d be paying an additional $25 per month, so by New Year’s Eve you’d be on the hook for an additional $200.  Now we’re up to $6,450.

Ah, but that’s not the end of it.  In addition to the penalties, the IRS also charges you interest of 4% on your balance due.  In this case, if you didn’t file and pay your return until the end of the year, the interest would be an additional $175, so your grand total would be $6,625 on a $5,000 tax liability.

The lesson?  File your tax return even if you can’t pay.  

As you can see from the example above, the biggest hit one takes is from Failure to File penalty.  The Failure to Pay penalty and the interest are small potatoes by comparison.  What’s more, the IRS will allow you to work out a payment plan that will avoid the Failure to Pay penalty altogether.  

So if you file on time and request a payment plan, all you pay is the interest, which at 4% is really pretty reasonable.  Try getting that deal from your credit card company.

Tax Filing Day is April 18^th – Don’t Forget!

After the 18th, I’m out of here for some well-deserved time off, but I’ll be back with new tax and finance topics in May.  If you have any tax questions or need assistance, you can e-mail me at jeffrey.ritchie@yahoo.com.

Thanks for reading!

Another Day Older and Deeper In Debt?

There’s no denying that it’s been a rough couple of years.  In my practice I’ve assisted more clients with bankruptcies and foreclosures since the downturn started about three years ago than I have in my entire career.  I’ve worked with people who’ve been hit with everything except the proverbial kitchen sink, and they’ve got the lumps to prove it.

So let’s talk about debt and how to deal with it, because even though the economy is showing some signs of life, I think we’re far from out of the woods, and many people are still struggling from the loss of income.

Financial burdens can suck the joy out of life.  Massive debt is emotionally oppressive and casts a shadow over just about everything else in your life.  So it’s not surprising that many people deal with debt issues by ignoring the mound of unpaid bills and hoping that somehow it will all just go away.

But that’s just about the worst thing you can do. 

Looking at all the financial horror stories I’ve witnessed over the past three years, they all have one common element, and that’s time.  The fact is that when you’re investing your money, time and compound interest can work wonders.  But when you owe money, time and compound interest can wreak havoc.  So that’s my first bit of advice for dealing with your debt burden:  Don’t procrastinate.  Start doing something to get your debt under control, and start doing it today.

The next thing you should do is understand the types of debt that you have, because not all debts are equal.  Secured Debt is any debt that is backed by collateral, something of value the creditor can seize if you default on your debt.  We’re talking mostly about mortgages and car loans.  Unsecured Debt is any debt that is not backed by collateral, so your creditor is taking a much bigger risk when loaning you money.  Bigger risk means higher interest rates.  That would be your credit card or the line of credit so generously offered by your bank.

So all other things being equal, the debts that you want to pay off first are your unsecured debts, starting with the one with the highest interest rates – and don’t forget to factor in the late fees that creditor may charge when you get behind.  Whichever one is costing you the most is the one you want to attack first.  Save your mortgage or other secured debts for later.

To deal with unsecured debt, the best place to start is by negotiating with your creditors. Banks don’t want you to declare bankruptcy and they don’t want you taking your balance to somebody else (especially if it means closing your old account). To prevent losing business, creditors are sometimes willing to offer lower rates or even settle debts for a lump sum payment less than what you currently owe.

Creditors know perfectly well that a host of competitors offer cards with low introductory rates and that their customers are not going to pay 20% (or more) indefinitely. Call the customer service desk of your current high-interest credit card and simply inform them that you’d like a lower rate – and it doesn’t hurt to tell them about the great offer you just received in the mail from the other guys.

If they’re not willing to bring the rate down, fill out the paperwork and transfer your balance. But be warned, these low rates can get pretty steep once the introductory period expires, so be disciplined in making payments on the balance regularly to eliminate the debt as quickly as possible.  This is a “grace period” where you can eliminate one of your debts, so use the opportunity wisely.

Lump sum settlements are a little harder to find, but it’s not impossible. In this case, you contact the credit card company offer to pay $5,000 cash to settle your $10,000 debt. Now it’s highly unlikely that the creditor will accept an offer like that, but just as with any other negotiation, you start low and meet somewhere in the middle. If the creditor is willing to play ball, you could take thousands off the balance and thousands more off the interest you’d be paying over time.

