Did you know that you have to pay back the homebuyer tax credit if you claim it and then sell your house (or otherwise stop using it as your principal residence) within the next three years? I didn’t, but apparently that’s the case. Here’s the scoop straight from the IRS:

Q: When must I pay back the credit for the home I purchased in 2009?

A: Generally, there is no requirement to pay back the credit for a principal residence purchased in 2009. The obligation to repay the credit on a home purchased in 2009 arises only if the home ceases to be your principal residence within 36 months from the date of purchase. The full amount of the credit received becomes due on the return for the year the home ceased being your principal residence. (source)

Note that there are no exceptions for military personnel who are deployed and sell their home. If they move out during deployment but retain ownership, the deployment “may be” considered a temporary absence such that the home can technically remain their primary residence.

If you find yourself subject to the recapture provision, you are required to repay the credit in full as “additional tax” when you file your Federal income tax return for that year. See IRS Form 5405 for additional details.

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Last week I contacted Ally Bank with a last minute change of heart. I had intended to roll our 12 month CD into a 5 year CD upon expiration, but had second thoughts when I saw that Series I Savings Bonds are more attractive than CD rates.

I actually contacted Ally on the renewal date and was thus able to get the money back out without any penalties. I did, however, notice that our “available balance” was lower than our actual balance.

When I asked about the discrepancy, I was told that we hadn’t sent in our signature cards, and were thus subject to backup withholding. Backup withholding? I wasn’t even sure exactly what that is.

I’ve seen the term many times over the years, but have always checked the box saying that I’m not subject to it. I’ve always known that backup withholding is a special form of income tax withholding, but I never really knew when it applied.

What is backup withholding?

Investment income is not typically subject to regular income tax withholding, but it may be subject to backup withholding to ensure that the IRS gets their money. In general terms, most payments that are reported on Form 1099 are potentially subject to backup withholding.

The backup withholding rate is currently 28%, which means that Ally withheld 28% of our interest earned. This amount will be sent to the IRS on our behalf, and will be reported on our 1099-INT at the end of the year.

Since it’s relatively late in the year, and the amount in question isn’t huge, this isn’t a big deal. Sure, we’ll lose the ability to immediately reinvest our interest, but it will be applied to our tax bill when it comes time to file 2009 taxes.

Who is subject to backup withholding?

According to the IRS (but boiled down into plain English) backup withholding applies if any of the following apply:

• You have not given the payer your Tax ID number,
• You have not certified to the payer that this number is correct,
• The IRS has notified the payer than the number is incorrect,
• The IRS has notified the payer to begin withholding because you have not reported all such income in the past, or
• You have not certified that you are not subject to backup withholding

I’m guessing that it’s this last point that tripped us up. I have no idea what the Ally Bank signature cards look like, but I’d be willing to bet that they have a checkbox to certify that you’re not subject to backup withholding.

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I’ve received several comments/e-mails asking about whether Congress has decided to make the first time homebuyer tax credit retroactive. If you saw my previous article, you’ll know that Congress has extended the first time homebuyer credit and added a new $6500 credit for existing homeowners.

Is the homebuyer tax credit retroactive… or not?

From everything that I’ve heard, the answer is that it will not be made retroactive. While this might not seem fair, the undelrying logic makes sense… Since the goal is to stimulate sales going forward, it makes no sense to hand out credits to people who have already bought. The likely effective date of the new credit will be December 1, 2009.

The bigger question is whether not the $6500 tax credit will be enough to push existing homeowners into the market for homes and mortgages. Even if it does, I’m not convinced that it will have much of an impact for anyone other than realtors. After all, for every homeowner that goes looking for a house, there will be one more house on the market.

Can you use the $6500 credit to buy a second home?

The only exception to this one-for-one swap will be if people want to use the credit to buy a second home. The primary limitation here is that the new home has to serve as your primary residence. I’m not sure how they’ll enforce this, but it seems like you could buy and move into a new home while keeping your old one as a rental property.

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This just in… The House of Representatives has voted to extend — and expand — the first time homebuyer tax credit.

Extending the $8000 credit, adding a $6500 credit

According to the NY Times:

The bill extends an $8,000 tax credit for first-time home buyers that was due to expire on Nov. 30, making it available to those who have a contract before May 1 on a primary residence priced at up to $800,000. The bill also creates a new credit of up to $6,500 for existing homeowners who buy a new residence if they have lived in their current one for at least five of the last eight years.

The income limits for the homebuyer tax credit are also going up, from $75k/$150k for individuals/couples to $125k/$225k. Beyond that, the credit phases out. This extension/expansion is projected to cost nearly $11B.

Extending unemployment benefits

This bill also extends unemployment benefits, as follows:

The measure [also] provides up to 14 weeks of additional assistance to unemployed people who have exhausted their state and federal benefits, but up to 20 additional weeks to those in about 26 states with unemployment rates exceeding 8.5 percent.

The President is expected to sign this bill into law as early as tomorrow (Friday). Also if you’re in the market for a mortgage, you can compare current mortgage rates here.

Thoughts?

Source: NY Times

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» $15,000 Homebuyer Tax Credit
» $15,000 Homebuyer Tax Credit Dropped from Stimulus Package
» $8,000 Homebuyer Tax Credit
» First Time Homebuyer Tax Credit Followup
» $15,000 Homebuyer’s Tax Credit is Back on the Table
» Refundable vs. Non-Refundable Income Tax Credits
» $7500 First Time Homebuyer Tax Credit

Not quite a year ago, I reported that Congress was considering suspending the required minimum distribution (RMD) requirement for retirees. The reason for this is that the stock market had just collapsed, and they didn’t want retirees being forced to liquidate holdings at the bottom.

While Congress ultimately acted, it was a classic case of too little, too late. What I mean by this is that they did wind up suspending the RMD, but they did so for 2009 instead of 2008.

What is the RMD?

Just to remind you, the RMD is the minimum amount that retirement account holders must withdraw from their tax-deferred accounts when they hit the age of 70-1/2. Your RMD is based on what was in your account on the last day of the previous year, so…

If the market tanks, you’ll need to withdraw a disproportionately large amount from your account

Should you skip your RMD?

To me, the issue of whether or not you should skip your RMD in 2009 hinges on your circumstances. If you need the money to get by, then you don’t have much of a choice.

If, on the other hand, you don’t have a compelling need, you should seriously consider leaving the money in place. Tax-deferred retirement accounts are powerful tools. By leaving your money in place, you’ll avoid paying additional taxes this year, and your investments will have even more time to recover.

If you’ve already taken your RMD in 2009 and wish you hadn’t, you might be in luck. As long as you get the money back into your IRA within 60 days, you can “undo” the withdrawal.

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Taxes are a huge consideration when planning for retirement. As you’re building up your nest egg, one of the big decisions that you’ll face is whether you should put your money in a traditional, tax-deferred account or a Roth-style account.

Of course, we don’t all face this dilemma. After all, access to Roth IRA accounts is limited by income (but see here and here), and access to a Roth 401(k) or Roth 403(b) is limited by whether or not your employer offers one. Many don’t, even if they offer tax-deferred versions of these accounts.

But what if you do have access to Roth accounts? How do you decide where to put your money? What follows is a quick overview of the major issues.

The tax deferred option

One of the biggest arguments in favor of using tax deferred accounts is that you’ll get your tax savings up front. These guaranteed savings can help those with limited means save/invest more money than they might have otherwise.

Taking an immediate tax break might also be a good option if you’re in a relatively high tax bracket. After all, if your income falls in retirement, you’ll have dodged higher taxes during your earning years in favor of lower taxes in retirement.

But what if tax rates increase dramatically between now and retirement? Even if you fall to a lower bracket, the applicable rate might wind up being higher. In that case, you’d have traded lower taxes during your earning years for higher taxes in retirement.

Another downside to tax-deferred accounts is that they effectively convert capital gains (currently tax at a favorable rate) into regular income. This is a very important fact to consider when deciding where to hold certain investment types.

The Roth option

Roth accounts make the promise of completely tax free withdrawals in the future in return for paying your taxes right now. This is a particularly good option if you expect to be paying higher taxes in retirement than you are right now.

Another risk that you’re running by using a Roth account is that Congress might change the rules. I currently view this as rather unlikely, but consider (for example) what would happen if we would adopt something like the Fair Tax between now and when you retire…

In such a case, you would have paid full income tax on your Roth contributions, and then you would be taxed again in retirement when you spend this money. Double taxation. Yuck.

What are we doing?

So how have we solved the problem? As with all things that involve uncertainty in the investing world, we’ve decided to diversify our risks. I honestly have no idea what will happen with tax rates going forward, and I can only project what our income might look like in retirement.

In view of these uncertainties, we’re taking advantage of both tax-deferred and Roth investment accounts. In doing this, it’ll be impossible for us to be 100% right, but we also won’t be 100% wrong. Given that we have both account flavors (not to mention a taxable investment account) at our disposal, we’ve given a lot of thought as to optimal asset locations.

In short, we keep our most tax inefficient investments in retirement accounts, with those with the highest expected rate of return in Roth accounts. Our taxable account, on the other hand, is loaded up with tax efficient investments.

What about you? If given the choice, how would you proceed?

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Two years ago, our tax preparer suggested we take advantage of tax breaks like IRAs and home ownership. We then looked at our options and started working on our IRAs. Buying a house just for a tax break wasn’t what we wanted, so we paid down our debt and saved some money on the side for our upcoming town house purchase.

We did, however, realize that we needed to be more informed when it comes to taxes, and to (legally) maximize any tax breaks we can get. If you’ve read much about taxes, you’ll no doubt have seen the terms “exemption” and “deduction.” Today, I’m going to talk a bit about what these terms mean, and why they matter.

Exemptions vs. deductions

First off, exemptions and reductions both reduce your taxable income, which is a good thing. Exemptions are specified amounts by which you reduce your taxable income — just for being you! For 2009, federal income tax exemptions (either personal or for dependents) are $3,650 each.

There are adjusted gross income (AGI) limits beyond which the exemptions are phased out. The specific limits vary depending on your filing status.

• Single: $166,800
• Married (Filing Separately): $125,000
• Head of Household: $208,500
• Married (Filing Jointly): $250,000

Income tax deductions, on the other hand, are actual expenses that you’ve paid during the tax year that you can claim against your taxable income. Some examples of expenses you can deduct are alimony, moving expenses, and charitable contributions.

Personal exemptions vs. dependent exemptions

As you may know, you can claim one exemption for yourself as long as you’re not claimed a dependent on someone else’s taxes. You can also claim an exemption for your spouse if you file a joint return.

