2006 Taxes in Review

As I’ve written about previously, our tax situation was considerably more complex in 2006 than in years past. Thus, I decided to enlist the help of a tax pro l just to be sure that we got everything right. Being the compulsive (and competitive) guy that I am, however, I also decided to do our taxes myself with Turbo Tax (as usual) such that I could compare my results against those of the pro.

Well, we recently got our taxes back, and guess what? My TurboTax results were almost identical to those of the pro. Going forward, this probably means that I’ll keep doing our taxes myself. Not only will we save a good bit of money on tax prep, but I also appreciate the insights that I gain from going over our tax situation with a fine-toothed comb.

In this context, I thought I’d put together a quick comparison of our 2005 and 2006 tax years:

First off, our total income in 2006 was up just under 51% vs. 2005. While it’s true that I received a substantial pay increase when I switched jobs, that really only affected the latter half of the year, and thus can’t explain this large advance on its own. The other major factor was income from self-employment, which increased twelve-fold (from a really some number to a not-so-small number).

Itemized deductions were up 44%. This was due in part to more mortgage interest due to our move to a more expensive house (and a slightly higher mortgage rate). But more than anything, this increase reflects a dramatic uptick in charitable giving.

As far as credits go, we’ve now entered the phase-out range for the Child Tax Credit, and thus we didn’t receive the full $4k to which we would have otherwise been entitled. This is a good news, bad news situation — while I love tax paying less in taxes, earning “too much” is a good problem to have.

What about taxes? Well, we moved from a state with no income tax to a state that has one, so there’s no historical information for state taxes. But with regard to federal taxes, our effective rate (after figuring in deductions and credits) jumped from 2.7% in 2005 to 11.6% in 2006 (it was just under 1.5% in 2004!). For the sake of comparison, our marginal rate this year was 25%. The uptick is, not surprisingly, a result of increased income combined with reduced access to the Child Tax Credit.

As far as over/underpayments go, we’ve received sizable refunds the past few years, primarily due to the way in which I’m paid — it’s sort of complex, and I won’t go into details here, but suffice it to say that I’ve been faced with substantial over-withholding that was difficult to predict/correct. In contrast, we were almost spot on in 2006, with a very small amount of taxes owed. It therefore appears that I guessed right, and the over-withholding was sufficient to offset our self-employment income without making estimated tax payments. Going forward, however, we’ll have to start making estimated tax payments every quarter.