Have you started thinking about doing your taxes yet? I haven’t. Rather, as I do every year, I’ve just been tossing all of our tax forms in a pile as they arrive, and I haven’t paid much attention to what’s here vs. what’s missing.

But now that we’ve moved into February, you should have everything you need to file your taxes, as most everything is supposed to be in your hands by January 31st.

Here’s a quick rundown of forms that you might be expecting:

• W-2 (for wages earned)
• 1099-DIV (for dividends received)
• 1099-INT (for interest earned)
• 1099-MISC (for miscellaneous income)
• 1099-B (for proceeds of broker transactions)
• 1099-C (for cancellation of debt)
• 1099-G (for government payments, including unemployment)
• 1099-OID (for certain investment income)
• 1099-R (for retirement distributions)

If your W-2 form is missing, you’ll need to check with your employer. If, on the other hand, you are missing a 1099 form, keep the following in mind:

For starters, a 1099-MISC is only required if you earned more than $600 from a given source over the course of the year. You might still get a 1099 even if you earned less than that amount, but if you don’t get one, don’t worry.

In contrast, 1099-INT and 1099-DIV forms are required for earnings in excess of $10. That being said, it’s quite possible that your bank or other financial institution has switched to electronic delivery, such that you need to login and download the forms.

You should also be aware that payments made to a corporation don’t require a 1099, regardless of the amount. Thus, if you’re self-employed and have incorporated your business, it’s quite possible that you won’t receive any 1099 forms related to your work.

Of course, you are still legally required to report all income whether or not you receive a 1099, so be careful… And if you do get a 1099, but don’t report the income, you’re just begging for an audit.

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I’ve talked quite a bit about making “backdoor” Roth contributions if you’re over the income limits for contributing to a Roth IRA. In short, you can make a non-deductible contribution to a traditional and then immediately convert it into their Roth.

This strategy has become so popular that mainstream publications such as Forbes have started talking about it. But is it legal? That was the topic of a recent discussion over on the Bogleheads forum.

This discussion was prompted by an article by Michael Kitces, who is a financial planner extraordinaire and the Director of Research for the Pinnacle Advisory Group.

According to Kitces, while the individual steps of the backdoor Roth maneuver don’t run afoul of IRS regulations, these contributions could be disallowed under the step transaction doctrine.

The step transaction doctrine is a legal principle that essentially allows the IRS to look at the overall effect of a multi-step transaction and treat it as a single, integrated event.

In other words, rather than looking at the legality or tax treatment of individual steps, the IRS is free to look at the overall result of the transaction — i.e., that an individual over the contribution limits was able to make a Roth IRA contribution — and tax (or penalize) it accordingly.

So… The question is whether or not the IRS would balk at backdoor Roth contributions. I’m not particularly concerned about it, in part because the removal of income limits for converting funds to a Roth IRA appears to have been specifically intended to allow high income individuals to do just that, but…

It seems at least theoretically possible that the IRS could view this as an over-contribution, which comes with a recurring penalty of 6%/year (albeit with a 3 year statute of limitations), and these transactions could be messy to unwind.

At the same time, it’s worth noting that IRA expert Ed Slott weighed in on this issue last spring, arguing that the step transaction doctrine is a non-issue for backdoor Roth contributions.

My pal TFB has also tackled the subject. The short version is that he’s recharacterizing his recent conversions, and will re-convert at a later date to reduce the odds of his conversions being viewed through the lens of the step transaction doctrine.

What about you? If you’ve been making backdoor Roth contributions, are you concerned about running afoul of the IRS?

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Related Articles at fivecentnickel.com:

» Contribute and Convert: Funding Our Roth IRAs Through the Backdoor
» Withdrawing Your Roth IRA Contributions (Followup)
» Contribute to Your Roth IRA, Even if it Stretches Your Budget
» Roth IRA Income Limits for 2007
» Traditional IRA vs. Roth IRA: What’s Your Preference?
» Roth IRA Income Limits for 2012
» Tax Credit for Retirement Savings Contributions
» Ratcheting up our Roth IRA Contributions

I’ve spent a good bit of time digitizing paperwork over the past couple of years. My primary weapon in this battle has been a sheet-fed scanner, though I sometimes snap pics with my iPhone and turn them into “scanned” pdfs using JotNot.

While it feels to good to be working toward a paperless financial world, however, the issue of whether or not these scanned documents would be acceptable has always bothered me. Having a store refuse a return because I didn’t have the original receipt would be annoying; having the IRS reject my documents could be a disaster.

So… Does the IRS actually accept scanned documents?

As it turns out, yes… They’ve actually accepted electronic documentation since at least 1997, when they issued IRS Revenue Procedure 97-22, which states:

This revenue procedure provides guidance to taxpayers that maintain books and records by using an electronic storage system that either images their hardcopy (paper) books and records, or transfers their computerized books and records, to an electronic storage media, such as an optical disk. Records maintained in an electronic storage system that complies with the requirements of this revenue procedure will constitute records within the meaning of § 6001 of the Internal Revenue Code.

Section 6001 of the IRC essentially requires you to keep and make available sufficient records to show whether or not you’re liable for taxes. It further states that such records must be retained “so long as the contents thereof may become material in the administration of any internal revenue law.”

The general requirements of the “electronic storage system” referenced in the quote above are that it:

…must ensure an accurate and complete transfer of the hardcopy or computerized books and records to an electronic storage media. The electronic storage system must also index, store, preserve, retrieve, and reproduce the electronically stored books and records.

There are some additional requirements, but the essence is that you can digitize your documents as long as they’re clearly legible (both on-screen and in hard copy) and easily retrievable. Just be sure to keep your data safe. In our case, we maintain both local and online backups of our data, so our digital documents are probably safer than hard copies.

And don’t forget to secure your files to protect them from prying eyes. The last thing you need is for your cache of sensitive data to fall into the wrong hands.

Of course, I’m not a tax pro, so I suggest that you check out the details and decide for yourself. The relevant guidelines can be found in this document from the IRS. The pertinent section (Rev. Proc. 97-22) starts on page nine.

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As January winds down, you should have received most of the paperwork that you’ll need to file your taxes. If you’re like most FCN readers — and most Americans in general — you’ll be e-filing this year.

Sure, e-filing is convenient. But guess what? It’s also much cheaper for the IRS to process your return if you file electronically. As it turns out, it costs the IRS $3.29 to process a paper return vs. $0.19 for an electronic return — a savings of $3.10 (or nearly 95%!) per e-filer.

Looking back at last tax season, more than 100M individual federal tax returns were e-filed. Thus, the e-filing program saved well over $300M last year alone — not to mention an awful lot of paper waste.

Source: GAO via Don’t Mess With Taxes

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Do you have a workplace retirement plan such as a 401(k), 403(b), or 457(b)? If so, then you might be interested in knowing that the contribution limits for these account types has increased for 2012.

This means that individuals under age 50 can contribute up to $17,000 to their 401(k) account this year, up from last year’s limit of $16,500. And if you’re over age 50, you can contribute an extra $5,500 toward your retirement this year.

Beyond the above, the aggregate limit (employer + employee contributions), which is specified by Section 415(c)(1)(a) of the Internal Revenue Code, has increased to $50k/year. This is the so-called 415(c) limit and, while it doesn’t affect many of you, it does have an impact on some people (especially if you’re self-employed and have a high incomes).

Note that 403(b) and 457(b) plans, as well as the Thrift Savings plan, are subject to the same contribution limits, so those of you in the non-profit, educational, and public sectors will likewise be able to save a bit more this year.

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Related Articles at fivecentnickel.com:

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» 401(k), 403(b), and 457(b) Contribution Limits for 2009
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» Open Enrollment Time
» Roth IRA Income Limits for 2007
» Roth IRA Income Limits for 2012

Your 2011 taxes are due in just under three months. That also means that you have just under three months left to make any 2011 IRA contributions that you might have been putting off.

But what if you’re neglected to contribute to an IRA because you’re not sure you can afford it? Maybe the only cash you have on hand is earmarked for emergencies, and you’re not willing to risk the 10% early withdrawal penalty that comes with a traditional IRA.

Well, I’d like to encourage you to think twice about that stance and consider making a Roth IRA contribution. As I noted the other day, Roth IRA contributions can be withdrawn at any time and for any reason without penalty. And if you don’t believe little old me about this, you can check it out for yourself in IRS Publication 590.

While I’m not crazy about this flexibility to the extent that it encourages (or at least allows) people to raid their retirement to buy shiny things, one huge benefit is that it gives you the flexibility to make a contribution even if you’re not sure you can afford it.

This flexibility is very valuable because you’re only allowed to contribute a limited amount to IRAs each year. In other words, if you fall behind on contributions now, you won’t be able to make up for it later when you can (hopefully) better afford it.

If you make the contribution now and fate smiles upon you, you’ll be able to re-build your emergency savings “on the outside” while having more money stashed away inside your Roth IRA. And if things go awry, you’re free to yank that money out (up to the amount that you’ve contributed) and use it to take care of whatever emergency you’re dealing with.

Some issues to be aware of:

1. This rule applies to Roth IRAs only, so don’t try this trick with a traditional IRA.
2. The usual contribution limits still apply, so don’t try to sock more money away than is allowed.
3. Roth IRA conversions are subject to a five year waiting period before they can be withdrawn without facing a penalty.
4. Make sure a Roth is right for you. If you expect to pay the same or higher taxes in the future, then a Roth might make sense for your situation. But if you expect your tax burden to fall in the future, a traditional IRA might be better — but remember, only Roth IRAs qualify for the penalty-free withdrawal of contributions.
5. Given that this is money that you may need to withdraw at any time, be sure not to put it at risk once inside the Roth. Instead, plug it into a money market fund or something similar until you’ve re-built your emergency savings.

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» Max That Roth! (Yet Again)
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» Traditional to Roth IRA Conversion at Vanguard

As a followup to Friday’s post on contributing to a traditional IRA and converting to a Roth IRA (i.e., funding a “back door” Roth) I wanted to spend a little time talking about Roth IRA withdrawal rules.

This post was actually inspired by a comment from a reader named John who is interested in using IRA funds to buy his family’s farm in about five years:

If I convert traditional, previously-deducted IRA funds to Roth IRA funds and then pay taxes on it, can I then withdraw the taxed contributions at a later time in order to purchase the investment property? I would not be withdrawing earnings, only the initial contribution.

The short answer is yes – with some restrictions.

Unlike the situation I talked about in my previous post, where you’re making a non-deductible contribution and then converting it, John is correct that he’ll have to pay taxes when he converts his deductible contributions (and any subsequent earnings). The reason for this is simple: you’ve never paid taxes on this money, so you have to do so before you can stick it in Roth IRA (since you pay taxes up front with a Roth).

The real question is whether or not John can pull this money out without consequences at some point in the future — but presumably before he reaches retirement age. Of course, if he waits until age 59.5, then all bets are off. He’s free to withdraw whatever he wants, whenever he wants.