Beyond this, you can claim an exemption for each person that you claim as a dependent — provided you meet the requirements. If you claim a child as a dependent for your taxes, then the relationship must pass a five part test:

• Age: Are they 18 or under? If they are a full time student, that increases to 23 or under.
• Relationship: They should be a member of your family such as your child, stepchild, sibling, or decedent of any of them.
• Support: The child cannot provide more than half of their own support.
• Residency: The child being claimed must have lived with your for the majority of the year, with some exceptions.
• Special test: Only one person can claim a qualifying child. You can’t divide the tax exemption. The IRS has rules to determine who gets the exemption if the parents can’t agree.

Besides claiming a child, there is an exemption for a qualifying relative. There are 4 tests that must be met to claim this exemption:

• Not a qualifying child: This simply means they can’t fall under the qualifying child rules if you are to claim the relative exemption.
• Member of household/family member: This is a residency based test to determine if they’re a member of your household. In some cases, such as relationships created by marriage, the relative may not have to live with you to qualify. Check with IRS Publication 501 for more details.
• Gross Income: The qualifying relative must have less than $3,500 in gross income during the tax year.
• Support: You have to provide more than half their total support. There are special rules if multiple people contribute more than 50% of the total support in aggregate, but no one individual does so.

Be honest with your answers and you’ll be able to claim the exemptions to which you’re legally entitled.

Standard vs. itemized deductions

When it comes to income tax deductions, you can either claim the so-called standard deduction, or you can itemize your deductions. You cannot do both. Obviously, you should choose the option that results in a lower tax bill.

In short, you should claim the standard deduction if you don’t have much in the way of itemized deductions. The standard deductions for most people are:

• Single/Married (Filing Separately): $5,700
• Head of Household: $8,350
• Married (Filing Jointly): $11,400

You can qualify for a higher standard deduction if you’re 65 or older or blind. Check IRS Publication 501 for more details. If you’re considering itemizing your deductions, take a look at Topic 500 – Itemized Deductions on the IRS website. It covers possible deductions for the following expenses and more:

• Medical and dental expenses
• State and local taxes
• Home mortgage points
• Interest expense
• Charitable contributions
• Business expenses
• Educational expenses

Closing thoughts

I’ve done my best to ensure that the above listed amounts are current (for tax year 2009), but you should always double-check to make sure that you’re working with valid information. You should also check with the IRS itself, or a qualified tax professional, to get answers relevant to your specific circumstances.

With that said, I’m curious to see how many of you file your own taxes. We did it ourselves last year, and we’re plan on doing it again this upcoming tax season.

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This is a guest post from Mike Piper, author of Investing Made Simple and proprietor of The Oblivious Investor. If you like what you see here, please consider subscribing to his RSS feed.

The Roth IRA vs. Traditional IRA question gets a lot of press, and that makes sense. By choosing correctly, you can significantly reduce the total taxes you’ll pay over your lifetime.

In a similar fashion, you can reduce your overall tax burden by planning your withdrawals strategically. That is, once you’re retired, how should you order your distributions? Should you take money out of your Roth first? Your 401(k)? Some combination of both?

The strategy: fill the lower tax brackets

The overall goal with planning your withdrawals is to take sufficient distributions from tax-deferred accounts to fill up the low tax brackets. The reasoning is that it’s better to pay 10% or 15% in taxes now rather than wait, take all the money out over the course of just a few years, and have the distributions bump you up into a higher tax bracket.

In fact, it can sometimes make sense to take distributions even if you don’t need the money to cover living expenses. (If that’s the case, it’s likely a good idea to use them for a Roth conversion, if you’re eligible.)

How about an example?

Martha and Mark are retired, and they’re both 60 years old (so they’re not yet receiving social security). Between interest income and Martha’s freelance writing work, they earn $13,000 over the course of the year. They only need $30,000 to cover their living expenses. They could take the extra $17,000 out of a taxable account, Martha’s Roth IRA, or out of Mark’s traditional IRA.

What should they do?

Without knowing the rest of the details of their situation, it’s impossible to say with absolute certainty what they should do. But the following analysis should provide a decent starting point.

Due to the standard deduction and personal exemptions, a married couple’s first $17,900 of income is free from income taxes. So it’s a no-brainer that they should take at least $4,900 ($17,900 minus their $13,000 of other income) from their traditional IRA because it’ll be entirely tax free.

They still need to come up with another $12,100 to pay their bills. If Mark and Martha expect their tax bracket to be above 10% later in retirement (e.g., due to social security or required minimum distributions from their tax-deferred accounts), it makes sense to take that from the traditional IRA as well, thereby paying tax at 10% now rather than at a higher rate later.

[Note: Because of the 10% tax, they'll have to take out $13,444 in order to have $12,100 left to pay bills.]

And by the same reasoning, it’s likely a good idea to take an additional $3,255 distribution from their traditional IRA in order to fill out the 10% tax bracket. They can then move that money into a Roth IRA, thereby paying tax at their 10% rate now and avoiding tax at a higher rate later.

In fact, if Mark and Martha expect to be in (or above) the 25% tax bracket later in retirement, it’s probably a good idea for them to take another $51,200 out of their traditional IRA and move it into a Roth, thereby filling out their 15% tax bracket this year as well.

Social security income complicates matters

Once an investor begins receiving social security income, things become more complicated, and the benefits of tax planning increase even further. The reason for the additional complexity is that, as your income proceeds through the 15% bracket, the portion of your social security income that is subject to income tax increases as well.

By strategically planning which accounts you take money out of each year, you can reduce the tax on both your retirement account distributions and on your social security income.

Takeaway lesson

Making small adjustments to your plans could potentially save you thousands of dollars in taxes each year. Unless you have a tax adviser who plays an active role in planning your finances (that is, he/she does more than just prepare your tax returns), it’s essential to have a solid understanding of taxation.

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Do you have a Flexible Spending Account (FSA)? We do, and we love it. Every year, my employer lets us set aside up to $5k in pre-tax dollars to pay for healthcare expenses that aren’t covered by insurance. This includes co-pays, deductibles, prescriptions, orthodontia, vision care, etc.

Well… The Senate Finance Committee has just approved healthcare legislation that would dramatically reduce the value of this perk. More specifically, they’re talking about instituting a $2500 annual cap on FSA contributions that would not be indexed to inflation. As things currently stand, FSA contribution limits are determined by individual employers.

What do you think?

Is this a big deal, or much ado about nothing? My view is that, while standardizing the contribution limits across employers isn’t all that egregious, $2500 is on the low side, and I hate it when Congress fails to index these sorts of things to inflation.

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States across the country are hurting. High unemployment numbers and reduced corporate profits have gutted tax revenue. At the same time, every state besides Vermont has a law requiring a balanced budget. As such, state governments are getting desperate to make ends meet.

A recent article in Forbes highlighted the lengths to which some states are going. They’ve been slashing budgets to the bone, but you can only cut so deep without compromising basic services. Thus, they’ve gotten creative when it comes to generating revenue.

Here are some of my favorites:

• California has proposed changing the date on state paychecks from June 30th to July 1st to “save” $1.2B (on paper) during the current fiscal year. It’s unclear what would happen next next fiscal year, when that $1.2B hits the balance sheets.
• Georgia lawmakers have proposed a “pole tax” — a $5 fee levied on strip club patrons. It didn’t pass.
• New York has proposed to put ads on garbage trucks and to institute an 18% tax on “sugary” drinks. The governor has approved a 46% increased in tobacco taxes and a 58% increase in wine taxes.
• An Oregon lawmaker proposed a $98 per ounce tax on medical marijuana, and even pushed to have the state do the growing. These measures never made it out of committee.
• A Michigan Senator introduced a bill to levy a $250 fee on strippers. The state might also agree to house California prisoners to make extra money, though it’s unclear to me how California would be able to pay.
• Nevada increased hotel taxes from 9% to 12%, and a Senator from Las Vegas has proposed a $5 tax on prostitute tricks. The latter measure didn’t pass. Even if it had, I’d think it would pretty tough to enforce.

Now… Just imagine what this list would look like if the Federal government wasn’t allowed to run a deficit!

Source: Forbes.com

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Remember back in February when I first talked about the $15,000 homebuyer tax credit? Well… It seems that Senator Johnny Isakson (R-GA), the original sponsor of that bill, is back at it again.

In addition to increasing the maximum tax credit from $8,000 to $15,000 (with a max of 10% of the home’s purchase), Isakson’s proposal would also make the credit available to all purchasers of a primary residence, not just first-time homebuyers. The income caps ($75k for individuals, $150k for couples) would also be eliminated.

As a former Realtor himself, Isakson has argued that “we don’t have a recession in first-time home buyers. We have a recession in the move-up market.” Thus, he believes that it’s time to expand the credit beyond just first-time homebuyers.

Interestingly, Isakson’s bill is backed by a bipartisan group of co-sponsors, including Lamar Alexander (R-TN), Jim Bunning (R-KY), Chris Dodd (D-CT), John Ensign (R-NV), Joe Lieberman (I-CT), Lisa Murkowski (R-AK), James Risch (R-ID), and David Vitter (R-LA). Not surprisingly, he has also picked up endorsements from a couple of real estate industry groups.

While I suspect that this program would actually work from the standpoint of getting people to buy/sell houses, at least in the short term, I’m not a big fan of throwing another $32B at the problem. What do you think?

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Did you know that you can convert directly from mutual funds to exchange traded funds (ETFs) without incurring taxes? I didn’t. I’ve been operating under the impression that selling the mutual fund shares would be a taxable event.

What I didn’t realize is that, at least with Vanguard equity funds, the conversion of conventional shares of an index fund into the corresponding ETF is a tax-free event. Here’s the scoop, direct from Vanguard:

Can I convert conventional Vanguard mutual fund shares to Vanguard ETFs?

Shareholders of Vanguard stock index funds that offer Vanguard ETFs may convert their conventional shares to Vanguard ETFs of the same fund. This conversion is generally tax-free, although some brokerage firms may be unable to convert fractional shares, which could result in a modest taxable gain. (Bond ETFs do not allow the conversion of bond index fund shares to bond ETF shares of the same fund.)

Vanguard will charge $50 for each conversion. (This fee is waived for Flagship clients.) Your brokerage provider may charge an additional fee for this service. For more information, contact your brokerage firm, or call 866-499-8473.

Once you convert to Vanguard ETFs, you cannot convert back to conventional shares. Also, conventional shares held through a 401(k) account cannot be converted to Vanguard ETFs.

Source: The Vanguard Group

This appears to be similar to the conversion of regular fund shares into “Admiral Shares” once your portfolio grows large enough. This is an attractive option for two reasons:

1. ETFs generally have lower expense ratios than index funds, and
2. ETFs aren’t subject to the year-end distribution of taxable gains

The fact that you can’t make the conversion within a 401(k) isn’t a huge deal, as year-end distributions within a tax-sheltered account aren’t taxable.