But now the question becomes, where can you scratch together the money to pay the lump sum?

Now if you have a large, high-interest credit card balance and some semi-liquid assets like an IRA, it might actually make good financial sense to take the tax hit for cashing out a portion of the IRA in order to pay off the debt. Now this is not something I recommend lightly, so make sure you run the numbers to make sure it’s to your advantage.

To make this determination, figure the tax consequences of taking money out of your IRA – and don’t forget the 10% penalty in addition to the tax liability based on your tax bracket. Then compare the tax consequences to the interest that will be paid on the credit card debt – the website bankrate.com has a handy calculator that can help make this calculation.

If you’re just making the minimum payment required by the credit card company, you’ll likely find that the interest you’re paying on the debt could be two or three times what you actually owed in the first place – and far less that the tax liability you’ll incur from the one-time raid on your retirement savings.

But here’s the thing. Don’t do this until you’re certain that your cash-flow situation is under control. If every month shows you sinking deeper into debt, don’t resort to tapping a retirement account because the result could be that six months from now, you’re back in debt but with a smaller retirement nest egg.  Make sure your current income can cover your current liabilities.

Now you might be thinking that you can’t just do this by yourself.  Negotiate with a multi-billion dollar credit card company?!  Sure you can, but if you want help, there are a couple of things to consider.  The first is that you can find any number of for-profit entities who say they specialize in debt reduction and have some vague but miraculous way of eliminating your debt.  At best, this is an exaggeration and at worst, it could be an invitation to fraud.

There are non-profit organizations out there who assist consumers with getting their debt under control.  But let’s be clear in understanding that just because an organization is non-profit doesn’t mean that their services are free.  You will have to pay for their assistance.   To find an approved consumer credit counselor in your state, go to this website. 

Only twelve days until the tax filing deadline!  Many happy returns!

How Big is YOUR Refund?

I’m going to wax philosophical today on the subject of tax refunds.

One of the perennial issues that I discuss with my tax clients is the question, “I have a colleague who makes the same as I do, but he always gets a bigger tax refund.  Why is that?”  I don’t think the American Psychological Association has ever identified a malady known as “Refund Envy,” but I could certainly give them some excellent clinical examples.

Let’s start with the non-philosophical answer to that question.  A number of factors determine the size of your annual tax refund, and it’s certainly possible (even likely) that even though Taxpayer Smith and Taxpayer Jones have the same income, their refunds could be miles apart.  Smith might have an elderly mother for whom he provides support – and thus claims as a dependent.  Jones might have deductible interest from a second mortgage or be writing off prior year stock losses.

I’ll get into the blood gore and guts of managing your refund (specifically how to strategically use your Form W-4 Withholding Allowances Certificate) in a future post, but for now let’s talk about the relative merits of big tax refunds.

Nobody likes getting stuck with a big tax liability at the end of the year.  But at the same time, you shouldn’t necessarily assume that a big tax refund is a fate to be envied.  Remember this if you remember nothing else:  Your tax refund is not a gift and it’s not a prize – it’s your money.  Getting a refund simply means that the government has been holding on to your money all year, and now it’s time for them to return it.

Without paying any interest.

Think about a refund in this way, and suddenly that big, fat check doesn’t seem nearly as appealing.  A tax refund basically amounts to your giving the federal government an interest-free, short-term loan.  When you starting thinking about what that big, fat check could have accomplished as a big, fat annual contribution to your IRA, it’s enough to make you a little ill. 

But there are people who insist that avoiding any complications with the Internal Revenue Service for underpayment of their taxes is worth missing out on that additional income.  The thing is, the penalty for a slight underpayment of your taxes is not particularly steep, and there are multiple conditions under which the IRS will waive the penalty altogether.  Over time, some people forfeit thousands in addition income to avoid a one-time penalty of less than a hundred dollars.

Now all of this is not to suggest that, for some people, a large refund is the worst thing that could happen.  Some taxpayers know themselves well enough to understand that if they had an extra $200 per month in their paycheck, they would spend it all in no time flat.  And using an IRA or 401(k) contribution to save for a short-term financial goal like the down payment on a new car would be a bad idea – the tax and penalties for early distributions from an IRA would wipe out a good chunk of your nest egg.