But before that time… Can he make a penalty-free withdrawal to buy the family farm?

For starters, we need to talk about the order of distribution. As with others types of IRAs, the IRS views all of your Roth IRAs (assuming that you have more than one) as a single pot of money. And when you withdraw, you are assumed to first be accessing your original contributions. After that money is depleted, you are assumed to be accessing dollars that you converted. And after that, you are assumed to be accessing earnings.

For original contributions: This would be money that he contributed straight into his Roth IRA, subject to annual contribution limits. As it turns out, you can withdraw your Roth IRA contributions at any time without paying any taxes (you’ve already paid taxes on this money) or penalties.

For conversions: Conversions (money converted from a traditional IRA into a Roth IRA are treated similar to contributions, with an important difference. If you withdraw money that you converted into your Roth less than five years after the conversion, you have to pay a 10% penalty. This stops people from simply converting their traditional IRAs into a Roth to gain immediate access to the money. But once the five year rule has been met, you can withdraw your conversions at any time without paying any taxes (you’ve already paid taxes on this money) or penalties.

For any subsequent earnings: Finally, what about any investment earnings/gains that have occurred inside of you Roth? Let’s say you contributed a total of $10k over the years, and it’s now worth $12k. The last $2k that you withdraw would be the earnings. For starters, any earnings that are withdrawn less than five years after you opened your Roth IRA are subject to income taxes. Moreover, if you are under 59.5, the withdrawal will be taxable unless you meet certain exceptions, and you it will also be subject to a 10% penalty. Once you reach age 59.5 and your account has satisfied the five-year rule, you can withdraw your earnings free and clear.

So what about these exceptions that I mentioned above? There are several things that will make a distribution “qualified,” and thus not subject to taxes or penalties. One is reaching age 59.5 (and having satisfied the five year rule in the case of earnings). The others include: distributions made to a beneficiary after your death, disability, or using the funds to pay certain costs associated with being a first-time homebuyer.

So…. The short answer is that yes, John can convert from a traditional IRA to a Roth IRA, pay any taxes that are due (just be careful about getting bumped into a higher tax bracket!) and then withdraw the conversions in five (or more) years without paying any additional taxes or penalties.

Note that I’m not saying that this is necessarily a good idea — that depends on the details of John’s circumstances, and that’s a decision that he’ll have to make for himself after considering a number of factors. Rather, I’ve just focused on what’s possible, and when the penalties will (or won’t) kick in.

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As a followup to my post earlier this week on Roth IRA income limits, I wanted to highlight how we typically make our Roth IRA contributions. For background, we’re in a relatively high (and variable) income tax bracket. Because of this, we flirt with the Roth income limits on an annual basis, and it’s hard to know for certain whether we’ll be above or below the line until late in the year.

While we could wait until the end of the year, or even early the following year, to determine whether or not we can contribute, I’d rather get it knocked out right away. Thus, we make what others have termed “backdoor” Roth IRA contributions.

For background, the income limits for converting from a traditional IRA to a Roth IRA went away back in 2010. Beyond this, there are no income limits for contributing to a traditional IRA. Yes, there are income limits for determining whether or not you can deduct your traditional IRA contributions, but you’re free to contribute no matter how much you make.

The workaround, then, is to contribute to a traditional IRA (this will be non-deductible if you make enough to be ineligible for a Roth) and then convert it to to a Roth IRA. And that’s exactly what we do every January. For those of you that invest with Vanguard, I’ve outlined the steps below to show you exactly how it’s done…

For starters, you’ll need to make your traditional IRA contribution. There are a variety of ways to do this, with the easiest be funding your IRA from a linked bank account. For now, I’ll assume that you’ve already done this.

Once your traditional IRA fund are in place, simply log in and select “Exchange (Sell funds to buy funds)” option from the “Transact on this account” pulldown menu.

When asked what you want to sell, choose the traditional IRA holding(s) that you wish to convert out of. When asked what you want to buy, choose the Roth IRA holding(s) that you wish to convert into.

Once you click to review, you’ll be warned that “A conversion is a taxable event. Generally, you’ll owe taxes on the amount you convert from your traditional, SEP, or rollover IRA into a Roth IRA.”

Assuming that you made a non-deductible contribution, that you don’t have any untaxed gains in the account you’re converting, and that you don’t have any other non-Roth IRA IRA accounts in your name, however, there will be no tax liability*. It will be as if you had contributed directly to the Roth IRA in the first place, except you’ll have circumvented the income limits.

Given the above, I selected the “Do Not Withhold” option when asked about tax withholding and then submitted the order.

That’s it. We’ve now fully funded our Roth IRAs for 2012 and don’t have to think about whether or not we’ll finish above/below the income limits.

*Note: If you have previously made tax-deductible contributions to a non-Roth IRA, even if they’re in a different account, making a conversion like this will generate a tax liability. The reason for this is that the IRS views all of your IRAs as one big pot of money, and they don’t let you pick and choose which dollars you convert.

The good news is that money in “qualified” plans, such as 401(k) or 403(b) plans, is not included in the tax calculation, so you could conceivably move all of your pre-tax money into a Solo 401(k) to effectively hide it before doing the “contribute and convert” thing.

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» Roth IRA Withdrawal Rules: How to Get Your Money Out Early
» Traditional to Roth IRA Conversion at Vanguard
» 2007 IRA Contribution Limits
» Ratcheting Up Our 403(b) Contributions
» Funding an IRA When You’re Not Sure You Can Afford It
» Look Before You Leap: Roth IRA Conversions in 2010

I recently wrote about Roth IRA contribution limits for 2012, which are unchanged from 2011. Today I want to talk about the current income limits for contributing to a Roth IRA. Here goes:

Married Filing Jointly: Contributions phase out from $173k-$183k
Single or Head of Household: Contributions phase out from $110k-$125k
Married Filing Separately, Living Apart: Contributions phase from $110k-$125k
Married Filing Separately, Other: Contributions phase out from $0-$10k

(Note that these numbers all refer to modified adjusted gross income, or MAGI)

The good news is that even if you exceed the income limits, there is a workaround for funding your Roth IRA. Indeed, as of 2010, the income limits for converting from a traditional IRA to a Roth went away, so if you earn too much, you can make a non-deductible traditional IRA contribution and then convert it to your Roth.

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Believe it or not, it’s already time to start thinking about filing your 2011 income tax return. In the coming weeks, you should be receiving your W-2 form(s), a variety of 1099 forms, etc. And if you pay estimated taxes, your 4th quarter payment is due next week (on January 17th).

So… With that in mind, I thought I’d post a quick reminder as to when your 2011 federal income tax return is due. As you’re likely aware, the filing deadline is April 15th of each year. But when the deadline falls on a weekend, it’s pushed to the following Monday. And when the deadline falls on a federal holiday, it’s pushed to the next business.

This year, like last year, is a bit different. This time around, April 15th falls on a Sunday, and Monday is not a federal holiday. And yet, your taxes are due on Tuesday, April 17th. Why?

The funny date is due to a April 16th being Emancipation Day, which is a holiday in Washington, D.C. Emancipation Day marks the anniversary of the signing of the Compensated Emancipation Act by President Lincoln in 1862, which freed the slaves in the District of Columbia.

Emancipation Day has been an official public holiday in D.C. since 2005, and it’s been responsible for shifting the 2006 and 2010 tax filing deadlines (in 2007 and 2011, respectively).

Oh, and don’t forget that you technically get one more day than you might otherwise think this year — 2012 is a Leap Year, which means that February has an extra day. In other words, you have no excuse for missing the deadline this time around.

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A few notes…

First, note that this limit is a combined limit for traditional and Roth contributions. Thus, while you can contribute to both in the same year, the total contribution cannot exceed the $5,000 (or $6,000) limit.

Second, your traditional IRA contributions may be tax deductible, depending on whether or not you’re covered by a retirement plan at work, and how much money you make. Details can be found here and here.

Finally, remember that you can make contributions for 2011 all the way up to April 17th, 2012 (the due date for filing 2011 tax returns). Thus, if you still haven’t gotten around to it making your 2011 contributions, you still have time.

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Related Articles at fivecentnickel.com:

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» Contribute and Convert: Funding Our Roth IRAs Through the Backdoor
» IRA Changes for 2008
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As a followup to my recent article about paying sales tax for online purchases, I wanted to highlight an interesting article from last summer that a reader named Heather pointed out in the comments section.

In short, Arizona has added a dedicated line to their state tax returns for taxpayers to reporting unpaid use taxes. This isn’t a huge deal in itself, but… According to a local tax pro named Ellen Campbell, the AZ Department of Revenue has been advising taxpayers that anyone who fails to report something on that line will be subject to an income tax audit.

Whether or not this is true remains to be seen, but it’s hard to imagine trying to enforce something like this. Perhaps it will raise your odds of an audit, especially if you fit certain other criteria (e.g., income above a certain threshold), but auditing every single return that fails to report use tax? Seem unlikely, but… Never say never.

Regardless, this is just more evidence that states are getting serious about collecting unpaid sales and use taxes.

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One of the reasons that many people love to shop online is that they can often get away without paying sales taxes. The reason for this is that companies without a physical presence (nexus) in a state aren’t typically required to collect sales tax.

This isn’t to say that you’re not supposed to pay tax on these purchases. In fact, if you make a purchase that would otherwise be subject to sales tax, you’re supposed to claim it on your state tax return and pay a use tax. But how many people do that? Not many. And states are starting to take notice.

According to a recent press release from CCH, 16 states have either enacted or proposed legislation to require online retailers to collect sales tax, or to “more strongly urge” consumers to pay their use taxes.

And the states aren’t alone in introducing this sort of legislation. Not long ago, the Marketplace Equity Act of 2011 (H.R. 3179) was introduced in Congress. This bill would allow states to require “remote sellers” to collect sales taxes, effectively ending the ongoing sales tax holiday that shoppers have been enjoying.

This bill, which has the backing of the Retail Industry Leaders Association, exempts “small sellers” with gross annual results of $1M or less nationwide, or $100k or less in a particular state from having to collect sales taxes. Interestingly, this bill has also attracted bipartisan support.

According to Rep. Steve Womack (R-AR), one of the bill’s sponsors, “The intent of this legislation is [...] to close a long-standing loophole that puts America’s brick and mortar businesses at a competitive disadvantage.”

Rep. Jackie Speier (D-CA) added that “The death of small businesses on Main Street can be attributed in part to the consumers who will visit the store test out the equipment, get advice on products like TVs and computers and cameras and bicycles, and then find and buy the item online, sometimes right on their mobile phone while still standing in the store.”

Sound familiar? I’ve been known to comparison shop in just this way — though I’m typically interested in the significantly lower prices that are available online, not the lack of sales tax.

So when might we see the online sales tax loophole closed? According to Daniel Schibley, a senior tax analyst for CCH, “While it may not have significant implications for this holiday tax season, consumers should be prepared to start seeing sales tax collected on more and more of their online purchases in the years ahead as cash-strapped states look for more revenue sources.”