As for the $50 fee, I suspect that’s in place to encourage people to wait and convert larger chunks rather than buying index fund shares and then immediately converting to the corresponding ETF following each transaction. Do so would allow you to dodge brokerage commissions, but would also create an unnecessary burden on Vanguard.

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In what is rapidly becoming an annual rite of passage, I just appealed our property tax assessment. For those that aren’t aware, I did this a year ago in response to an unreasonable jump in the “value” of our house following a renovation, and we got a quick reduction in our assessment.

This time around, the slow real estate market resulted in a year-over-year decrease of about 4%. While any little bit helps when it comes to property taxes, this decrease was considerably less than for other homes on our street. Curious as to why that was, I decided to look closer.

In reviewing the change, I think I might have discovered the culprit… The county seems to think that our house is significantly larger than it really is. Even after accounting for the addition (completed in late 2007), the supposed square footage of our house somehow increased by another 400 sq. ft. during the past year.

Last night, I drafted a letter to the County Board of Tax Assessors outlining our case. Assuming that things proceed like they did last year, we should have a response within about a week. If we’re not happy at that point, we have the option of appearing before the Board of Equalization. Hopefully it won’t come to that.

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This is just a quick reminder to anyone out there that pays estimated taxes… The second quarterly payment is due this coming Monday (June 15th). So… If you haven’t done so already, it’s time to get things pulled together and write that check. If you pay late, you might end up facing an underpayment penalty at the end of the year.

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On Monday, I returned home from work to find a letter from the IRS in our mailbox. My heart sank. Fearing the worst, I opened the envelope and peered inside. What I saw wasn’t nearly as scary as I had feared. Yes, we’re technically being audited, but it’s just a “correspondence audit.” Moreover, it’s the byproduct of an IRS error, and we have the documentation to prove it.

What is a correspondence audit?

Before we go any further, I thought I’d define exactly what it is that we’re talking about… A correspondence audit is simply a letter from the IRS notifying you of a possible error on your return. The letter will contain details of the error, as well as information on how to make things right. They might ask for additional documentation, or they might simply recalculate your taxes for you.

In most cases, the IRS initiated contact because they think that you owe them additional taxes and/or penalties. That’s not always the case, though, as they once notified me that I had made an error in their favor and thus owed less than I though. Regardless, you have the right to contest their decision.

What triggered our audit

According to IRS records, we never made our final estimated tax payment for 2008. As such, they sent us a “CP 23” notice for underpayment of estimated taxes. This notice included a breakdown of the payments they had recorded on our behalf as well as a recalculation of our taxes — and a fairly hefty penalty.

The problem with all of this is the we did make this payment. In fact, if you’ve been reading along for the past few months, you might remember that I had a bit of a panic last January when I dropped the check in the mail a day late.

Note that the IRS notice wasn’t complaining about our payment being postmarked a day late. Rather, they have no record of our payment whatsoever. Once I realized what was going on, I hopped online and verified that the check had cleared within a week of me having mailed it. That’s the good news. The bad news is that the ball was now in our court, and I needed to contact them to get this all straightened out.

Straightening things out

While I generally prefer to handle important issues such as this in writing, the IRS instructions said that I should call if I disagreed with their assessment. And so I did…

After spending 30 minutes on hold on Monday night, I hung up and decided to try on Tuesday morning. Unfortunately, the IRS was “experiencing high call volume” when I called back, and I was thus advised to try again later.

When I finally got through, I got transferred around a bit as they tried to locate our payment. In the end, they couldn’t, so they asked me to fax them a front/back copy of the check along with a brief explanation and a copy of our “CP 23” notice.

Tips for dealing with the IRS

The biggest thing that I’ve learned from this experience is that you shouldn’t take IRS correspondence at face value. It seems that they’re just as prone to mistakes as everyone else, so don’t assume that you’re in the wrong. Be sure to investigate everything for yourself.

Another big lesson is the importance of keeping good records. I was able to get things sorted out on my end in a matter of minutes because I had a record of exactly when we sent our payments. I was also able to hop online and immediately pull up a scan of the mystery check from our online banking interface.

Beyond the above, be sure to take detailed notes when you’re on the phone with the IRS. This should include the name and ID number of the phone rep, the date and time of the call, and a synopsis of the discussion. If you’re unsure of anything, don’t be afraid to ask for clarification.

Finally, your best bet when dealing with the IRS is to go out of your way to avoid trouble in the first place. One change that I anticipate going forward is that I’ll probably start using the Electronic Federal Tax Payment System (EFTPS), as there’s a much lower likelihood of an electronic payment getting mis-applied.

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Are you feeling stimulated? Well, you should be. I was updating Quicken over the weekend when I noticed that the reduced federal income tax withholding schedules have kicked in. In case you haven’t heard, that’s how the “Making Work Pay” tax credit is being handed out.

According to an IRS press release:

“Available for tax years 2009 and 2010, the Making Work Pay credit is 6.2 percent of a taxpayer’s earned income with a maximum credit of $800 for a married couple filing a joint return and $400 for other taxpayers, but it is phased out for higher income taxpayers. Most workers will qualify for the maximum credit. Because the credit is refundable (people can get it even if they owe no tax), most low-income workers will also qualify for the full credit.

Though all eligible taxpayers will need to claim the credit when they file their 2009 income tax return next year, the benefit will generally be spread out over the paychecks they receive beginning this spring and continue until the end of the year.

Many higher-income taxpayers will see little or no change in their take-home pay. That’s because the Making Work Pay credit is phased out for a married couple filing a joint return whose modified adjusted gross income (AGI) is between $150,000 and $190,000 and other taxpayers whose modified AGI is between $75,000 and $95,000.”

No, reduced withholding isn’t as exciting as a second stimulus check, but it has a similar effect. In my case, I get paid monthly, and my federal withholding dropped by $80/check.

Have any of you else noticed a bit more take home pay?

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Have you finished your taxes yet? We haven’t. I actually entered most of our information into TurboTax at least a month ago, but I never finished the job.

My lack of motivation was due in part to the fact that we owe a significant amount. This was by design, so we have the money on hand. That being said, there’s no point in hurrying if we’re not getting a refund. Sure, I could’ve at finished everything up back when I started, but I didn’t. Thus, I’ll have a busy evening pulling things together.

If you still haven’t filed…

For those that still haven’t filed their taxes, it’s time to issue my annual reminder: don’t forget to sign your tax return! This is less and less of a problem with the move toward e-filing, but… For those that still file a paper return, it’s important to know that the IRS does not consider your return to be valid unless you sign it.

Beyond that, here are thirteen lucky articles to help you last-minute filers:

• TurboTax vs. TaxCut: Which is Better?
• Common Income Tax Deductions
• Twelve Commonly Missed Income Tax Deductions
• Limits on Itemized Income Tax Deductions
• Uncommon Charitable Tax Deductions
• Ten Common Income Tax Credits
• Refundable vs. Non-Refundable Income Tax Credits
• $8,000 Homebuyer Tax Credit
• How to Claim the First-Time Homebuyer Tax Credit
• How to Claim the Recovery Rebate Credit
• Are Unemployment Payments Taxable?
• Ten Tips for Avoiding an Income Tax Audit
• How to Request an Income Tax Filing Extension

For those that are done…

If you’ve already filed, then it’s time to start looking ahead:

• 2009 Federal Income Tax Brackets
• Social Security Taxes in 2009
• Five Tips for Fighting an Audit

Hopefully you won’t need that last one, but it’s there if you do.

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Tax Day is less than two weeks away, and taxpayers across the country are worried. According the results of a recent survey by CCH CompleteTax, nearly two-thirds of tax filers are concerned that they might overlook tax breaks or make mistakes that could result in penalties. And it looks like they’re right to be worried.

Check out these other results:

• Less then 25% could knew that tax credits are generally more advantageous than tax deductions;
• Only about one-third could identify the child-related tax break offering the greatest savings; and
• Less than half could identify the education-related tax break offering the greatest savings.

Another scary statistic is that only about half of taxpayers are taking advantage of tax-advantaged retirement plans in 2009. To be fair, 18% of those surveyed are already retired, but… Roughly one-third of the non-retirees in the survey didn’t contribute last year, and don’t plan on doing so this year, either.

In case you’re curious, here are the full results of the survey.

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A reader name Patrick just wrote in to point out a recent IRS press release about a special tax break for new car purchases in 2009. From the release:

“The Internal Revenue Service announced today that taxpayers who buy a new passenger vehicle this year may be entitled to deduct state and local sales and excise taxes paid on the purchase on their 2009 tax returns next year.”

While you’ve been able to deduct sales taxes for quite some time now, this deduction was previously limited to those that itemize their deductions, and you also had to make a choice between deducting your state income tax and your sales tax.

Details of the New Car Sales Tax Deduction

The deduction is limited to state local sales and excise taxes on up to $49,500 of the purchase price of a qualified new car, light truck, motor home, or motorcycle. In order to qualify, the vehicle must have been purchased between February 16, 2009 and January 1, 2010.

The deduction phases out for individual filers with modified adjusted gross income of $125k-$135k and joint filers in the $250k-$260k range. As noted above, you can claim this deduction even if you don’t itemize your deductions.

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A few weeks ago, I did a head-to-head comparison of TurboTax vs. TaxCut, and I also noted that TurboTax has been rated the best tax preparation software.

At the time, however, I wasn’t aware that you can use TurboTax for free if you make less than $30k. Note that I’m not talking about the free 1040EZ filing that they offer when you hit their homepage. Rather, I’m talking about their so-called Tax Freedom Edition, which is available as part of the Free File Alliance.

Note that this is a more or less complete version of TurboTax, with access to not only the 1040EZ, but also the 1040A and 1040 forms. In order to qualify, you must meet at least one of the following criteria:

• Earned an Adjusted Gross Income (AGI) for tax year 2008 of $30,000 or less; or
• Qualify for the Earned Income Tax Credit (EITC); or
• Served Active Duty Military with AGI of $56,000 or less

If you don’t qualify, be sure to sign up to win TurboTax for free. You have just under 12 hours left to enter. Good luck!

Hat tip: Poorer Than You

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» 2007 Taxes Filed (Sorta)

With just under a month to go until Tax Day, I’m pleased to report that I have three more copies of TurboTax Premier to give away. To be perfectly accurate, the winners won’t receive a physical product. Rather, they’ll receive a prepaid access code good for one free federal return + one free state return + free e-filing.

For those of you that are impatient, you can actually start your return for free this weekend using TurboTax online, and then simply enter the code when it comes time to file/pay.

As before, I’m offering multiple ways to win. While you can only win one copy, you’re welcome to try for all three. Read on for details…

Win by Commenting

For the first copy, simply leave a comment below telling me a bit about yourself (where you live, what you do for a living, or whatever else you feel like sharing) and/or how you found this site. On Monday evening, I’ll randomly pick a winner from all commenters. Only one comment per person, please.