Since very few banks offer Vacation Club or Christmas Club accounts (they went the way of a shiny toaster with a new checking account), and those that do offer interest rates of an astounding one-fifth of one percent, you could certainly argue that using your annual tax refund as an enforced savings plan is not the worst idea in the world.  It actually makes sense for the right person.

The point here is that your tax refund is your money, and you should use it in a way that’s beneficial and comfortable for you as an individual.  So what I’m really trying to say here is size doesn’t matter.

That last sentence was your reward for reading this blog all the way to the end!  Have a great day!

Welcome to My Blog!

We're going to start this blog with a little personal finance.  Already own a home?  Great!  Managed to keep your home during the recent economic disaster?  Well Done!  Pass this along to someone who is testing the home-buying waters.

How To Lose Money On Your First Home

First of all, congratulations on your decision.  With interest rates still very favorable and the existing home market still struggling, you really couldn’t find a better time to buy your first home.  The potential bargains to be had out there are the best that we’ve seen in decades and (one hopes) will be the best we’re likely to see again at any time in the future.

That being said, you can still lose a bundle on your first home if you follow just a few simple steps.

Fall In Love.  Your first home is going to be your first place that you can call your own -- whether you’re a single person or half of a couple.  It’s where you’ll get that dog your parents never allowed you to have and where you’ll bring your first child home from the hospital for the first time.  You’re going to make wonderful memories in your first home – so remember that it doesn’t make much difference which home you’re in.

People in love do foolish things, not least of which is to overlook the obvious faults in the object of their affections to the point that their friends wonder, “What does she see in him?”  The same goes for a first house – don’t fall in love with a certain architectural style to the point that you’re willing to overlook an otherwise undesirable neighborhood, and don’t love a great neighborhood so much that you ignore that leaky roof or a cracked foundation. 

Here’s the thing.  The National Association of Realtors says that the average length of home ownership is six years.  That’s because young couples buy a first house, then buy a larger house when they start having children, then move once (or more) during their working years, and then downsize to a smaller house in retirement.  The odds are you’re not going to live in this house forever, so it’s better to buy the house that’s the best deal, even if it’s not the storybook home you always dreamed of.

Don’t Run All The Numbers.  Over the long term, the most costly thing people can neglect to do is account for all the costs of home ownership.  The purchase price – no matter how far the seller came down – is only part of the equation.  Other factors contribute to the total costs, and one of the biggest and most obvious things people overlook is the property tax rate.

In suburban communities, it is possible to have two homes with the same valuation, directly across the street from each other, but Home A has a higher property tax rate because it’s in a different tax district that Home B.  You might wind up paying an extra $300-$400 per year in property taxes because you bought a house that was in the wrong location by only a few yards, and over the course of many years, that could really add up.

On a related matter, if you’re in the market for a condo or in any neighborhood that has a Home Owners Association (HOA), you may be paying monthly HOA fees that could go up to $500 or more depending on the amenities in your development.  And be forewarned that some HOA's can be downright merciless in their demand that you pay your fees – one study showed that more than 75% of HOA’s have initiated litigation against one of their members.

Trust Your Realtor.  No offense to the realtors out there, but the inescapable fact is that realtors typically work for the seller and not for the buyer.  Especially when you’re a first-time homebuyer and particularly if you’re relocating, it can seem like a god-send to have a realtor who can recommend services like home inspectors and mortgage brokers.  But in most cases you’ll be better off either securing these services yourself or, at least, in getting a second opinion.

Many banks won’t write a loan without a home inspection, and it’s important to make sure that the inspection is completed by a person who is trained and licensed to do the job.  Remember that in some states, there are no licensing requirements to be a home inspector, so ask to make sure that the inspector you select has any one of several national certifications.  Don’t trust the person that your realtor “has been using for years for this sort of thing.”  That’s no guarantee that the inspection will be thorough.

When it’s time to finance your new home, chances are your realtor will recommend a local mortgage broker who, again, is someone with whom he or she has a long-standing business relationship.  This is the financial equivalent of a blind date that is going to end in a proposal of marriage (let's face it - not many marriages last thirty years any more).  So don't assume that the rates and closing costs provided by the "dear friend" of your realtor are the best deal in town.  Shop around.  Even a quarter of a percentage point difference in loan rates can translate into thousands in additional interest you'll have to pay over the long haul.

Are there other ways to lose a bundle on real estate?  Sure.  But these will do for starters.