What do you think? Are you hoping to see a leveling of the playing field between online and real-world retailers? Or will you miss the ability to shop online without having to pay sales taxes?

Hat tip: Don’t Mess With Taxes

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Related Articles at fivecentnickel.com:

» Arizona to Audit Everyone Who Fails to Report Sales and Use Tax?
» Sales Tax Deduction for New Car Purchases
» Don’t Miss These Tax Breaks, Part 1
» States With No Income Tax
» How to Decide if Travelling to a Sales Tax Holiday is Worthwhile
» Cash for Clunkers – Ending Soon
» Home Sales UP in February
» Mall Jewelry Store ‘Sales’

According to a blurb on CNN/Money, the IRS is sitting on a little more than 99k undelivered tax refund checks totaling $153M. The checks in question, worth an average of $1547 each, were returned to the IRS due to mailing address errors. As big as these numbers appear, these checks correspond to just 0.01% of all returns, so only a (very) small minority of refunds were affected.

Regardless, if you want to avoid problems, you should opt for direct deposit when you file your tax return. And if your check doesn’t show up, be sure to follow up with the IRS.

Speaking of which… If you were supposed to receive a check, but it never arrived, you can use the “Where’s My Refund?” tool to resolve any delivery problems.

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» One Year Ago This Week (November 12th – November 18th)

Do you find that $20 bill in your pocket evaporating faster than ever, and your paychecks taking you shorter and shorter distances? It’s no hallucination. There’s a shift going on. It’s a shift helping ensure the comfortable middle-class lifestyles our parents enjoyed become as obsolete as an eight-track tape player.

Costs once borne by better-heeled folks are increasingly bearing down on the fragile shoulders of American taxpayers. Expenses, burdens, commitments, and responsibilities once assumed by employers are now the obligation of the American wage earner. In short, if you look around, you’ll find things are being shifted. And the more they’re shifted, the more likely you are to be shafted.

Try this: Go to any search engine and type in the phrase “costs shifted to taxpayers.” Next, tweak that line and make it “costs shifted to employees.”

You’ll find article after article bearing the same essential story line. Expenses not so long ago shouldered by someone in corporate America are now being subtly and gradually transitioned to the backs of average folks.

There’s the case in Ohio where the payouts to victims resulting from medical malpractice lawsuits may soon be vacuumed from Buckeye taxpayers’ accounts rather than insurers’. There’s the report from Washington State about a state senate initiative to let employers and insurance companies negotiate with injured workers and pay out less than the workers’ claims are worth, with the logical result that injured, disabled individuals will turn to public assistance.

And of course, there are the instances of mega-rich retail empires that gorge on profits while failing to pay living wages or provide affordable health insurance to their workers, ensuring those workers will turn to taxpayer-financed programs like Medicaid to garner the assistance they or their family members will likely require.

Caught in the crossfire

Your ability to raise kids and build college, home, and retirement savings might not be too badly dented by just one of these shifts. But when the shifts are coming from all directions, well, it’s no surprise editorial cartoons are portraying the U.S. middle class as a chalk line on pavement behind police tape.

Amid the growing library of books examining this phenomenon, one of my favorites is David Cay Johnston’s New York Times bestseller Free Lunch.

What’s that, you say? There’s no such thing as a free lunch? That’s right, someone must pick up the tab when, as the book’s subtitle says, “the wealthiest Americans enrich themselves at government expense.” That someone is you.

In the book, Johnston details how tax subsidies continue to be dispensed to the country’s most-moneyed individuals while jobs for average Americans disappear. Who’s reaping those windfalls? Big box retailers, gigantic shopping complexes, professional sports franchises, and politically-connected companies get the money that’s been shifted. All the while, schools and libraries, police departments, parks and playgrounds, and John Q. Public get shafted.

Johnston maintains a consistently indignant stance throughout the book, but rises to near blood-boiling rage — and takes his readers there as well — when describing a particular category of outdoor sporting goods retailer whose nearly city-sized stores are planted just off the exit ramps of many interstate highways.

These retail corporations (Johnston pinpoints two particular names) seek subsidies from local municipalities that include free land, monetary grants, and recapture of sales, property, and other taxes to build and operate stores, arguing their stores will bring traffic into the town once they arrive.

The only problem is that once they arrive, they usually don’t generate the boomtown commercial atmosphere promised. (One store I pass in the extreme corner of northwest Indiana sticks out in the middle of a one-time cornfield, but the area around it is as bleak as a 1930s-era Dust Bowl hamlet.)

Townsfolk have paid the tab for the store, and are helping fund its continued operation through tax givebacks, while the retailer’s corporate owners reap giant profits. How big? Between 2004 and 2006, one retailer earned $223 million, while collecting almost $294 million in subsidies. I don’t know about you, but I call that elevating the role of shifting and shafting to an art form.

Don’t shaft yourself

So, why all this about the shift and the shaft? I’m not asking you to occupy Wall Street or rage against corporate greed. That’s not going to make one iota of difference in how your personal household finances stack up.

But it could be you’re looking for a reason to put your financial house in order. It might be you’re the type who needs a little righteous indignation to spur you to life-changing action. It may be you can make needed personal spending, saving, and investing transformations only by coming to grips with the full extent of the encroachment into the pants pockets of you and your fellow Americans.

If that’s the case, while you’re not likely to be able to avoid being affected by all the shifting, you may be able to survive some of the shafting.

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On Friday, I talked about using your 401(k) to pay off your mortgage. Then, over the weekend, a reader wrote in to ask about a different scenario – a family member lending you the money to pay off your mortgage. Robert asked:

Is a $100k personal loan from a family member to pay off a mortgage debt taxable?

The short answer is that personal loans are not themselves typically taxable — assuming that it’s truly a loan, and will be paid back. However, if there is no (or not enough) interest being charged, the IRS can figure what the interest on the loan should have been and treat it as though the borrower had incurred.

These calculations are based on the “Applicable Federal Rate” for a short, medium, or long-term loan. The AFR changes monthly. You can see the most recent values at IRS.gov – click here. You can learn more about “Below Market Loans” by reading IRS Publication 550.

Since the lender is required to report the interest as taxable income, this could create some tax issues. In most cases, however, this isn’t a big deal, as the unpaid interest can be treated as a tax-free gift from the lender to the borrower. This works without any complications as long as the total amount of unpaid interest is less than the current year’s gift-tax exclusion, which currently stands at $13k.

Now for some good news… With some exceptions, this rule does apply to loans under $10k. In addition, if the loan is for $100k or less, the interest that must be reported by the lender (or treated as a gift) is limited to the total of the borrower’s net investment income for the year. And if the borrower’s net investment income is $1k or less, the amount is treated as zero.

But what if you the lender ends up forgiving the loan and you never repay all or a portion of it? In that case, the amount forgiven will be treated as a gift, and will be subject to the annual and/or lifetime gift tax exclusions. If the lender is in no danger of exceeding their lifetime limit, the forgiveness can be done all at once.

If, on the other hand, the lender wants to preserve their lifetime exclusion, then they can forgive the principal (and ongoing interest) in chunks of up to $13k/year (per recipient) until the entire amount has been forgiven.

As always, I highly recommend that anyone facing complex tax situations like this seek out professional advice. It’s not terribly expensive to buy an hour or two of a tax pro’s time, and you could save yourself a significant chunk of money, not to mention a bunch of headaches.

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Earlier this week, I ran across an article about a new piece of legislation being promoted by two Georgia Congressmen who want to allow people to pull money out of their retirement accounts to pay down their mortgages.

Dubbed the Hardship Outlays to Protect Mortgage Equity (HOME) Act of 2011, the legislation would allow homeowners to withdraw up to $50k or half of the account value, whichever is smaller, without paying the usual 10% penalty. In short, you’d have to use the funds to make mortgage payments within 120 days of receiving the distribution.

You can read the text of the bill here: HOME Act of 2011

The sponsors, Sen. Johnny Isakson and Rep. Tom Graves, argue that people who are faced with losing their homes should not be forced to pay a penalty to access their own money. At the same time, many financial experts are skeptical. One big concern is that people would be pulling money out of 401(k) accounts that are protected from creditors and putting it into a home that could ultimately be taken from them.

Another justification that Isakson gave is that people could use the withdrawals to get their underwater mortgages back above water, thereby allowing them to refinance their mortgage to a more favorable rate. Of course, with the recently announced changes to the HARP program, those with underwater mortgages will now have an easier time refinancing, so it might not be necessary to raid their 401(k) to make this happen.

One concern I have is that, if passed into law, the new rules would effectively allow anyone with a mortgage to raid their retirement account, whether or not they really need the money to cover their payments. While I understand the desire to help people stay in their homes, the last thing we need to do is make it too easy for anyone and everyone to pull money out of retirement accounts.

What do you think? Is this a good policy move? Or are we just kicking the can down the road, essentially transforming the problem from unaffordable mortgages into unaffordable retirements?

As an aside, I know of at least one reader out there will likely be strongly in favor of this idea… Our good friend Carlos, who cashed out his 401(k), paid the 10% penalty (plus taxes), and used the proceeds to pay off his mortgage just three years after buying his house.

Source: AJC.com

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In what’s sure to be a bit of welcome news, the Social Security Administration has announced that Social Security recipients will receive a 3.6% increase in payments, effective this coming January. This is the first such increase in benefits since 2009, when there was a 5.8% increase. The lack of increases over the past two years was due to low inflation.

Based on the average Social Security payment of $1,038/month, this works out to an increase of $39/month.At the same time, however, Medicare premiums are expected to increase, which could wipe out the value of a Social Security increase.

The Social Security wage limit (i.e., the amount of wages subject to Social Security taxes) is also set to increase next year from the current level of $106,800 to $110,100. This increase will affect roughly 10M of the 161M workers who pay Social Security taxes each year.

In other words, this is a good news, bad news sort of thing. Good news if you’re a Social Security recipient — though be on the lookout for those Medicare premium increases — but bad news if you’re employed and earning more than the Social Security wage limit.

Source: LA Times

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We’re now a little more than a week into the 4th quarter of 2011, which means that you have less than three months to make moves to reduce your tax liability for this year. While there’s a limit to how much you can do, you can save a nice chunk of change by taking a few simple steps.

Below, I’ve outlined a handful of ideas for minimizing your tax bill. There’s still plenty of time to make these things happen, but time flies — especially around the holidays — so don’t dawdle.