Win by Tweeting

For the second copy, you’ll need to create a Twitter account (unless you already have one), follow me (@fcn; unless you’re already following me), and then Tweet the following message (you can just copy/paste it):

Win one of three copies of TurboTax Premier – Follow @fcn and re-tweet – Details: http://is.gd/o7xR – #fcntax

Be sure to include the ‘#fcntax’ tag at the end so I can easily find your entry. On Monday evening, I’ll randomly pick a winner from everyone who enters via Twitter.

Win by Subscribing

The last copy is reserved for RSS and/or e-mail subscribers. For the duration of the contest, I’ll be including a “secret” e-mail address at the end of each article in my RSS feed. Simply subscribe (if you haven’t done so already) and keep an eye out for the secret address. Once you have it, just shoot me a quick e-mail (just one) at that address. On Monday evening, I’ll randomly select a winner from amongst the messages I receive at that address.

The Fine Print

Entries will be accepted through 9PM Eastern on Monday, March 23rd. I will contact the winners via e-mail and/or Twitter, so please be on the lookout, and please be sure to use a valid e-mail address. Note that the winners will receive their prize directly from the PR firm that handles TurboTax, so you’ll have to provide me with a U.S. mailing address (no PO boxes, please) that I can pass along to them. Void where prohibited. Good luck!

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This is a guest post from Bob Meighan, who is VP of TurboTax.

In challenging economic times, every dollar counts. While I can’t predict what the economy or market will do, I can help you identify opportunities to make sure you get the biggest tax refund possible. With less than 2 months until the filing deadline, here are my top tips for maximizing your tax deductions and tax credits.

Recovery Rebate…

Although the recovery rebate applied to last year’s tax return, many taxpayers did not qualify for the full amount of the rebate. If you took a pay cut, lost your job, or added another kiddie to the family in 2008, you may have a second chance at the $600 to $1,200 rebate plus another $300 for each dependent.

Stock Market Meltdown…

Even though your investments may have tanked in 2008, you won’t receive any tax benefits if you remained on the sidelines. Gains and losses don’t get reported on your tax return until you actually sell the investment. A similar rule applies to assets in your retirement accounts, which include your IRA, Keogh and 401(k) plans. You don’t report these gains and losses until you start withdrawing from the plan.

If you did sell last year, most mortals will report a net loss. A net loss reduces other income up to $3,000. Any excess can be carried over to your 2009 tax return where you can do the same income offsetting — again up to $3,000.

Job Loss…

First, the bad news (other than losing your job). Unemployment benefits are taxable. While this sounds especially punitive given the circumstances, the IRS considers unemployment benefits as income and you need to report them. Also, severance pay, bonuses, 401K and other pension distributions that you received as part of your severance package may be taxable.

On the other hand, if you spent money to search for a job (even if it is unsuccessful) or move to start a job, these expenses are deductible. However, like most tax laws, there are some restrictions on this deduction. For example, if you’re looking to land your first job out of school, job search expenses are not deductible, but moving expenses are. What a dichotomy!

Foreclosure…

Losing a home has to be terribly emotional, but there are tax benefits. Recent legislation provides tax relief to homeowners who’ve had their mortgage forgiven or reduced. Whereas in the past this was a taxable event, now it is non-taxable. To qualify, the home must be your main residence and you cannot be in bankruptcy. At year end, the amount that qualifies for tax relief is reported on Form 1099-C.

Tips for a Quick Refund…

75% of all taxpayers get a refund. Last year the average refund was just over $2,400. If you’re in this happy group, file now! Here’s how to accelerate your refund.

File Electronically – By sending digitally submitting your return to the IRS, you’ll get your refund in about 10-14 days. That beats the 4-6 weeks for printing and mailing the return. Plus, with e-filing, you don’t have to print, copy, sign, attach W-2s, and mail. It’s a very easy process to e-file. By the way, even if you owe additional taxes, e-filing enables you to file now and schedule payment for April 15 by direct deposit. It’s super convenient!

Select direct deposit – Direct deposit can shave another 7 days off your refund cycle. Before you know it, your refund dollars will be in your account working for you instead of for the IRS.

In closing, tax laws are complex, confusing and full of exceptions. You have three choices today for doing your taxes — use an accountant, use tax software, or do them by hand. Surprisingly, about 15-20 million American still sweat it out with paper and pencil. If you do, I encourage you to try tax software. There are many free online services, like TurboTax, that give you a great way to discover all the benefits of tax software — free.

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With all of the layoffs that are currently taking place, I thought I’d spend a few minutes talking about whether or not unemployment benefits are taxable. In short, they are. Because unemployment payments are technically classified as income, you have to pay income tax on them. Sucks, huh?

Here’s the answer straight from the IRS (see Topic 418 for more details):

Unemployment compensation is includible in gross income. You must report unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.

If you receive unemployment at some point during the year, you should received Form 1099-G showing how much you were paid. Oh, and if you don’t make a “voluntary withholding request,” you might have to make estimated quarterly tax payments to avoid an underwithholding.

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Having just finished a first pass through our taxes, my thoughts have naturally turned to our audit risks. We haven’t done anything sketchy, and I also know that the odds of getting audited are quite low, but still… I really don’t relish the idea of having to fight an audit.

To that end, I thought I’d highlight some suggestions that I ran across in an article on MSN. If you’re interested in this topic, you should also check out my earlier article on red flags that might trigger an audit.

For starters…

Rule 1: Check your arithmetic. While IRS computers are set up to automatically correct mathematical errors, having too many errors could indicate a sloppy return, which could trigger an audit. I’m not particularly concerned about this one, as we use TurboTax and there’s not really much room for errors.

Rule 2: Arrange your finances so they don’t stand out. If you’re self-employed, be very careful when claiming business deductions for what might be construed as personal expenses, and be prepared to back up your claims. Also keep in mind that individuals that receive a substantial portion of their income in cash are more likely to be audited, as the IRS is more likely to find additional tax dollars by reviewing their returns. Honestly, there’s not a lot you can do here other than not cheating.

Rule 3: Substantiate. Substantiate. Substantiate. During an audit, the IRS will typically focus on areas where taxpayers typically fail to keep the required substantiation, including automotive expenses, travel, meals, and entertainment. The rules here are simple. If you want to deduct mileage for business, you need to keep a mileage log. If you want to deduct meals or entertainment, a receipt is required for expenditures over $75. Regardless of the amount, you must record the amount paid, the name and location of the restaurant, the person you entertained, that person’s business relationship with you, and the business discussion related to the entertainment. If you don’t talk business, it’s not allowed.

Rule 4: Know when to file. While it’s always good to file your return early if you’re expecting a big refund, you should always wait to file at the last minute if you owe taxes — no sense in giving the IRS their money any earlier than necessary. Moreover, waiting to file at the last minute is decreases your chances of being selected for an audit. You might even consider paying any taxes due by April 15th, but filing an extension such that you can wait to submit your tax return until October. Perhaps it’s overly paranoid, but we did this last year.

Rule 5: Plan your taxes to preempt an audit. If you have any odd, tax-related expenditures, don’t be afraid to attach proof to your tax return. For example, in the case of an especially large medical bill or a particularly generous charitable donation, attach a copy of the bill or check. While the IRS computers will still kick out your return, there’s a chance that a real, live person will decide against an audit when they review your return.

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Are you eligible for the new $8,000 first-time homebuyer tax credit? Wondering how to claim it? Well, you’ve come to the right place. Earlier today, a sharp-eyed reader named Sonny pointed out that the IRS just issued a revision to Form 5405 yesterday. This form, title “First-Time Homebuyer Credit” walks you through the process of claiming your credit.

In hopes of answering a few FAQs, here are some tidbits from the instructions:

Who Can Claim the Credit

In general, you can claim this credit if you purchased you main home located in the United States after April 8, 2008, and before December 1, 2009 and you (and/or your spouse if you are married) did not own any other main home during the 3-year period ending on the date of purchase. If you build a home, you are assumed to have purchased it on the first day that you occupied it.

Who Cannot Claim the Credit

You cannot claim the credit if your modified adjusted gross income (MAGI) is $95k or more ($170k or more for married filing jointly). You are also excluded if you are a non-resident alien, your home is located outside the United States, you acquired the home gift or inheritance, or you purchased it from a related person. There are also a few other somewhat esoteric exclusion, so be sure to read the form carefully.

Details of the Credit

For homes purchased in 2008… The credit will still be little more than an interest-free loan which will have to be paid back in 15 equal installments starting in 2010. If your home ceases to be your main home before the 15 years is up, you’ll have to pay back the balance in the year in which you move.

For homes purchased in 2009… The repayment requirement is waived as long as it’s your main home for the 36 month period beginning on the purchase date. If your home ceases to be your main home within that 36 month period, you’ll have to pay back the credit in the year in which that happens. There are some exceptions, so be sure to read the instructions carefully.

The amount of the credit is the smaller of $7500 ($8000 for homes purchased in 2009) or 10% of the purchase price of the home. You get the full amount if your MAGI is less than $75k ($150k for married filing jointly). The credit is gradually phased out from $75k-$95k ($150k-$170k for married filing jointly).

What This Means for You

If you’re using a tax pro, make sure they’re up to speed on these changes. They should be, but you can never be too careful. If you’re using tax prep software such as TurboTax or TaxCut, be sure to download any updates (the online versions should be automatically updated). If you do your taxes by hand, be sure to download and use the latest version of IRS Form 5405.

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Yesterday afternoon, the economic stimulus package was signed into law. After weeks of wrangling and lots of speculation, the final bill included $212B in tax cuts along with $575B in spending. So what’s in it for you? What follows is a rundown of some of the major taxpayer benefits.

“Making Work Pay” Credit

While you won’t be getting a stimulus check, individuals earning less than $75k/year (and couples earning less than $150k per year) qualify for a $400 per individual ($800 per couple) tax credit. This credit will be doled out in the form of reduced withholding increasing your take home pay by an estimated $8-$13 per week. Social Security recipients who don’t qualify because they don’t work will receive a one-time $250 payment.

First-Time Homebuyer Credit

I’ve written about this extensively over the past few weeks, so it should come as no surprise that the stimulus package includes an $8,000 tax credit for first-time homebuyers. This credit is available to first-time homebuyers that purchase a home between January 1st 2009 and November 30th, 2009. This is a refundable tax credit that is phased out for individuals with AGI of $75k or higher and couples with AGI of $150k or higher.

Alternative Minimum Tax Relief

This is a bit of a red herring, as the Alternative Minimum Tax (AMT) would’ve undoubtedly been patched sometime this year whether or not it was included in the the stimulus package. Nonetheless, the fix is in, and a number of “middle income” taxpayers that otherwise might have been snagged will instead escape the evil clutches of the AMT.

Education Tax Credits

The “American Opportunity” education tax credit will take the place of the Hope Credit in 2009/2010. This credit, which is available for the first four years following high school graduation, covers up to $2,500 in tuition and related costs per year (including school-related book and computer purchases). This credit phases out for single taxpayers with AGI of $80k-$90k and married taxpayers with AGI of $160k-$180k.

Earned Income and Child Tax Credits

The Earned Income Credit (EIC) will be temporarily expanded for families with three or more children. The $1,000 Child Tax Credit will also be extended to additional low-income families.

Unemployment Tax Break

Individuals receiving unemployment benefits in 2009 won’t have to pay federal income tax on the first $2400 that they receive. Moreover, unemployment benefits will increase by $25/week and will also last longer. There will also be a 65% subsidy of health insurance premiums for the unemployed under the COBRA program.

Sales Tax Deduction for Vehicle Purchases

Individual tax payers with an AGI of less than $125k ($250k for joint filers) will be able to deduct state, local, and excise taxes on the purchase of a new car or truck in 2009 even if they don’t itemize. This deduction applies to the taxes paid on the first $49,500 of the vehicle’s purchase price.

Energy Incentives

Purchasers of plug-in hybrid vehicles can qualify for a tax credit of as much as $9,100. In addition, there will be a number of incentives for individuals who make energy-efficient home improvements.

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Update: I’ve posted additional details surrounding this credit and how to claim it. Please click through to read: How to Claim the First-Time Homebuyer Tax Credit.

Okay, details regarding the House/Senate compromise on the economic stimulus package are starting to come out. As I noted yesterday, the Senate’s $15,000 homebuyer tax credit has been stripped from the final version. In it’s place is an $8,000 tax credit for first-time homebuyers. Note that this credit does not need to be paid back, unlike the original $7,500 first-time homebuyer tax credit. To qualify, the purchase has to be made between January 1st, 2009 and before November 30th, 2009 and you have to stay in your home for three years. This is a refundable tax credit, and it’s phased out for individuals with AGI of $75k or higher or couples with AGI of $150k or higher.

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» Have You Filed Your Taxes Yet?

Over the past week or so, I’ve heard from several readers who are somewhat confused about refundable vs. non-refundable tax credits and, ultimately, what it means to “pay taxes.” As a quick reminder, tax credits directly reduce your tax liability on a dollar-for-dollar basis. In contrast, tax deductions reduce your taxable income (and thus result in a fractional decrease of your tax liability).

Getting a Refund vs. Not Owing Taxes

Before we talk about refundable vs. non-refundable tax credits, we first need to talk about what it means to have a zero tax liability. This is likely old news to many of you, but… Just because you get a income tax refund does not mean that you haven’t paid any taxes. In fact, the tax money that is withheld from each of your paychecks is essentially a pre-payment of your total tax bill.

If more is withheld than you ultimately end up owing, you get a refund. Conversely, if you owe more than was withheld, you have to send in additional funds with your tax return (and you might also have to pay a penalty). Your total tax liability can be found on line 11 of IRS Form 1040EZ, line 37 of IRS Form 1040A, or line 61 of IRS Form 1040. If this number is greater than zero, then you’ve paid taxes whether or not you get a refund.

Refundable vs. Non-Refundable Tax Credits

Now that we’re all on the same page, we can turn out attention to tax credits… As noted above, there are two general categories of tax credits: refundable and non-refundable. The vast majority of tax credits are non-refundable, in that they can reduce your tax liability to zero, but not below. In contrast, a refundable tax credit can reduce your tax liability below zero. As such, refundable tax credits can be more properly viewed as a payment — you’ll still get it even if you don’t owe any taxes.

Much of the recent confusion surrounding refundable vs. non-refundable tax credits has been generated by all of the talk about homebuyer tax credits. The original $7500 tax credit for first-time homebuyers is a refundable credit. However, the fact that it’s supposed to be recaptured of the following 15 years makes it more of an interest-free loan than a credit. In contrast, the proposed $15,000 homebuyer tax credit is a non-refundable credit. Note that the “first-time homebuyer” language has been stricken from this version, and it also won’t need to be paid back.

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Related Articles at fivecentnickel.com:

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» $8,000 Homebuyer Tax Credit
» Taxpayer Benefits in the Economic Stimulus Package
» Ten Common Income Tax Credits
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» Making Work Pay: Tax Credit Results in Reduced Federal Income Tax Withholding
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Breaking news out of Congress… After the Senate inserted a $15,000 tax credit for homebuyers into the economic stimulus package, it appears to have been removed while the House and Senate were reconciling their two versions. From an AP News report:

Working to accommodate the new, lower overall limit of the bill, negotiators effectively wiped out a Senate-passed provision for a new $15,000 tax credit to defray the cost of buying a home…

There aren’t a lot of details yet, but it looks like they’ll be falling back to the $7,500 house version of this credit (presumably with no repayment requirement, but only available to first-time homebuyers).

Update: Looks like it will be an $8,000 tax credit for first-time homebuyers.

Source: Yahoo! News

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Related Articles at fivecentnickel.com:

» $15,000 Homebuyer Tax Credit
» $8,000 Homebuyer Tax Credit
» $15,000 Homebuyer’s Tax Credit is Back on the Table
» $7500 First Time Homebuyer Tax Credit
» Congress Extends $8000 Homebuyer Tax Credit, Adds New $6500 Credit
» Refundable vs. Non-Refundable Income Tax Credits
» Ten Common Income Tax Credits
» Second Stimulus Check?

TurboTax and TaxCut are widely regarded as the best tax software for consumers, and both have their fair share of fans. Given that I just sat down to start working on our taxes this weekend, I thought it would be worth comparing the two in hopes of helping anyone that’s trying to decide between them. Note that I haven’t actually made it all the way through my taxes (yet), so some of what follows is based on my preliminary impressions. Also note that I’ve never used TaxACT, so it’s not included.

The Interview

Both TurboTax and TaxCut use an interview format to get the information that they need to properly fill out your various tax forms. While both packages do their best to point out tax law changes as well as life events that might impact taxes, the TurboTax interview feels a bit more comprehensive.

Data Importing

Both TurboTax and TaxCut import data from prior year tax returns, and each is capable of importing data from the other. Beyond this, TurboTax also has the ability to directly import W-2 and 1098/1099 data directly from employers and financial institutions. TaxCut can’t do this, which is kind of a bummer.

Built-In Support

Both packages offer a healthy dose of frequently asked questions (FAQs) and extensive help files. TaxCut does a nice job of presenting this information in the sidebar as you progress through the interview. Something that I really like about TurboTax, however, is that they pull in the most common questions that users have been asking online. This implementation makes it very easy to dig for information that’s too specific to make it onto a list of FAQs, and it’s straightforward to post questions of your own.

Live Support

The Premium version of TaxCut comes with one free phone or e-mail help session on a single topic (additional sessions are $19.95/each). In addition, they offer free audit support via H&R Block. For their part, TurboTax has a downloadable self-help audit support center, and they likewise offer live support. However, there’s no free (live) help included with TurboTax. Rather, you’ll have to pay as you go.

Price Comparison

Pricing for TurboTax ranges from $29.95 for the basic version up to $74.95 for the Home & Business version and $109.95 for the full-blown Business version. There is also a free version for those with very simple taxes. TaxCut starts at $19.95 for the basic version and ranges up to $79.95 for the Home & Business version. There is no free version, and they also don’t have a full-blow business version. Both offer free federal e-filing.

Which is Better?

Honestly, the debate over which tax software is the best will likely come down to personal preference. I’ve been partial to TurboTax in the past, and I still feel that way. For what it’s worth, PC Magazine also considers TurboTax to be the best. Don’t get me wrong, TaxCut is a fine program, but it’s just not my cup of tea.

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If you didn’t receive a stimulus check last year (or if received less than the full amount) and your circumstances have changed such that you now qualify (or qualify for more), then listen up…

The “Recovery Rebate Credit” is a one-time tax credit that’s intended to make up for the unpaid portion of your stimulus payment if (and only if) you received less than you were due. Viewed another way, the stimulus checks that were sent out last year were simply a prepayment of this credit, such that you may not qualify for any additional payment at this time. Confused? Read on.

Eligibility for the Recovery Rebate Credit

If you fall into one of the following categories, you may be eligible for the credit:

• Individuals who did not receive a stimulus check
• Individuals who received less than the maximum amount
• Families that gained a qualifying child during 2008
• Individuals that were claimed as a dependent on someone else’s return in 2007, but not in 2008
• Individuals who did not have a valid Social Security number in 2007, but received on in 2008

Note that membership in one of these groups does not necessarily qualify you for this tax credit. Keep reading to learn how you can determine the amount of your Recovery Rebate Credit (if any).

Claiming the Recovery Rebate Credit

The Recovery Rebate Credit can be claimed IRS Form 1040, 1040A, or 1040EZ. Note that the instructions for all three forms include a worksheet to help you calculate the total credit that you are due for tax year 2008. Once you have this number in hand, simply subtract from it the amount of your stimulus check (if you received one). If you can’t recall how much you received, you can look it up on the IRS website.

Still with me? Good. If you do this and you wind up with a positive number, then you can claim a credit for this amount. The instructions for your particular tax form will tell you where to enter this amount. If you wind up with zero or a negative number, you won’t be receiving an additional credit. The good news here is that you won’t have to pay back any overage if you received too much in the first place.

If you don’t wish to run these calculations yourself, you can simply enter “RRC” on the appropriate line on your tax form and the IRS will figure the credit for you. Alternatively, if you’re using tax prep software, the necessary values should be automatically figured for you.

Avoiding Errors

The IRS has reported that upwards of 15% of returns that have been filed thus far have errors when it comes to the Recovery Rebate Credit. Thus, they have published some tips for avoiding problems. In general, they say that:

Some tax returns erroneously claim the credit, do not claim the proper amount of recovery rebate credit or mistakenly enter the amount of the stimulus payment they received on the recovery rebate credit line.

To avoid delays in tax refunds, it is critical that taxpayers know the correct amount of the stimulus payment they received last year, if any, to help determine whether they qualify for the recovery rebate credit now.

The amount of the stimulus payment will not be entered directly on the tax return. For people using a paper tax return, the stimulus payment amount will be required when completing a related worksheet. For people using tax software, the stimulus payment amount will be needed as part of the return preparation process.

The amount of your stimulus payment will be noted on Notice 1378, which the IRS mailed to everyone that received a stimulus payment last year. Alternatively, as noted above, you can lookup the amount of your stimulus check on the IRS website. If neither of these work for you, then you can call the IRS at 1-866-234-2942 and ask them how much you got.

Note that, for most filers, the correct value for this credit will be zero, as most taxpayers received what they were due in the form of their stimulus payment. Once again, if you are unsure how to proceed, you can always let the IRS calculate the amount of the credit for you.