Tax-saving steps for 2011

• Make charitable contributions. I’m thinking here of not just cash contributions, but also of donating stuff from around your house that you no longer need. Just be sure to keep proper documentation in case you get audited.
• Do some tax loss harvesting. I’ve talked about this in the past, but… If you have any losing investment positions, you can sell them and buy into a similar investment. This allows you to book the loss on paper while staying in the market so you don’t miss out on a potential recovery.
• Max out your retirement accounts. I’m thinking here of both IRAs and employer plans, like a 401(k) or 403(b).
• Contribute to a 529 plan or a Coverdell ESA. This won’t reduce your Federal tax bill, though you may get a state tax break. Moreover, your investments will benefit from tax free growth.
• Contribute to your Health Savings Account (HSA). If you have a high-deductible health plan, be sure to contribute to your HSA. Contributions are tax deductible, and can be withdrawn tax free to pay for qualified medical expenses.
• Business expenses. If you anticipate incurring any major business expenses early in 2012, you might consider moving them up to the very end of 2011 so you can benefit from the tax break 12 months sooner.

Finally, while this won’t reduce your 2011 tax burden, it’s also time to start thinking about spending out your flexible spending account (FSA). As a reminder, FSAs are subject to the use-it-or-lose-it rule, so you’ll want to be sure you don’t have anything left over at the end.

While some FSA plans have a grace period after January 1, others don’t. Be sure to check the details of your plan so you don’t have unspent funds at the end.

If you have any other suggestions, please share them in the comments.

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This is just a quick reminder that, if you requested an income tax filing extension, your 2010 income tax return is due this coming Monday, October 17th. Assuming that you did request an extension, you likely made an estimated payment when you submitted Form 4868.

Be sure to claim credit for this payment on the appropriate line of your tax return:

• Form 1040, line 68
• Form 1040A, line 44 (include in total)
• Form 1040EZ, line 10 (include in total)

If you’re filing a 1040A or 1040EZ, you should also enter the words “Form 4868″ and the amount paid alongside the value on line 44 or 10.

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It’s an ever-present threat to Americans and one that has been compared to the ultimate stressors in life, such as a death in the family, divorce or job loss. As a taxpayer, it’s always a lingering question in the back of my mind. Am I at risk of an IRS income tax audit?

Even though the overall percentage of taxpayers who are audited is low, tax returns undergoing this scrutiny can be chosen at random. Thus, no American citizen is completely safe. And as your income goes up, so does your risk of an audit. In fact, according to statistics from the IRS Data Book for the fiscal year ending September 30, 2009, 6.4% of returns with a total income of more than $1M were audited.

Although your overall chances of being audited continue to be slim, there are a number of red flags to be aware of that can reduce your chances of getting real up close and personal with the IRS.

• Among the more recent audit red flags is the homebuyer tax credit. Be aware that, due to fraudulent homebuyer tax credit claims in 2008, the IRS will be more closely scrutinizing taxpayer returns that claim this credit.
• Also, starting this year, the IRS plans to take a closer look at online income from eBay and other auction sites. This is the result of a new law requiring banks and payment settlement companies that process credit cards, debit cards, and electronic payments to report amounts received by merchants to the IRS.
• Beginning with specified securities purchased in 2011, brokers will be required to calculate gains and losses, classifying them as either short- or long-term, and report this information to the IRS. This new requirement is in response to security sellers overstating the tax basis to pay less tax.

Along with these new developments, there are a number of additional risk factors that you should be aware of.

• Because the tax system makes it easier for self-employed individuals to underreport income and falsify deductions, the IRS goes to extra lengths to make sure the self-employed remain compliant. Recently, there has been a renewed effort in making sure income is properly reported, due to a Treasury Inspector General finding that a number of self-employed taxpayers were dishonest in their income disclosures.
• Those who use automobile expenses as a deduction should be aware that this is a big red flag for the IRS. It is vital that those using a personal car for business keep a meticulous daily log of business mileage that includes odometer readings, dates, locations and meeting details.
• High itemized deductions that exceed typical IRS ranges for your income group can significantly impact your chances of an audit.
• Also, be aware that home office tax deductions should only be taken by taxpayers who use their office as a principal place of business. If you work at home intermittently, it’s best to forego this deduction.
• Due to years of abuses, alimony has become a big red flag in terms of IRS audits. In terms of taxable alimony income, the deductions by one spouse will be matched by those of the other.
• Make sure your return does not contain mathematical errors. Even a simple mistake can give the IRS a reason to further scrutinize your figures and lead to the dreaded audit.
• Are your expenses too high as a percentage of your income? If you are making $40,000 a year and have a $6,000 monthly mortgage, the IRS may come calling on the assumption that you have unreported income.
• Although not an uncommon scenario, married couples filing taxes separately are automatically at higher risk of an IRS audit. This is especially true for those with large itemized deductions that may be duplicated on both returns.
• Generosity is a favorable trait, however make sure you do not claim charitable contributions that total more than what your income level warrants, or you could be the target of an IRS audit.

Keep in mind that the IRS has three years from the date you filed to collect extra tax, or six years for those who didn’t report more than a quarter of their income. And for those evading tax and filing fraudulent returns, there is no statute of limitations. These non-taxpayers can be audited by the IRS at any time.

Although it’s not always possible to avoid all audit red flags, being aware of them will help you avoid a fate many equate to losing a loved one. Although, in this case, the departed will most likely be a good chunk of your cash.

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Ultimately, the tax cuts stayed in place and the 2011 income tax brackets were essentially a slightly modified version of the 2010 tax brackets. This year, there is no such drama, so it’s really just a matter of adjusting the brackets (and the standard deduction) for inflation.

Over the past year, inflation has averaged 2.43%, which is slightly below the average over the past 20 years, but higher than the previous year, when inflation ran at 1.48%. While the IRS uses a somewhat convoluted approach to make their adjustments, the good folks at the Tax Foundation have already run the numbers.

Federal Income Tax Brackets for 2012

Here’s a quick rundown of what the Federal income tax brackets are expected to look like in 2012:

And here are a few related points:

• The personal and dependency exemption will rise to $3,800
• The standard deduction for married filing jointly will rise to $11,900
• The standard deduction for singles will rise to $5,950

Looking ahead, last year’s fighting resulted in a two year extension of the Bush-era tax cuts, which means that their currently set to expire at the end of 2012. As for what 2013 has in store for us, your guess is as good as mine.

Related: How Do Federal Income Tax Brackets Work?

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• Find and apply for a 0% balance transfer credit card or the best cash back credit card with no annual fees.
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In case you haven’t been paying attention, President Obama is expected to announce a bevy of proposed changes that are aimed at reducing the deficit. Perhaps the most intriguing of these is the so-called “Buffett Rule,” which will be a new minimum tax rate for individuals making over $1M/year.

Details still aren’t available, but it sounds like this new rule (if adopted) could do what the Alternative Minimum Tax (AMT) was intended to do when it was introduced back in 1969 – i.e., prevent the richest households from getting off with little or no tax liability despite being in a high income tax bracket.

Here’s what the IRS says about the AMT:

The tax laws give preferential treatment to certain kinds of income and allow special deductions and credits for certain kinds of expenses. The alternative minimum tax (AMT) attempts to ensure that anyone who benefits from these tax advantages pays at least a minimum amount of tax.

Unfortunately, the AMT was never indexed to inflation, so there’s a mad scramble every year by Congress to patch the law and increase thresholds. Even still, the AMT currently hits millions of taxpayers that it was never intended to hit.

Not surprisingly, the Buffett Rule has already stirred up a ton of controversy, and the details aren’t even known yet. Setting politics aside, I’m intrigued by the possibility of replacing the AMT with a new system that actually does what it’s supposed to do. I’m definitely curious to hear more.

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Just over a month ago, we were dealing with wild stock market swings in the wake of the debt ceiling debacle, and market indices had fallen to levels where many of us were carrying paper losses. I thus suggested that it might be a good time to harvest some losses for tax purposes.

Harvesting our losses

I’m not sure about you, but I followed through and harvested a significant chunk of losses. The beauty of this is that you can carry unused losses forward indefinitely, and you can also use your losses to write off $3k/year in ordinary income, which is taxed at a higher rate than long-term capital gains.

Assuming a federal rate of 25% and assuming a state income tax rate of 6%, that $3k/year tax break works out to an annual savings of $930. And that will continue until we’ve used up our losses. Not bad for a few minutes work.

Anyway… When I made these moves, I ended up shifting money from the Vanguard Total Stock Market Index (VTSAX) into the Vanguard Large Cap Index (VLCAX). Thus, we were never out of the market, meaning that we’d be fully invested in the event of a quick rebound. While these two funds track each other rather closely, they follow different indices, so we’re also safe when it comes to avoiding a wash sale.

To make things easier on the back end (more below) and to avoid trouble with Vanguard’s frequent trading policy, I then converted our mutual fund shares into the equivalent ETF (i.e., I converted VLCAX into VV).

Returning to the issue of wash sales… To avoid triggering a wash sale, we weren’t able to move back into the Total Stock Market Index for 31 days (not counting the original trade date). Given that our original sale was made on August 10th, and that there are 31 days in August, we had to sit in VV until at least September 10th.

Note: To determine your wash sale window, simply pull out a calendar and count forward (or backward) 31 days starting with the day after (or before) your transaction date.

Making the roundtrip

While I’m comfortable with holding VV for the long term, my preference would be to get back into VTI (the ETF equivalent of the Vanguard Total Market Index Fund) if we could do so without incurring any gains. And guess what? Given the recent performance of the stock market, we’re not too far from being able to make that happen. Depending on how things go today, it might have even happened by the time you read this.

Assuming that I can make this roundtrip work, I will have banked a bunch of losses and our portfolio will look exactly as it did before the process started (albeit with some ETFs in place of regular mutual fund shares). While I’m not particularly interested in generating losses (who is?), we might as well make a bit of lemonade when the market hands us lemons.

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Not quite a year ago, when Congress was extending the Bush-era tax cuts, they also enacted a “Payroll Tax Holiday.” In short, this meant that your FICA taxes would be reduced by 2%.

For those that are unaware, your FICA taxes total (on the employee side) 7.65% of your gross compensation, with 6.2% going toward Social Security and 1.45% going toward Medicare. Once the “holiday” kicked in, the Social Security portion was temporarily reduced to 4.2%.

The Social Security portion of this tax, referred to in your pay stub as FICA-OASDI, applies to your first $106,800 in earned income. After that, the Social Security tax drops off, but the Medicare tax remains in place. Given this, the Payroll Tax Holiday is worth up to $2136/year (that’s 2% of $106,800).

With that said… It’s worth noting that this tax break is currently on the chopping block as part of the deficit reduction talks. In truth, this was only a one year break, but once tax cuts are enacted it’s politically difficult to get rid of them, so I fully expected this to continue into the future. Looks like that may not be the case.

What do you think? Should we ditch the Payroll Tax Holiday at the risk of further under-funding our Social Security obligations? Or leave it in place in hopes of spurring consumer spending, and helping to get the economy back on track.

AP via Bargaineering

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Over the past week, we’ve witnessed a painful stock market meltdown. It started in late July, intensified through the debt ceiling debate, and culminated with a 7% decline yesterday in the wake of the US credit downgrade. But with every challenge comes opportunity…

Harvesting your losses

As long as you have a sufficiently long time horizon, market turmoil like this is nothing more than a bump in the road. Instead of panicking, my wife and I are sticking to the plan and trying to make the best of a bad situation. For us, this means that we’re doing a bit of tax loss harvesting.