More details: IRS.gov

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» $8,000 Homebuyer Tax Credit
» How to Request an Income Tax Filing Extension
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» Making Every Dollar Count at Tax Time
» Senate Passes Economic Stimulus Tax Rebate
» Home Depot Rebate Update

Big news tonight… The Senate just voted to give a tax credit of up to $15,000 to homebuyers. While I haven’t found details of the proposed implementation, I know that Senator Johnny Isakson of Georgia was pushing for a larger credit that would be available to all buyers of a primary residence, not just first-time homebuyers. He also wanted to extend the eligibility period to December 31, 2009 and waive the repayment requirement. I’ll update when I know more.

Update: From Isakson’s press release:

Specifically, Isakson’s amendment to the pending economic stimulus bill would provide a direct tax credit to any homebuyer who purchases any home. The amount of the tax credit would be $15,000 or 10 percent of the purchase price, whichever is less. Purchases must be made within one year of the legislation’s enactment, and the tax credit would not have to be repaid.

The amendment would allow taxpayers to claim the credit on their 2008 income tax return. It also seeks to prevent misuse by only allowing purchases of a principle residence and by recapturing the credit if the home is sold within two years of purchase. The amendment would sunset the current $7,500 housing tax credit on the date of enactment.

So… It sounds like that people who already bought might be out of luck. This reads like they’ll be subject to the rules that were in place when they bought. It’s still possible, of course, that the repayment requirement on the $7500 tax credit will be waived. Of course, none of this means anything until it’s actually signed into law.

Update: The Senate version of the $15,000 homebuyer credit has been removed from the stimulus package.

Update: Looks like it will be an $8,000 tax credit for first-time homebuyers.

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Related Articles at fivecentnickel.com:

» $8,000 Homebuyer Tax Credit
» $15,000 Homebuyer Tax Credit Dropped from Stimulus Package
» $15,000 Homebuyer’s Tax Credit is Back on the Table
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» $7500 First Time Homebuyer Tax Credit
» Did Congress Make the Homebuyer Tax Credit Retroactive?
» Getting a Good Deal on a New Home
» Congress Extends $8000 Homebuyer Tax Credit, Adds New $6500 Credit

Unlike income tax deductions, which reduce your taxes by reducing your taxable income, tax credits offer a straight up, dollar-for-dollar reduction of your tax bill. In other words, a $500 tax credit will reduce your tax bill by $500. In contrast, a $500 tax deduction will reduce your tax bill by anywhere from $50-$175 (depending on your income tax rate). Better still, many tax credit are “refundable,” which means that you can take advantage of them even if you don’t owe any taxes.

What follows is a rundown of common income tax credits. While this list is by no means exhaustive, it’s a good starting point as you begin pulling your taxes together.

Earned Income Tax Credit

The Earned Income Credit (EIC) is a refundable for low-income individuals/families. The amount of this credit depends on income level and family size. Details can be found in IRS Publication 596.

Saver’s Tax Credit

The Retirement Savings Contribution Credit provides a credit for a portion of an individual’s qualified retirement contributions. You have to be at least 18 years old and not a full time student to qualify. There are also AGI limits that might affect your eligibility for this credit. See Chapter 5 of IRS Publication 590 for details.

Child Tax Credit

The Child Tax Credit is a credit given provided to taxpayers for each dependent child who is under the age of 17 at the end of the tax year in question. A maximum of $1000 can be claimed per child, though the credit is limited based on your AGI. There is also an additional child tax credit that is available for those that are eligible for the tax credit, but have three or more qualifying children. Details can be found in IRS Publication 972.

Adoption Tax Credit

The Adoption Tax Credit applies to qualifying expenses associated with adopting a child. Note that the credit might be higher if you adopt a child with special needs. You should also be sure to check with your employer, as many benefits packages offer reimbursement of a portion of the costs associated with adoption. For details on this credit, see IRS Topic 607.

Child and Dependent Care Tax Credit

The Child and Dependent Care Tax Credit is intended to offset expenses associated with the care of children under the age of 13, or for a disabled spouse our dependent, such that the taxpayer can work. See IRS Publication 503 for details.

Education Tax Credits

The Hope Credit and Lifetime Learning Credit are intended to defray expenses related to education. The Hope Credit applies to the first two years of post-secondary education, whereas the Lifetime Learning Credit is available for all post-secondary education for an unlimited number of years. See IRS Publication 970 for details.

Social Security Tax Credit

As you may or may not know, Social Security taxes are capped such that, if you earn enough money, you don’t have to pay Social Security taxes on the overage. For 2008, the limit was $102,000. While your employer should respect this limit when figuring your withholding, it’s likely that you had too much money withheld if you had multiple employers for a total of more than $102k in earnings. This credit allows you to recover the excess withholding. See IRS Topic 608 for details.

Foreign Tax Credit

The Foreign Tax Credit is intended to reduce the double tax burden when income from a foreign source is taxed by both the originating country as well as the United States. This credit applies not only to individuals that have worked in foreign countries, but also to individuals that have received income from certain foreign investments (including many international mutual funds). See IRS Publication 514 for details.

AMT Credit

If you previously paid the Alternative Minimum Tax (AMT), but are not liable for it this year, you might qualify for the AMT Tax Credit. This credit allows you to recover a portion of your previous AMT payments. See IRS Topic 556 for details.

First-Time Homebuyer Credit

Finally, we have the First-Time Homebuyer Credit. This one has actually been in the news a lot lately, and we’ve talked about it some here. In short, this is a $7500 tax credit (that’s the maximum amount; it’s actually 10% of the purchase price up to $7500) provided to first time homebuyers who purchase a house between April 9, 2008 and June 30, 2009. As things currently stand, this “credit” is an interest free loan that has to be repaid in 15 equal yearly installments. That being said, there has been a lot of talk about turning this into a refundable tax credit as part of the forthcoming economic stimulus package. See IRS Topic 611 for details.

Update: The Senate has pushed this up to a $15,000 homebuyer tax credit.

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In recent weeks, I’ve gotten a number of e-mail inquiries about the possibility of a second stimulus check. Instead of answering these inquiries individually, I thought I’d take a moment to answer them all here. But first…

Why the Sudden Interest?

I’m guessing that recent interest in this topic has been driven by publicity surrounding the forthcoming economic stimulus package. Prior to that, President Obama (at the time, Candidate Obama) mentioned the possibility of a second round of checks while campaigning back in July, and Fed Chairman Bernanke lent his support to another stimulus check (among other things) back in October.

Will There be a Second Stimulus Check?

As it turns out, there’s no mention of stimulus checks of any sort in the “American Recovery and Reinvestment Plan” (that’s the official name of the forthcoming stimulus bill). Beyond that, I asked my Magic 8 Ball if there will be a second check, and the response that I got was “OUTLOOK NOT SO GOOD.”

Okay, okay… I’m lying about the Magic 8 Ball, but it seems that the underlying message is on point. As of right now, there’s no evidence to suggest that a second stimulus check is on the way.

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Awhile back, I wrote about the best tax prep software. I’ve always been partial to TurboTax, and it seems that I’m not alone… PC Magazine has named TurboTax as it’s Editors’ Choice award winner. Here’s their summary:

TurboTax and H&R Block’s TaxCut wage a mighty battle in the premium personal tax preparation software market every year, with TaxACT mopping up the more budget-conscious and knowledgeable filers. This year, the outcome is the same as in recent years: TurboTax is our Editors’ Choice. Though TaxCut wins points for its more reasonable pricing and remains a formidable foe in terms of functionality, it hasn’t evolved as skillfully as TurboTax has. Both premium apps continue to do a commendable job of exploding the 1040 into palatable chunks that can be more easily digested and processed, but TurboTax — especially in the Premier version — takes apart complex topics and eases you through them with a greater variety of at-the-ready guidance and versatility.

I’ve actually used TurboTax for the past six years (at least), and have been very satisfied with it. Because our taxes have gotten quite complex over the years, I used both TurboTax and a tax pro for our 2006 taxes and the results came out nearly identical, so I’ve fallen back to self-preparing. My only quibble last year was that the AMT documentation was a little sparse, but I muddled through and figured things out just fine.

Also be sure to check out my TurboTax vs. TaxCut comparison.

Source: PC Magazine

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Did you know that you certain itemized deductions are subject to limits if your adjusted gross income (AGI) is too high? For 2008, the AGI threshold is $159,950 (or $79,975 if you are married filing separately). If you make more than that, you’ll may have to forgo a portion of your income tax deductions. The real bummer here (if you’re affected) is that you’re not only sitting in one of the highest income tax brackets, but you’re also losing out on a portion of your deductions.

Which Itemized Deductions are Limited?

According to IRS Publication 17, the following deductions are subject to the limit on itemized tax deductions: taxes paid, interest paid, gifts to charity, job expenses, and certain other miscellaneous deductions.

Which Itemized Deductions are Not Limited?

The following deductions are not subject to the limit on itemized tax deductions: medical and dental expenses, investment interest expense, gifts by cash or check that you choose treat as qualified contributions, casualty and theft losses of personal use property, casualty and theft losses of income-producing property, and gambling losses (wooho!).

How do You Figure the Itemized Deduction Limit?

If your itemized deductions are subject to the limit, then the total of all such deductions is reduced by the smaller if the following values reduced by two-thirds*:

• 80% of your itemized deductions that are affected by the limit, or
• 3% of the amount by which your AGI exceeds the applicable income limit ($159,950 or $79,975 as the case may be)

Confused? It’s not actually as bad as it sounds, and there’s a worksheet in the instructions to Form 1040, Schedule A that walks you through it. Note that the two-thirds reduction means that the (formerly) so-called 3% limit (the second bullet point, above) is now a 2% limit. Leave it to the IRS to make it so convoluted.

*Note: IRS guidance states that the values should be “reduced by two-thirds,” but what they really mean is that you should use “two-thirds of the value.” They later state this more clearly when they say that you should divide the values by 1.5 (dividing by 3/2 is the same as multiplying by 2/3). Ugh. Thanks IRS.

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Related Articles at fivecentnickel.com:

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A reader named Brandon recently wrote in to encourage me to write more about commonly missed income tax deductions. As it turns out, he dug up my article from last year and wound up saving $200 on the retirement tax credit that he would’ve otherwise missed. With that in mind, I thought I’d highlight this list of eleven commonly overlooked tax deductions from a recent issue of Kiplinger’s .

1. State sales taxes. This one makes the most sense for people in states without an income tax, as you can choose between deducting your state sales tax and state income tax. Nonetheless, since you can use a tabled value to figure your deduction, it’s always a good idea to run it both ways.
2. Reinvested dividends. While this isn’t technically a deduction, it’s a tax break that a lot of people miss out on. If you’ve been reinvesting dividends, the cost basis of your holdings are higher than you might otherwise think. This in turn reduces your capital gains (or increases your capital losses) when selling.
3. Out-of-pocket charitable contributions. Keep track of mileage driven for charity, as well as all those smaller contributions you make throughout the year.
4. Student loan interest paid by Mom and Dad. Since the IRS treats student loan repayments by parents as a gift to their child, students that aren’t claimed as dependents can actually deduct up to $2,500 of the loan interest paid by their parents.
5. Moving expense to take first job. Expenses related to finding your first job are not deductible, but your moving expenses are, even if you don’t itemize. As long as you move more than 50 miles, you can deduct the cost of getting yourself and your stuff to the new locale. You can even deduct mileage.
6. Military reservists travel expenses. Members of the National Guard or military reserve can deduct travel expenses related to drills or meetings as long as they travel over 100 miles and are away overnight. The deduction covers the cost of lodging plus half the cost of your meals. You can also deduct mileage, parking fees, and tolls.
7. Child-care credit. If you pay someone to take care of your kids such that you can work, you might qualify for a tax credit. Note that this is true even if you claim your childcare-related expenses through a tax-favored reimbursement account at work because such accounts are capped at $5,000 while expenses up to $6,000 can qualify for the credit.
8. Estate tax on income in respect of a decedent. You can get an income-tax deduction for the amount of estate tax paid on an IRA the you inherit from someone else.
9. State tax you paid last spring. If you owed state taxes when you filed your 2007 return, you can deduct that amount along with the state income taxes that were withheld during 2008.
10. Refinancing points. Any points that you pay when you refinance can be deducted (on a monthly basis) over the life of the new loan. Moreover, all unamortized mortgage points left over from prior years are deducted all at once if you end up refinancing your mortgage in any particular year.
11. Jury pay paid to employer. Some employers continue to pay their employees’ full salary when they’re on jury duty, but require that the employees turn over their jury pay. Since the IRS views this as taxable income, you need to be sure to deduct it. If you don’t, you’ll end up paying double taxes on a portion of your income.

Also be sure to check out my list of common income tax deductions. Keep in mind that these sorts of deductions not only reduce your tax liability, but could also keep you from slipping into the next higher income tax bracket. The last thing you want to do is pay too much in the way of taxes!

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As I noted on Friday, changes are afoot when it comes to the $7500 first time homebuyer tax credit. More specifically, there has been talk of converting this from a pseudo-credit that actually has to be paid back into a true credit. I just wanted to follow up on that article with a bit more information from this summary of the “American Economic Recovery and Reinvestment Plan” from the House Ways and Means Committee:

“Refundable first-time home buyer credit. Last year, Congress provided taxpayers with a refundable tax credit that was equivalent to an interest-free loan equal to 10 percent of the purchase of a home (up to $7,500) by first-time home buyers. The provision applies to homes purchased on or after April 9, 2008 and before July 1, 2009. Taxpayers receiving this tax credit are currently required to repay any amount received under this provision back to the government over 15 years in equal installments, or, if earlier, when the home is sold. The credit phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). The bill would eliminate the repayment obligation for taxpayers that purchase homes after January 1, 2009. The provision would retain the credit recapture if the house is sold within three years of purchase. This proposal is estimated to cost $2.562 billion over 10 years.”

As frustrating and unfair as this change will seem to people that took advantage of the credit in 2008, the limitation of this change to 2009 actually makes sense. After all, the goal is to get people to go out and buy houses, which means that people that have already taken the plunge aren’t the target audience.

Thanks to Ross for digging this up!

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Related Articles at fivecentnickel.com:

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» $7500 First Time Homebuyer Tax Credit
» Refundable vs. Non-Refundable Income Tax Credits

Last night, a reader named Heather asked the following question:

We are debating about whether or not to take the $7500 from the government for being first time home owners. In 2 years, we will have to start paying “them” back $500 for the next 15 years. If we were to sell our house in that time and not make a profit, the debt would be forgiven. I’m not sure I want to owe anyone anything, but hubby thinks of it as an interest free loan… What’s your take on this?

Oddly enough, I was in the process of writing about the first time homebuyer credit when her question rolled in. Weird. Anyway…

The First Time Homebuyer Tax Credit

When it was first proposed in the “Housing Rescue Bill,” the first time homebuyer tax credit was, as Heather noted, little more than an interest free loan (more on this below).

According to IRS guidance, the credit:

• Applies to homes purchased after April 8, 2008 and before July 1, 2009
• Reduced a taxpayer’s tax bill or increases their refund dollar-for-dollar
• Is fully refundable, meaning that you can get it even if you owe not taxes

The amount of the credit is 10% of the purchase price of the home in question, up to a maximum of $7,500 for single taxpayers, or married couples filing jointly. There are, however, a couple of catches…

For starters, the credit is phased out based on your modified adjusted gross income (MAGI). For married couples filing jointly, the credit phases out between $150k-$170k. For all others, the phase out range is $75k-$95k.

The other problem is that it’s not really a credit. Rather, this “credit” has to be paid back in equal installments over the next 15 years along with your taxes. Not such a great credit anymore, huh?

That’s the bad news. The good news is that changes may be afoot…

Conversion to a True Credit?

House Democrats recently outlined their $835 billion economic stimulus package, and one of the things that they’re hoping to do is make the homebuyer tax credit a true credit — with no repayment necessary. Of course, this is still subject to negotiations between the House and Senate, and to passage of the economic stimulus package itself, but…

If it happens, buyers who qualified for the credit in 2008, or those who do so in 2009, will be relieved of the repayment requirement. Is this enough to make you go out and buy a house? Probably not. But if you’re buying one anyway, be sure to take advantage.

Update: The Senate just passed an amendment to the stimulus bill that would create a $15,000 tax credit with no repayment requirement. Moreover, it would be available to all purchasers, not just first-time homebuyers.

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Yikes! I just realized that I forgot to pay the 4th quarterly installment of our 2008 estimated taxes, which were due on January 15th. After the initial panic subsided, I did a bit of digging and was relieved to find out that it’s really not a big deal. Here’s the straight dope from Fairmark.com:

Penalty for Underpayment

What happens if you don’t pay enough, or don’t pay soon enough.

If you don’t pay enough estimated tax, or don’t pay on time, you’ll have to pay a penalty. It’s best to avoid this penalty, of course — but you don’t have to lose sleep over it. The penalty is equivalent to nondeductible interest on the amount you underpaid, for the period of the underpayment. If you underpay only a small amount, or you correct the underpayment quickly, the penalty will be small.

Based on that, it looks like we’ll be on the hook for two days of interest, which shouldn’t be a big deal. In fact, I’ve heard that the IRS doesn’t even bother billing for this if the amount is small enough. That makes sense, I guess, as it costs them money to print and mail an invoice and then handle the payment when it comes in.

Note that you’re exempt from penalties on a late Q4 payment if you’ve already paid in at least as much as your previous year’s total tax bill, or if you file your taxes and pay the full amount due by February 2, 2009.

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In honor of National Tax Advice Day (which was yesterday, whoops!) I’m giving away two copies of Tax Cut to loyal readers such as yourself. I’ve recently written (and solicited opinions) about the best tax software, and Tax Cut certainly has its share of supporters, so don’t miss your chance to get a free copy.

I’m doing this giveaway in two parts. For the first copy, simply leave a comment below between now and Tuesday evening at 9PM Eastern and I’ll randomly select a winner. Be sure to use a valid e-mail address when commenting.

For the second copy, I’m going to emulate my pal Jim and require that you follow me on Twitter (if you’re not already doing so) and send me a message (@fcn) containing a financial tip of some sort. For those that know I’m talking about, you can re-tweet this message for an extra entry.

Here’s an example of what your message should look like (be sure to include #fcntaxcut in your tweets and/or re-tweets so I can find them easily):

@fcn #fcntaxcut [Your financial tip here...]

Here again, I’ll be accepting entries until Tuesday evening at 9PM Eastern. Note that I’ll likely contact the winner via Twitter, so keep an eye on your account.

Note that the winners will receive their software directly from the PR firm that handles Tax Cut, so you’ll have to provide me with a U.S. mailing address (no PO boxes, sorry) that I can pass along to them. Void where prohibited. Good luck!

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A few days ago, I wrote about the FICA-OASDI and FICA-HI taxes. For those that missed it, the former goes toward Social Security whereas the latter goes toward Medicare.

As I noted in that article, Social Security taxes are capped, such that (assuming you make enough money) you only have to pay this tax on a portion of your income. In 2008, the cap kicked in at $102,000, but…

In 2009, the cap is increasing by $4,800. As such, you’re on the hook for Social Security taxes on your first $106,800 in earned income but, beyond that, you only have to pay the Medicare portion.

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Have you ever wondered about those pesky FICA taxes that show up every paycheck? These are federal payroll taxes collected under the Federal Insurance Contributions Act (FICA). These taxes are used to support Social Security and Medicare. My employer denotes them as FICA-OASDI (Old-Age, Survivors, and Disability Insurance) and FICA-HI (Hospital Insurance), respectively.

Calculating Your FICA Taxes

The Social Security portion of the FICA tax is a flat 6.2% of gross compensation for wage earners, whereas the Medicare portion of the tax is 1.45%. These taxes are levied on both the employee and employer so, for every dollar taken from your paycheck, your employer is also paying a dollar. Of course, if you’re self-employed, you are both employer and employee. As such, these tax rates are effectively doubled to 12.4% and 2.9% for Social Security and Medicare, respectively.

The good news here is that, if you make enough money, the Social Security tax goes away. In 2006, the Social Security threshold was $94,200. In 2007 it was $97,500, and in 2008 it was $102,000. Thus, every dollar over $102k that you earned in 2008 is free of the 6.2% (or 12.4%) FICA-OASDI tax, though it’s still subject to the 1.45% (or 2.9%) FICA-HI tax.

While your employer should be aware of this cutoff and automatically stop withholding FICA-OASDI when you pass the threshold, you should keep an eye on them just to be sure. Also, if you work multiple jobs, or change jobs mid-year, you have to be especially careful, as each employer has no idea what’s going one elsewhere. If you pass the threshold in aggregate, they’ll withhold too much. The good news is that you can claim the overage back when you file your income taxes.

FICA Exemptions

While nothing in life is certain except for death and taxes, it’s actually possible to get out of paying FICA taxes, but only under very specific circumstances. As it turns out, students that are enrolled half-time (or more) at a university and who are also working part-time for that university are exempt from FICA payroll taxes. Aside from that, you’re on the hook for these taxes.

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According to a recent piece in the Boston Globe, the most important thing that you can do as we head into tax season is to make sure that your return is accurate. According to tax attorney Ian Comisky,”Because of a huge deficit and major enforcement initiatives by the IRS, an inaccurate return will have a better chance of being picked up than in prior years.”