The term “tax loss harvesting” refers to selling shares to book your losses, replacing them with a similar, but not identical, investment vehicle (so you don’t trigger a wash sale or miss out on a near-term recovery) and writing off the losses at tax time.

As it turns out, investment losses (i.e., “capital losses”) can be used to offset investment gains (i.e., “capital gains”). And if you don’t have any (or enough) gains to offset, you can use your losses to offset ordinary income. While you’re limited to offsetting $3k/year of ordinary income, you can carry your losses forward until they’re used up.

In the 25% tax bracket, every $3000 in ordinary income that you offset equals a $750 tax savings – not bad for a bit of paperwork, right? And if you book enough losses, you can do this for several years to come.

Avoiding a wash sale

As I noted above, the main thing that you need to look out for is triggering a wash sale. The wash sale rule requires investors to wait at least 31 days after selling a security for a loss before repurchasing the same security, or a “substantially identical” investment. If you buy back in within 30 days, the IRS will treat it as if you never sold in the first place, and you’ll lose the ability to claim a loss.

You should also keep in mind that the IRS will also treat it as a wash sale if you make your purchase within the 30 days before the sale of your downtrodden shares, so you can’t simply buy shares ahead of the sale to avoid triggering a wash sale.

Once the 30 day window has elapsed, you’re welcome to exchange back into the original investment. Just be aware that, if the market has recovered in the mean time, you might wind up booking gains when you switch back, wiping our part (or all) of your tax savings. Of course, if things continue to head south, you could wind up booking even more losses when switching back.

As far as “substantially identical” goes, the IRS hasn’t provided a clear definition. When it comes to stocks, this isn’t a huge deal. In general terms, you should be safe selling one company and buying another, even if it’s in the same industry. But for mutual funds and ETFs, things are a bit murkier.

The general consensus is that you can’t, for example, sell an index mutual fund and buy the equivalent ETF. Likewise, you can’t sell a fund from one company and buy another company’s fund that tracks the same index (e.g., Vanguard 500 Index vs. Fidelity Spartan 500 Index). But you can swap out investments that track different indices, even if they’re from the same mutual fund family (e.g., Vanguard 500 Index vs. Vanguard Total Stock Market).

Of course, I’m not a tax professional. I’m just sharing what I believe to be true based on my own research. If you’re nervous about this sort of thing, you’d be well advised to do your own research, or to check with an investment or tax pro.

Choosing loss harvesting “partners”

In general terms, when you trade one investment for another while tax loss harvesting, you’ll want them to fill the same niche. To be sure that’s the case, I recommend going to Google Finance and punching in the ticker symbol of your current investment.

Once the chart comes up, add the symbol of the replacement investment using the “Compare:” box. Now click out to a longer timeframe – say 5 or 10 years. Do the prices of the two investments track each other fairly well? If so, great. You’ve found a good match. If not, keep looking.

So, dear readers, have you taken advantage of the recent turmoil by harvesting some investment losses?

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(click map to enlarge)

The biggest thing that jumped out at me from this map was the tendency for sales tax holidays to be limited to southern and southwestern states. Yes, there are a handful of outliers in the midwest and northeast, but the overall geographic pattern is unmistakable.

Another interesting tidbit is that, in a related article, the Tax Foundation argued that “sales tax holidays are based on poor tax policy and distract policymakers and taxpayers from real, permanent, and economically beneficial tax reform.” They go on to argue that if a state needs to offer a “holiday” from their tax system, then perhaps their tax system is “uncompetitive.”

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» 2011 Sales Tax Holidays for Back-to-School Shopping
» Paying Sales Tax for Online Purchases
» 2010 Sales Tax Holidays
» Arizona to Audit Everyone Who Fails to Report Sales and Use Tax?

(click map to enlarge)

Some interesting tidbits…

The ten states with the highest sales tax rates (from highest to lowest) are: Tennessee, California, Arizona, Louisiana, Washington, New York, Oklahoma, Illinois, Arkansas, and Alabama.

At the other end of the spectrum, Delaware, New Hampshire, Montana, and Oregon have no state sales tax. Interestingly, New Hampshire also has no state income tax, though it does tax investment income along with inheritance, business income, etc.

Please note that the above map includes local sales taxes (city, county, and municipal) as a weighted average based on population numbers, so the numbers might not match up exactly with the rates that you pay.

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» Don’t Miss These Tax Deductions

It’s that time of the year again… Time to start thinking about back-to-school shopping. And you know what that means, don’t you? Time for a sales tax holiday! What follows is an alphabetical listing of states with sales tax holidays, along with a brief summary of what is included in each. Note that there are a few differences from last year, though the number of participating states (16) hasn’t changed.

Sales tax holidays, state-by-state

Alabama: August 5-7. Clothing up to $100/item, computers up to $750/item, school supplies up to $50/item, books up to $30/item. (link)

Arkansas: August 6-7. Clothing up to $100/item, school supplies. (link)

Connecticut: August 21-27. Clothing and footwear up to $300/item. (link)

Florida: August 12-14. School supplies up to $15/item, books and clothing up to $75/item. (link)

Iowa: August 5-6. Clothing up to $100/item. (link)

Louisiana: August 5-6. All “tangible personal property” up to $2500/item. (link)

Maryland: August 14-20. Clothing and footwear up to $100/item. (link)

Mississippi: July 29-30. Clothing and footwear up to $100/item. (link)

Missouri: August 5-7. Clothing up to $100/item, computers up to $3500/item, school supplies up to $50/item. (link)

New Mexico: August 5-7. Clothing up to $100/item, computers up to $1000/item, school supplies up to $15/item. (link)

North Carolina: August 5-7. Clothing and school supplies up to $100/item, instructional material up to $300/item, computers up to $3500/item, other computing supplies up to $250/item, sports equipment up to $50/item. (link)

Oklahoma: August 5-7. Clothing up to $100/item. (link)

South Carolina: August 5-7. Clothing, school supplies, computers, bedding, linens, etc. (link)

Tennessee: August 5-7. Clothing and school supplies up to $100/item, computers up to $1500/item. (link)

Texas: August 19-21. Clothing, school supplies, and backpacks up to $100/item. (link)

Virginia: August 5-7. Clothing up to $100/item, school supplies up to $20/item. (link)

This should be a fairly comprehensive list, but it’s always possible that I missed something. If so, please let me know and I’ll update it ASAP. Note that a few states – including Louisiana, Maryland, Missouri, Texas, and Virginia – have at least one other sales tax holiday during the year. These extra holidays cover things like Energy Star appliances, hurricane preparedness, and/or hunting supplies.

And now for some final words of wisdom… Just because you don’t have to pay sales tax doesn’t mean you’re getting a great deal. In fact, some stores may avoid running sales on certain items during the sales tax holiday in hopes of capitalizing on the holiday buzz. In other words, saving 6% (or whatever) on sales tax, but missing out on a 20% off sale the week before (or after) isn’t a very good deal.

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Related Articles at fivecentnickel.com:

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» Tax Holidays Starting Soon
» 2010 Sales Tax Holidays
» Back-to-School Shopping on a Budget
» Sales Tax Holidays Reconsidered
» State Sales Tax Holidays
» One Year Ago This Week (July 30th – August 5th)

Municipal bonds, which are issued by states and local communities, are a popular choice for those who are looking for a fixed income investment in a taxable account. The reason for this is that the income generated by muni bonds is tax exempt, which boosts their effective yield as compared to taxable bonds.

Beyond being a boon to investors, this tax break is a great help to the communities that issue the bonds, as they can pay a lower interest rate and still be competitive with higher rate bonds that don’t share this tax advantage. But this all comes at a price… According to the Joint Committee on Taxation, the federal government will lose out on over $200B in tax revenue due to the muni bond tax exemption between 2010-2014.

Given the above, it’s perhaps not surprising that lawmakers are talking about reforming the tax treatment of municipal bonds. Of course, according to Jason Zweig, this has been talked about over 100 times since 1918, and it’s never happened. But with all the recent interest in reducing the deficit, it seems that more people are talking about it than in the past.

Aside from taking away a well-loved tax shelter from investors, the taxation of municipal bonds would essentially equate to the federal government taking money away from local communities, as those communities would have to start paying higher interest rates to make their bonds attractive enough to draw investors.

Given the rough shape that many states are currently in, it’s hard to imagine Congress acting to make things worse, but you never know. One possibility is that, if the tax exemption was taken away, the feds would provide subsidies to local communities to help offset the added cost, but at a rate lower than the tax exemption.

Who knows… As I noted above, this has been debated multiple times in the past and has never gone anywhere but, given the current economic climate, it’s probably worth keeping an eye on these discussions.

Source: CNN/Money

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» Series I Savings Bonds Rates – May 2011
» Savings Bond Purchase Limit Increased to $10k in 2012

Several people have asked why I like Series I savings bonds, so I thought I’d address that with a dedicated post…

For context, the Treasury has recently announced that they’re (mostly) getting rid of paper savings bonds, which effectively cuts the annual purchase limit in half (from $5k paper + $5k electronic to just $5k electronic). While you can work around this limitation by buying savings bonds with your tax refund, that’s a bit of a hassle.

Inflation protection

For starters, I bonds offer a degree of inflation protection, as their rate (updated every May and November) is partially pegged to the CPI. The rate is actually made up of two components – a variable rate calculated from changes in the CPI and a fixed rate that represents a premium over inflation.

Recently, the fixed rate has been pegged at 0%, which means that you have to depend on that variable rate to generate your return. In other words, your “real” (inflation adjusted) return is 0% before taxes. Not great, but at least you’re not lagging behind inflation, as you would if you stuck your money in a savings account.

Tax treatment

Another nice feature of savings bonds (both I and EE bonds) is that the interest is exempt from both state and local taxes, and federal taxes aren’t due until the bonds are redeemed. Thus, savings bonds give you an IRA-like tax deferral in addition to existing IRA contribution limits.

And guess what? If you use your bond proceeds to pay for college, the interest income will ultimately be tax free (subject to restrictions; details). Thus, they can be a nice complement to things like a 529 plan.

Effectively higher rates

A common criticism of I bonds is that, due to the low (currently zero) fixed rate, you’re guaranteed to lose to inflation after taxes, even with the state and local tax exemption. As I’ve noted above, this isn’t entirely true, as you can use the proceeds to pay for college and get a federal tax exemption.

To crystallize the above points, let’s take a look at the tax equivalent yield of current I bonds. As of May 2011, the variable rate stands at 4.6%. Compared to available savings and CD rates, this is quite high. Sure, it might drop in the future, but only if inflation likewise declines.

So what about the tax equivalent yield? The tax equivalent yield of an investment is the rate that you would have to earn in a fully taxable investment to equal the return that you’re getting in a tax-advantaged investment. You calculate it by dividing the rate of the latter by one minus the tax rate, as follows:

Tax Equivalent Yield = Tax-Free Yield / (1 – (% Tax Bracket / 100))

Assuming that you live in a state with a 6% income tax rate, which is a fairly middle-of-the-road value, your tax equivalent yield on a current I bond would be roughly 4.9% – not too shabby. But wait! What if you’re planning on using it to pay for college, and you’re in the 25% tax bracket? In that case, (25% federal + 6% state) your tax equivalent yield would increase to nearly 6.7%!

Yes, your rates will bob up and down every six months, but it’s hard to argue with those sorts of numbers given the current interest rate landscape. Of course, if you live in a state with no income tax, the numbers will change, but that federal exemption is still a big deal.

Reasonable redemption policies

Finally, we have to consider getting your money back out… Sure, you’ll get better-than-bank interest rates, but what good is that if you can’t access your money? There’s good news and bad news here. For starters, you can’t redeem your savings bonds during the first 12 months. Period.

Once 12 months has passed, however, you can redeem for a 90 day interest penalty. And this penalty could be very low if you do it during a period of low inflation (when rates are at their lowest). After five years, the penalty goes away entirely.

So there you have it… We like Series I savings bonds for the combination of inflation protection and tax advantages – and the accompanying boost in terms of tax equivalent yield. They’re not sexy, and they’re not exciting, but they are a valuable part of our portfolio.

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» Series I Savings Bonds Rates – May 2011
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» Series I Savings Bond Rates – November 2010
» Series I Savings Bonds Now Paying 3.36%
» What are Series I Savings Bonds?

About a year and a half ago, we paid off our mortgage. The issue of whether you should pay off your mortgage early or invest has always been a hot topic in financial circles, but I can tell you this much:

We haven’t regretted our decision to pay off our mortgage. Not even once.

Of course, just because we’ve paid off our mortgage doesn’t mean that we’re living for free. We still face a number of expenses, including property taxes, routine maintenance, homeowners insurance, etc. So just how much do these things really cost?

Let’s start with property taxes. Property taxes vary widely based on location, but around here they average about 1% of a home’s assessed value per year. Unfortunately, the only real way to combat this bill – aside from moving to a less expensive home – is to appeal your assessment. The good news is that this can be done. In fact, I’ve successfully appealed our assessment on more than one occasion.

Next up, insurance. Once again, rates vary based on a number of factors. While you could technically drop your homeowners policy once your mortgage is paid off, you’d be a fool to do so. You can, however, save on homeowners insurance by shopping around, increasing your deductible, etc. In our case, homeowners insurance runs roughly 0.2% of the value of our home per year.

Another big issue is maintenance. I’m talking here about things like painting, pest control, replacing your carpet and appliances, etc. The general rule of thumb is that you should budget roughly 1-2% of the value of your home per year for ongoing maintenance. Some years will be less, and others will be more – possibly much more.

In the six years we’ve lived in our house, the biggest maintenance issue we’ve dealt with has been replacing our water heater. Looking ahead, however, I’m expecting to have to replace the roof sometime in the next ten or so years.

There are, of course, other expenses that I haven’t factored in here such as lawn maintenance – either paying someone to cut your grass, or buying and maintaining a mower and associated equipment so you can do it yourself – utilities, HOA fees, etc. These things vary so widely based on your circumstances, however, that it’s hard to come up with a general rule of thumb.

Combining just the property taxes, homeowners insurance, and general home maintenance, we arrive at a rough estimate of 2.2%-3.2% of our home’s value per year. Given that our house is worth somewhere in the neighborhood of $325k, that means we’re facing roughly $7k-$10k in annual housing costs even in the absence of a mortgage payment, and that’s without considering utilities or lawn care.

I mainly bring this up to combat the overly-simplistic view that once you pay off your mortgage, you’ll be essentially living for free. The reality is that even without a mortgage payment, you’re still likely to face significant housing-related expenses.

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Do you do your own taxes? If so, you might be interested in this offer from TaxACT Online… Click through for details, but the short version is that you can pre-register to receive the “TaxACT Ultimate Bundle” for the 2011 filing season for $13.95 – this includes both your Federal and State return as well as free e-filing.

This isn’t the exactly the deal of the century, as the regular price is $17.95, but it’s a $4.00 discount without having to actually commit to anything. You basically just create an account by going through this link and you’ll be assured of getting the pre-release pricing when it comes time to file.

Once the 2011 version is online, you’ll be able to play with it and decide whether or not you like it. If you do, you can pay for it. If not, you can move on and use something else. I’ve never used TaxACT, so I don’t have any firsthand experience with it. That being said, TaxACT did receive a number of favorable comments in my earlier post about the best tax prep software.

P.S. Yes, I know that many are still recovering from trauma of doing their 2010 taxes, but you know what they say… The early bird gets the worm!

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With the 2010 tax filing deadline safely behind us, I want to turn your attention to important tax-related deadlines for the remainder of the year. The most relevant dates for me are the estimated tax payment deadlines, though I’ve also requested filing extensions in the past.

March 15th, 2011 – This was the deadline for corporate tax returns (Forms 1120, 1120A, or 1120S) unless you requested a six month extension (see September 15th, below).

April 18th, 2011 – Not only were your taxes due on this date (unless you requested a six month extension; see October 17th, below), but this was also the deadline for you 1st quarterly installment of estimated taxes (assuming that you are making estimated payments). This was also the deadline for estate income tax, trust income tax, or partnership tax returns though you were allowed to request a five month extension (see September 15th, below).

June 15th, 2011 – Deadline for 2nd quarterly installment of estimated taxes. This is also the deadline for US citizens living abroad to file their individual tax returns for 2010 (though you can request a four month extension).

June 30th, 2011 – Deadline for filing your Report of Foreign Bank and Financial Accounts if you have over $10k (in total) in foreign bank accounts.

September 15th, 2011 – Deadline for 3rd quarterly installment of estimated taxes. This is also the deadline for filing corporate tax returns if you requested an extension back in March.

This is also the deadline to file estate income tax, trust income tax, or partnership tax returns if you requested an extension back in April.

October 3rd, 2011 – Final deadline for self-employed individuals to establish a SIMPLE IRA for 2011.

October 17th, 2011 – Final income tax filing deadline for those who requested a six month extension back in April. This is also the deadline for funding a SEP-IRA or Solo 401(k) for 2010 if you requested an extension.

December 31st, 2011 – Last day to set up a Solo 401(k) for 2011 (assuming that you are self-employed).

January 15th, 2012 – Deadline for 4th quarterly installment of estimated taxes*.

*Note: As always, you can skip this last payment without penalty if you file your return and pay the full balance due no later than January 31, 2012. Otherwise, if you make your estimated tax payments late, you will be subject to late payment penalties.

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Over the past year or so, we’ve seen a lot of debate over the definition of wealthy. Much of this discussion has centered on whether or not individuals (or families) earning $250k or more per year are “rich” and should see their tax rates rise.

Without getting into the underlying politics, I think that one thing that most of us can agree on is that people with that kind of earning power are definitely not poor. Or are they? I recently ran across a story over on MSN Money that questioned whether or not $250k is enough to make ends meet.

For starters, I’ll just say this: Yes, $250k/year is clearly enough to make ends meet. As evidence, I offer the fact that less than 3% of American households earn that much, but most of use are getting by. I’d go so far as to say that if you’re earning that much and struggling, then you must be making some really bad decisions when it comes to managing your money.

And yet… When BDO USA, a national tax accounting firm, analyzed the finances of a hypothetical family of four (Mr. and Mrs. Jones and their two lovely children) living one of eight different locales, they concluded something entirely different:

It’s not exactly Easy Street for our $250,000-a-year family, especially when they live in high-tax areas on either coast. Even with an additional $3,000 in investment income, they end up in the red — after taxes, saving for retirement and their children’s education, and a middle-of-the-road cost of living — in seven out of the eight communities in the analysis.

They attribute these difficulties in large part to high levels of student loan debt, a pair of car loans, and a mortgage for 80% of the value of a “typical” home for a family of four. This “typical” home was a huge variable, as real estate prices varied widely across communities.

Taxes also take a big bite, and can vary widely based on where you live. And taxes aren’t the only thing that varies amongst locations. Other components of the cost-of-living vary widely from one locale to another, with groceries cost 72% more in New York vs. Idaho (for example). And those sorts of differences occur across the board in most spending categories.

Overall, the worst scenario included in the analysis was Glendale, CA, where Mr. and Mrs. Jones would wind up over $23k in the hole. Of course, this is a bit overblown, as the number crunching included $33k per year going into retirement accounts, and $8k per year in college savings. The best case scenario was Plano, TX, where the Jones family would nearly $5k left over at the end of the year.

Is $250k/year enough?

What do you think about all of this? Is $250k enough to make ends meet? If anything, I’d say that this is a perfect example of why it’s so dangerous to try to keep up with the proverbial Jones’.

Don’t break the bank paying for college, scale back on your house to reduce your mortgage payment (not to mention property taxes and maintenance), resist the temptation to borrow money for new cars (much less two of them), and so on.

Like I said above, if you can’t make ends meet on $250k/year, then you’re doing something very, very wrong.

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In honor of taxes being due today, I thought I’d point out the new Tax Receipt calculator over on the White House website. In short, this is a tool that gives you a percentage breakdown of how your tax dollars are being spent. Even if you don’t want to look up your own numbers, it’s still instructive to hop on over there and plug in some numbers.

Not surprisingly, the top two items on the list are defense spending (26.3%) and healthcare (24.3% – includes Medicare, Medicaid, health research, etc.), followed by “Job and Family Security” (21.9% – includes unemployment and a number of things that fall under the broad category of “welfare”). At the other end of the spectrum are things like agriculture (0.8%) and natural disaster response (0.4%).

Another interesting tidbit is that 7.4% of your income tax payments will go toward “net interest” on the national debt.

Have you checked out your Tax Receipt?

If so, were you surprised by anything that you saw?

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This morning, I talked about what happens if you file your taxes late. The short version is that you’ll face penalties that are more severe than if you had file your return (or request an extension) on time, but fail to include payment for the amount due.

Okay, but what if you can’t afford to pay the amount due? As it turns out, the IRS allows for what they call an “Installment Agreement,” which is basically a payment plan that lets you pay what’s due in smaller, more manageable increments.

If you owe $25k or less…

If you owe $25k or less, you can us the Online Payment Agreement (OPA) to set up your payment plan. Alternatively, you can use Form 9465. If you’ve already received a bill from the IRS, you also have the option of calling the number on the bill.

If you owe more than $25k…

If you’re in the unfortunate situation of owning more than $25k, you may still qualify for an Installment Agreement, though you might have to fill out Form 433F in addition to using the OPA or filing Form 9465.

Either way, it’s best to pay now…

Even if you set up a payment plan, you’ll still face penalties and interest for your underpayment, so it’s best to pay your taxes when they’re due – if at all possible. But if not, then be sure you jump through the proper hoops to keep yourself out of trouble. You don’t want to anger the IRS.