That being said, you shouldn’t live in fear of an audit. While there are things that you can do to decrease your chances of being audited, you shouldn’t cheat yourself out of legitimate tax breaks “just to be on the safe side.” If you qualify for a particular income tax deduction then, by all means, you should take it. Just don’t claim things that you can’t substantiate, and don’t try to hide your income.

The bottom line here is that, if you’re both honest and careful, you have nothing to fear from an audit. Yes, it will cost you some time, and it will likely be stressful, but you should emerge (more or less) unscathed.

(Knock, knock, knock… That’s me knocking on wood.)

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With tax season just around the corner, I thought I’d go ahead and open a thread on the best tax prep software. As I’ve noted in the past, we’ve always used TurboTax, which is produced by Intuit. Turbo Tax is not, however, the only kid on the block. Moreover, they’ve recently been the subject of a good bit of internet controversy…

For those that aren’t aware, TurboTax changed their base price from $44.95 to $59.95 and they also instituted a $9.95 fee for each additional return that you prepare with it. On the brighter side, they decided to throw in one free e-filing this year, which helps to offset the price increase a bit. Nonetheless, citizens of the internet revolted and trashed their rating on Amazon. The end result was hundreds of 1-star ratings. Intuit finally relented and dropped the $9.95 fee for each additional return.

The best tax prep software

That brings us to the subject of the current post… There are three major players when it comes to tax prep software:

• TurboTax (PC/Mac or online)
• TaxCut (PC/Mac or online)
• TaxACT (PC or online)

While all three offer both free (for simple returns) and paid versions, there are also a number of lesser known free options (again, for very simple returns) available through the IRS’ free file program.

Which tax prep software do you like best?

Assuming that you use tax prep software, what’s your favorite, and why? If you don’t use tax prep software, how do you prepare your taxes? By hand? Or do you enlist professional help?

Oh, and while we’re on the subject of financial software, Quicken fans should be sure to check out the Quicken 2009 discounts that I wrote about previously.

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As I noted a week ago, both the House and the Senate have voted to suspend the Required Minimum Distribution (RMD) for 2009. Unfortunately for those hoping for relief in 2008, this news was too little, too late. That being said, the Treasury Department has the authority to grant RMD relief for 2008, and they’ve apparently been studying their options.

While I haven’t heard anything official one way or another, a reader named Howard has been in touch with the legislative staff of the House Ways and Means Committee. According to him, the Treasury has decided that there’s nothing that they can do for 2008 (see comments here and here). So… Assuming he’s correct, those hoping for an RMD waiver in 2008 are out of luck.

Not sure what the heck we’re talking about?

Check out “What is a Required Minimum Distribution (RMD)?” In short, it’s a mandatory withdrawal that retirees have to take from their retirement accounts once they reach the age of 70-1/2, and there has been concern that retirees who didn’t take their RMD early in the year would be forced to withdraw a disproportionate amount of their funds.

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Late last week, I wrote about the House voting to suspend the required minimum distribution (RMD) for 2009 (the Senate has since voted in support of this measure). Today I thought I’d spend a bit of time explaining exactly what the RMD is for those that aren’t familiar with the term.

What is a Required Minimum Distribution?

The terms Required Minimum Distribution refers to a minimum amount that a retirement plan account owner must withdraw each year once they reach the age of 70-1/2 (or at retirement if they work past that age). The RMD rules apply to all employer-sponsored retirement plans including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEP-IRAs, SARSEP plans, and SIMPLE IRAs. Note that the RMD rules also apply to Roth 401(k) accounts, but they do not apply to Roth IRAs while the owner is alive.

How do you calculate the RMD?

RMD amounts are generally calculated for each account based on their balance on December 31st of the prior year. Calculations are based on a life expectancy table published by the IRS in Publication 590. There are also worksheets available to help with the calculations. Note that you can always withdraw more than the RMD, but that excess withdrawals cannot be credited toward your RMD in subsequent years.

When must your RMD be taken?

As noted above, RMDs have to be taken for the year in which the account holder turns 70-1/2. However, during that first year, the distribution can be delayed until April 1st of the following year. For all subsequent years, the RMD must be taken by December 31st of the year.

Where do the RMD funds have to come from?

While you have to calculate the RMD separately for each IRA account, you can withdraw the total amount from just one IRA if you wish. Likewise, if you have multiple 403(b) accounts, you must calculate the RMD for each account, but you can withdraw the total RMD from just one if you wish. For other types of retirement plans, such as 401(k) and 457(b) plans, you have to take the RMD separately for each account.

What happens if you don’t take your RMD?

If your fail to take your RMD, or don’t withdraw enough, or don’t do it in time, the amount not withdrawn will be taxed at 50%. The additional taxes are reported on IRS Form 5329. The good news is that you can get the penalty waived if you can show that the shortfall was due to a “reasonable error” and that you are taking “reasonable steps” to fix the situation. In this case, you still need to file Form 5329 (read the instruction carefully), but you should also attach a letter of explanation and hope that the IRS agrees with your definition of “reasonable.”

Why all the talk about suspending the RMD?

There has been a lot of recent attention paid to the possibility of suspending the RMD. The reason for this is that, as noted above, the RMD is based on your account balances on December 31st of the prior year. For 2008, that means that people who have waited until late in the year to take their RMD will be forced to withdraw a disproportionate amount of funds.

Take, for example, an individual whose RMD calculation amounted to 5% of their account balance as of December 31st, 2007. If that individual had an especially aggressive portfolio that has since fallen by 50%, and if they didn’t take their RMD early in the year, then the RMD amount would now equal 10% of their balance. That being said, the suspension that’s currently being bandied about won’t actually help, as it won’t go into effect until 2009.

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Lost in all the hubbub about the $700B bailout bill was a series of income tax breaks for individuals. While a number of these won’t have any impact on the majority of Americans, they’re still worth knowing about just in case…

1. An AMT fix. The alternative minimum tax (AMT) is the bane of the upper middle class tax filer’s existence. Without an annual patch, and every-increasing fraction of Americans would get snagged. The bailout included just such a fix for tax year 2008.
2. Mortgage debt forgiveness. Congress recently passed a law saying that if you sell your home for less than you owe, restructure your mortgage, or get foreclosed on, the cancelled mortgage debt won’t count as income through 2009. This has now been extended to 2012.
3. A break on education. You can now deduct up to $4k in school tuition if your AGI is $80k or less for single filers ($160k or less for joint filers).
4. A sales tax deduction. The option to deduct stat and local sales tax instead of state income tax was extended.
5. Tax-free donations. If you’re at least 70-1/2 years old, you can withdraw up to $100k from an IRA and give it to a charity tax-free.
6. Energy tax credits. In 2009, you can get a credit of up to $500 for energy-efficient home improvements such as adding insulation or replacing windows.

Source: Money Magazine

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A Hill staffer wrote in his morning to let me know that the House passed legislation that will suspend the required minimum distribution (RMD) from retirement accounts in 2009. The Worker, Retiree and Employer Recovery Act (H.R. 7327) suspends the IRS requirement that individuals withdraw a minimum amount of money from their retirement accounts every year once they reach the age of 70-1/2.

This waiver applies to all defined-contribution plans, including 401(k), 403(b), 457(b), and IRA accounts, and is good news for seniors whose investments have been pummeled by the recent stock market turmoil. Instead of being forced to sell investments to take their RMD, they’ll be able to sit tight and wait for a recovery. Unfortunately, it’s too late to help for 2008, so retirees will still have to take their RMD this year or face a stiff penalty from the IRS.

Update1: The Senate has also approved this measure.

What follows is a listing of the key provisions of this legislation as it relates to retirement plans:

TITLE II – PENSION PROVISIONS RELATING TO THE ECONOMIC CRISIS

Taxpayer Relief

One-year suspension of the required minimum distribution (RMD): The bill would place a one-year moratorium on the RMD for 2009. This suspension is available to everyone regardless of their total retirement account balances.

Relief for single-employer plans

Allow pension plans to “smooth” out their unexpected asset losses: The bill permits employers to “smooth” the value of pension plan assets over 24 months instead of having to apply the mathematical average that Treasury requires. This change will soften the accounting of 2008 plan losses.

Adjust the transition to the new funding rules: PPA phases in full pension funding targets from 90% to 100% over 5 years (2008 – 92%, 2009 – 94%, 2010 – 96%, 2011 – 98%, 2012 – 100%). If a plan misses its target in a phase-in year, then the target automatically increases to 100%. The bill adjusts the “phase-in” rule to allow plans which miss their phase-in funding target to retain the same target and not jump to the 100% target. For example, plans that are less than 92% funded in 2008, their shortfall would be estimated relative to 92%, not 100%. With a sizable number of plans below 92% funded next year, the adjustment of this phase-in rule could provide significant relief.

Worker protections

Temporary change of the limitation on benefit accruals. For purposes of staving off restrictions on benefit accruals as a result of being < 60% funded, plans would be able to look back to the previous plan year to determine their funded status as it would apply to workers’ ability to accrue benefits.

Relief for multi-employer plans

Plans may elect to “freeze” their plans’ status for one year: For plans starting between October 1, 2008 and October 1, 2009, multi-employer plans may elect to freeze their current funding status based on the previous year’s level. This would freeze the terms of the funding improvement or rehabilitation plan adopted at any time during the previous plan year.

Plans may elect to extend correction periods: Plans generally must bring their funded position up to statutory standards within a correction period (10 years or 15 years). This structure aims at enabling stakeholders in troubled plans to phase in the higher contributions or deeper benefit cuts over a period of time. Plans may elect a 3-year extension of the current funding improvement or rehabilitation period, from 10 to 13 years and from 15 to 18 years. Election of this extended correction period would help offset 2008 equity losses.

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On more than one occasion, I’ve received an e-mail asking for advice on how to keep from slipping up into the next tax bracket. The motivation behind such e-mails is typically a misconception of how our progressive tax system works. What many people don’t realize is that our federal income tax brackets reflect marginal rates, not a rate that is applied to your entire income. Here’s a quick example based on current income tax rates…

For a married couple filing jointly in 2008, the 10% tax bracket covers income from $0 to $16,050. From $16,050 to $65,100 the tax rate is 15%. And from $65,100 to $131,450 the tax rate is 25%. A couple with a taxable income of $100k will be in the 25% tax bracket, but they won’t have to pay 25% in federal income taxes on the full amount. Rather, they’ll pay just 10% on the first $16,050, 15% on the next $49,050, and 25% on the last $34,900. This works out to $17,687.50, or an effective rate of just under 18%.

Of course, you should still try to minimize your taxable income as much as possible by contributing to retirement accounts, taking advantage of perks like a flexible spending account (FSA), and maximizing your income tax deductions. But, as you can see from the numbers above, you have nothing to fear from earning a bit more money and finding yourself in a higher tax bracket. Moving to a higher tax bracket will never cause you to take home less money than if your income were lower.

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