(More info on Installment Agreements from IRS.gov: link)

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With just a few days left before taxes are due, I thought it would be worth talking about what happens if you miss the deadline and wind up filing late. The short answer is that you run the risk of penalties and interest, and failing to file on time is much worse than failing to pay on time. For more details, read on…

Enforcing the filing deadline

For starters, rumor has it that the IRS doesn’t bother checking postmarks for returns that are just a couple days late, so you might be okay. The problem is that there is a lot of variation inherent in the US Postal Service, and they’ll also be receiving millions (and millions) of last minute returns. Thus, as long as your return is close to being on time, they might not even notice.

I can’t speak for the actual filing deadline, as I’ve never rolled the dice on that one, but I’ve certainly found this to be true for quarterly tax deadlines. On more than one occasion in the past, I’ve mailed our quarterly payments a day or two late and I’ve never heard back from the IRS about it. It might be that they didn’t notice, or perhaps they realized that it was more costly to print and mail a notice than it was to just let it slide.

But if you do file late – and the IRS catches you – the interest and penalties will accrue from the actual due date through the postmark date. So… What if you file (or pay) late, and you get caught?

Penalties for filing and/or paying late

As it turns out, the penalty for “failure to file” is much steeper than the penalty for a late payment. Thus, if you can’t afford the amount due, you should still file your return (or request a filing extension) in a timely manner and then explore alternative payment options.

To be a bit more specific, the penalty for late payment is typically 0.5% of your unpaid taxes per month (or portion thereof) after the deadline that your taxes go unpaid. This penalty can wind up being as much as 25% of your total amount due, so don’t let it slide any longer than absolutely necessary.

In contrast, the penalty for filing your return late is typically a whopping 5% of your unpaid taxes per month (or portion thereof) after the deadline that they receive your return, topping out at 25%. And if you file more than 60 days late, the minimum penalty is the smaller of $135 or 100% of the taxes that you owe.

Keep in mind that, as long as you request an extension and pay in at least 90% of your actual tax liability by the original due date (including withholding and estimated payments), you’ll avoid any underpayment penalties as long as the balance if paid no later than the extended due date.

(More on penalties from IRS.gov: link)

What if you’re expecting a refund?

If you’re expecting a refund there’s actually no need to file on time. As I’ve detailed above, all penalties and interest are based on your unpaid balance. If you don’t owe a dime, the penalties will add up to a whopping zero dollars. Thus, as I’ve detailed elsewhere, if you’re expecting a refund, you may not have to file on time.

Of course, if the IRS owes you money, you should do whatever you can to collect it as quickly as possible. And keep in mind that the IRS statute of limitations runs out after three years so, whatever you do, make sure you claim your refund within that timeframe or you’ll forfeit the money that you are due.

P.S. If you need more time to finish your taxes, don’t forget to request a state income tax filing extension in addition to your federal extension.

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What about a state income tax extension? Is there a form for that, too?

Assuming that you’re running behind on tax prep, and that you’re not living in one of a handful of states with no income tax, this is a very real issue. The reason I didn’t touch on it in my original post was that the answer varies by state.

The easiest ways to find out how to request an extension for your state income tax return are to:

• Run a google search for something like: yourstatename state income tax filing extension (obviously you should insert your actual state’s name)
• Click through to your state’s revenue agency from this handy map from the Federation of Tax Administrators

Note that you may need to scroll down a bit in the Google results to find the official information, but it should be fairly close to the top of the search results. For example, on this search for the Kansas information, the Kansas Department of Revenue FAQs page (with extension info) is the top hit, whereas on this search for the Missouri information, the official information is around the fifth hit.

Alternatively, if you’re e-filing with something like TurboTax, you can file your Federal extension request electronically and then access the necessary state forms from within the software (or web interface).

Bonus tip: If you’re due a refund, you may not have to worry about filing on time. The reason for this is that the penalty for filing late is typically a percentage of your taxes owed with the return. If you owe nothing, there’s no penalty – though you will delay your refund by not filing in a timely fashion. Note that there are some arcane exceptions, so be sure to double check on your circumstances.

Double bonus tip: If you live in Massachusetts or Maine, you actually have until Tuesday, April 19th to file your state income tax return because both of those states will be observing Patriot’s Day on the 18th – but your Federal return will still be due on the 18th, so get busy.

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This is a guest post from Jennifer Rose Hale.

You filed your taxes 12 days ago, and the “ding!” from your computer is an e-mail alert from your bank. You’ve got money! Sure enough, it’s your tax refund. If you got one, you’re not alone: the most recent figures from the Internal Revenue Service show that over 111 million individuals received refunds in 2010, with the average amount close to $3,000.

Your refund, whether it’s close to the average or just big bucks in your life, is calling to you to spend, spend, spend. So, to borrow from Dennis Hopper in “Speed,” what are you gonna do?

Let’s look at some common ways you could blow that money, and some alternatives to increase your savings rates — and improve your life — instead.

Big vacation… Or a better job?

If things are going rough at work, it’s tempting to use your refund on a getaway, to buy yourself a week (or even two) to forget your projects, your boss… Heck, even the name of your company, if you do it right.

In the long run, though, a bad job situation will just boomerang back to you as soon as your plane’s wheels touch down again at home. Maybe it’s time to pick up some online training or buy a copy of “48 Days to the Work You Love” or “What Color Is Your Parachute?” Aim yourself in a better direction with a small purchase, and put the remaining savings to work for you in your retirement fund — that big getaway at the end of your career.

Eventually, you’ll get the chance to say goodbye to your boss altogether, but you might as well enjoy your job while you get there.

New wardrobe… Or a new you?

You’ve been waiting for those hundreds — maybe thousands — of dollars to refresh your wardrobe, and you’re planning a big run at Macy’s (if you expect hundreds) or Anthropologie (more likely thousands) to get a whole new look.

Instead of a new wardrobe, focus on a happier, healthier you. Join the Y and pick up a cookbook with healthy recipes. The money you save cooking at home could be tucked into a high interest savings account, and a fully-stocked emergency fund will lower your stress levels.

HDTV… Or high-def relationships?

Electronics are often at the top of the shopping list when the refund comes. Staying at home with a movie on a widescreen HDTV — with 3D, even — is a big temptation. But as weeks and months pass, you may find yourself seeing your friends less and less, and your couch more and more.

Spend a few dollars on a bottle of wine and some ingredients for dinner, and invite your friends or family over for a game night. You can take the savings and put it toward a down payment on a home loan with good mortgage rates, for a more comfortable setting to host your parties in the future.

If your friends complain about the size of your TV screen, tell them you’ll happily accept an early housewarming present.

Car down payment… Or a payment-free future?

That $500, $1,000 or $3,000 may seem like the perfect amount to put down on a new car purchase or lease. It may feel pretty tired to schlep around town in the hatchback that took you through college and beyond, and it seems like everyone you know has a hybrid — or at least something without French fries mashed into the rug.

That lease or six-year loan, however, will cost you a fortune in interest or balloon payments — and you’re signing up for a big bill for years into the future. Instead, shop around for online savings accounts, CDs or money market accounts with high interest rates. These FDIC-insured accounts are low-risk enough to hold your money’s value for the near future and will build enough interest to sweeten the deal. Add to it steadily, and within a couple of years you may have enough to buy a respectable used car outright.

The ground-in French fries? They add character.

Fritter it away… Or build new habits?

The easiest way to spend your refund is to just… Spend it. Dinners out, a game console, a new set of wine glasses, movie tickets and season passes. Before you know it, your hundreds or thousands are all gone, the party’s over, and you have nothing much to show for it.

Instead, you could look at this as an opportunity for a great new habit: paying yourself first. Follow the core advice from personal-finance tomes such as “The Wealthy Barber” and start investing for your future — not just for retirement, but for all the wonderful wants and needs you’ll have 10, 20 or 30 years down the line. With this new habit, and a little patience, all the rest of your wants can be achieved — comfortable home, fun toys, cool cars — and a life with a little less stress.

So that “ding!” from your e-mail alert could be the path to short-term spending… Or long-term contentment.

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Guess what? There’s just one week standing between you and the income tax filing deadline. Have you filed your tax return yet? If not, you’d better get moving!

By now, you should have long since received all of the necessary paperwork, including your W-2 and 1099 forms. If not, be sure to check out these two articles:

• How to Handle a Missing 1099 Form
• How to Handle a Missing W-2 Form

The good news is that, even if you won’t be able to get your hands on these forms over the next week, you may be able to reconstruct the necessary values from banks statements, pay stubs, etc.

But what if you won’t be able to get your taxes done in time? What then? The good news is that you’re entitled to an automatic, six month filing extension. All you have to do is ask. The bad news is that this extension still doesn’t get you out of the expectation to pay what’s due before April 18th.

Here’s how it works… To request an extension, simply fill out IRS Form 4868 – or you use your preferred tax prep software to make the request. The deadline for such requests is April 18th, 2011.

Unfortunately, you still have to estimate how much you’ll owe and submit a payment along with your extension request. This is a very important point because, if you don’t pay in at least 90% of your tax bill via withholding, quarterly estimated tax payments, and your final payment that goes in with Form 4868, you’re underpayment will be subject to 7% interest and up to 25% in penalties.

If you do choose to file an extension, you can claim credit for this lump sum payment on your final return by entering it on the appropriate line of your tax return:

» Form 1040, line 68
» Form 1040A, line 44 (include in total)
» Form 1040EZ, line 10 (include in total)

If you file a 1040A or 1040EZ, you should also enter the words “Form 4868″ and the amount paid alongside the value on line 44 or 10. That’s it. Making this request is pretty straightforward, but it still takes a bit of figuring, so it’s in your best interest to tackle it before the absolute last minute. Good luck!

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In general terms, there shouldn’t be much of an impact on e-filers. According to IRS Commissioner Doug Shulman, the automatic processing of electronic returns will continue even in the face of a shutdown, and any associated returns should go out on time. But if you filed a paper return, the processing of your return may be delayed, meaning that your refund will likewise be delayed.

Regardless of what happens, it’s important to note that the tax filing deadline will still be April 18th, and that any checks that you send along with your return will be cashed without delay.

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Every year around this time I get inundated with questions from people wondering when they’ll receive their tax refund. If you’ve been wondering about this, then be sure to check out the “Where’s My Refund?” tool on the IRS website*.

To use the tool, you’ll need your Social Security number, your filing status, and the whole dollar amount of your expected refund. From there, it’s just a matter of plugging in the numbers and clicking submit. Assuming that they’ve processed your return – and that you entered the right info – your refund status should pop out. Note that you can check on your return 72 hours after filing if you e-filed, whereas you’ll have to wait 3-4 weeks to check the status if you filed a paper return.

In our case, I met with our tax guy for a final review last Thursday and he e-filed our return shortly thereafter. As of yesterday, the IRS is reporting that we should receive our refund – our first tax refund in several years – no later than April 19, 2011.

*Note: If you have an iPhone or iPod Touch, “there’s an app for that.” It’s called IRS2go, and it’s little more than a front end for the “Where’s My Refund?” tool. Regardless, it gives you the ability to check on your refund on the go.

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This is a guest post from Richard Barrington. Richard is a banking analyst for MoneyRates.com who spent over 20 years as an investment industry executive.

So you think you’ve got a creative way to save money on your taxes…

You might want to stop right there, because creativity and tax returns can be a dangerous mixture. Based on the experiences of some tax and financial professionals, here are five examples of questionable tax deductions:

1. Time isn’t always money. If you invest in improvements to a rental property, the cost of those improvements can increase the cost basis of that property. However, if you do the work yourself, don’t try to include the cost of your time in the increase to basis. In the eyes of the IRS, it only counts if you paid a professional to do it.
2. A vast entertainment empire. A musician believed he could deduct the rent on all three rooms of his apartment – his kitchen, because that’s where he discussed gigs over the phone, his living room, because that’s where he practiced, and his bedroom, because that’s where he kept his saxophone. On a percentage basis though, these were trivial in comparison to the primary uses of these rooms.
3. Trout fishing. People say that fishing can be therapeutic, but that doesn’t mean it qualifies as a medical expense. Neither do the associated travel, food, beverage, or lodging expenses.
4. Sex toys. Perhaps there was a physical problem being addressed. Or perhaps this person needed a mental health break and didn’t like trout fishing. Either way, unless they were prescribed by a physician, sex toys are unlikely to qualify as a medical expense.
5. Opportunity cost. The owner of a vacation property tried to write off the lost rent from a cancelled reservation as a bad debt. Money you could have earned but didn’t doesn’t carry the same weight as money you had and lost.

What’s the harm in trying?

Sure, the IRS might disallow your deduction, but what’s the harm in trying? Well, if your creative deduction is deemed to constitute tax evasion, it could cost you a fine of up to $250,000 as well as possible prison time. And though you’ll have gambled and lost, that’s not tax-deductible either.

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Well, guess what? If you took advantage of the original $7500 version of the first-time homebuyer tax credit, it’s time to start paying it back. Repayment is to be made in 15 equal annual installments starting with your 2010 income taxes. To make the payment, you’ll need to file IRS Form 5405 – coincidentally, this was the same form you used to claim the credit in the first place.

If you’re affected by this, you’ve probably already received “Notice CPO3a, Repaying your First-Time Homebuyer Credit,” listing the amount you have to re-pay. If you haven’t gotten this, or if you’ve misplaced it, then simply divide the total amount of your credit (you can look it up on your old tax return – you kept a copy, didn’t you?) and divide by 15. For those that qualified for the full credit, that works out to a repayment of $500/year.

Note that the 15 year “recapture period” only applies if the home you purchased continues to serve as your main home. If you convert your to a rental property or a second/vacation home, then you’ll need to pay the full unpaid amount on your next tax return. And if you sell your home to a third party, you have to repay the amount of the credit only up to the amount of the gain on your sale.

Other exceptions include the following:

• If you transfer your home as part of a divorce settlement, the spouse that keeps the home is responsible for the remaining repayments.
• If your home is destroyed or condemned and you purchase a replacement within two years, you’ll need to continue making repayments going forward.
• If you lose your home in a foreclosure sale, you’ll need to repay the credit up to the amount of your gain, if any.
• If you die, no further payments are due.

I’m not sure about you, but we bought our home back before the homebuyer credit was introduced, so this doesn’t apply to us. If it applies to you, be sure to be familiar with all of the repayment details – especially the possibility of having to make a lump sum repayment if you sell your home.

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If you’re amongst the paper filers, here’s a friendly reminder:

Don’t forget to sign you tax return!

According to IRS guidance, your return will not be considered valid unless you (and your spouse, if applicable) sign it. Note that this is true even if someone else prepares your return.

What if you forget to sign your return?

If you submitted your return without signing it, all is not lost. In all likelihood, the IRS will simply send you a letter requesting your signature. And once they receive your signature, they’ll go ahead and process your return. Thus, if you think (or know) that you submitted your return without signing it, you should probably just sit tight and wait to hear from the IRS.

*Note: If you are e-filing, you will have the option of signing your return electronically using a PIN code. If you choose not to do this, then you will have to complete and sign IRS Form 8453.

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States with no income tax

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee*
• Texas
• Washington
• Wyoming

*Note: New Hampshire and Tennessee don’t tax wage income, but they do interest and dividends. The applicable rates are 5% and 6%, respectively.

What about other taxes?

Of course, income tax isn’t the only thing to consider when figuring a state’s tax burden. You also have to factor in things like property taxes, sales taxes (both state and local), special assessments, and so on. For example, while Alaska and New Hampshire have no state sales tax, Tennessee has a 7% state sales tax on all purchases (including food, clothing, and medicine).

On the other end of the spectrum are states like Hawaii and Oregon, whose state income tax rates top out at 11% (albeit for only the highest income earners). For their part, Hawaii throws an another 4% state sales tax on top of their income tax, whereas Oregon has no state sales tax.

And just look at those poor Californians… Their top state income tax bracket it 10.3% and they get to pay an additional 8.25% in state sales tax. Yikes. I sure am glad that I don’t live in California!

What about you? What’s the tax situation in your state? If you live in a state without income taxes, what do you think? Are they making up for it with other forms of taxation? Or are you seeing less in the way of government provided services?

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A week ago, I asked how you guys will be preparing your taxes. As of this writing, just over 340 readers have responded, and the results are quite interesting. By far, the most popular response (with 48% of all votes) was commercial tax prep software, followed by a professional tax preparer (25%), electronic fillable forms (20%), and filling out paper forms manually (6%).

This week, I’m interested in hearing about how you’ll be filing your taxes. While those that fill out their forms by hand (paper and pencil) don’t have a choice, most everyone else does. For example, even if you use commercial tax prep software, you can either e-file or print and mail your return. The same goes for using a professional preparer.

Looking at the graph below, you can you that e-filing has become increasingly popular in recent years, with nearly 70% of all returns filed in 2010 (corresponding to the 2009 tax year) being e-filed. Based on these data, one can only assume that the 2011 numbers will be even higher.

And now, time for the poll…

As for us, we’ll be mailing hard copies of our returns this year. It’s not that I have anything against e-filing… In fact, when we’ve used TurboTax in the past, we’ve always e-filed. So why are we mailing a hard copy now? Mainly because that’s how our tax guy does things.

What about you? Are you mailing hard copy or e-filing your return? Please vote in the poll above, and also feel free to leave a comment to provide a bit of context.

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Do you have a home office? If so, have you ever considered taking the home office tax deduction? One common concern with taking this deduction is that it might trigger an income tax audit. But is that really the case?

Well… The general consensus seems to be that concerns over audits related to the home office tax deduction are a bit overblown. Moreover, even if you’re audited, you have nothing to worry about as long as you have a legitimate claim to the home office tax deduction.

This is, of course, a relatively complex topic, and it is covered in detail in IRS Publication 587, “Business Use of Your Home.” What follows if a thumbnail sketch of the requirements to get you started.

Defining a home office

According to the IRS, if you use a portion of your home “exclusively and regularly”:

• as your principal place of business, or
• as a place to meet or deal with patients, clients, or customers in the normal course of your business, or
• in connection with your trade or business where the business portion of your home is a separate structure not attached to your home,

then you may be able to take the home office tax deduction. For certain other uses, including rental, storage, or use as a daycare facility, you have to use your property regularly, but not exclusively, in a business capacity.

Establishing exclusive and regular use

Probably the biggest limitation for most people is the “exclusive” use requirement. In general terms, this claim is easiest to support if you use a separate room for your business activities, though you can get away with a portion of a room if you can show that no personal activities take place in the business section.

But even if you have work full time in a home office space, if your kids use it to do their homework in the evenings, or your spouse uses it for working on a hobby over the weekend, then it doesn’t meet the exclusive use requirement.

As for regular use, this is a bit of a grey area. If you work in the office a few hours per day, you’re probably okay. But if you’re trying to deduct a space that you rarely use, and is just incidental to your business, then you should probably steer clear of the deduction.

What about employees?

What if you don’t own a business, but you frequently work at home? Can employees still take the home office tax deduction? Maybe…

If you are an employee that happens to spend time working at home, you have to meet the same standards as a business owner. In addition, your use of the home office space must be for your employer’s convenience, not your own.

If, for example, your employer doesn’t provide you with office space, and you have to use a portion of your home to do your job, then you’re probably in the clear. But if you simply prefer to telecommute a few days a week, then you can’t take the home office deduction.

Claiming the home office deduction

So how do you go about claiming the home office deduction? For starters, you can claim any “direct” expenses in full. This would include things like maintenance or repairs that are limited to the business portion of your home.

As for indirect expenses, such as those associated with maintaining and running your entire home, you can deduct those based on the percentage of your home that is dedicated for business use. For example, if you live in a 2000 square foot home, and you have a 200 square foot home office, then you’re using 10% of the total space as a home office.

Your indirect expenses include utility bills, homeowner’s insurance premiums, HOA fees, security monitoring, etc. Mortgage interest and property taxes are also deductible, but in that case you’re moving the deduction from your personal balance sheet to the business side. If you rent your home, you can deduct a percentage of your rent for the portion of your home dedicated to you business.

If you own your home, you can also claim depreciation, which is basically an allowance for wear and tear. This is a relatively complicated topic, and not easy to cover in a single article like this. As such, I’ll simply direct your attention to Publication 587, which has an entire section dedicated to depreciation.

As noted above, full details surrounding the home office tax deduction can be found in IRS Publication 587, and you use Form 8829 to figure your deduction, which then gets reported on your Schedule C.

Do you claim the home office deduction?

Even though we run our business ventures entirely out of our home, we’ve never taken the home office deduction. The reason for this is that we don’t have a dedicated space for our activities, so we can’t justify the deduction.

What about you? Do you claim the home office deduction? If so, do you have any tips or tricks to share? If not, why not?

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As a followup to yesterday’s poll about your preferred method for preparing your taxes, I wanted to point out a cool little app that allows you to quickly complete and file your taxes using your iPhone or Android smartphone…

It’s called SnapTax, and it’s limited to those who file a 1040EZ. You simply shoot a picture of your W-2 and it uses optical character recognition (OCR) to transfer the data to your return. Answer a few additional questions, tap “File Now,” and you’re done. Pretty cool.

The downside is that it costs $14.95 to file your 1040EZ. In case you weren’t aware, the 1040EZ is a one page form that you should be able to fill out by hand in just a few minutes (see for yourself: link). And if your AGI is below $58k, you can e-file your return for free.

Another potential downside is that it seems like there’s the potential for errors when trying to OCR a bunch of numbers. With words, you could build a smart OCR engine that checks for spelling mistakes, etc. to minimize errors. But with numbers? Not so much. Thus, you should probably double-check the inputs.

If you’re still interested, here are the links for the iPhone and Android versions.

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