Taxes

One of my good friends just returned from a long honeymoon in Hawaii. She had gotten married in early February and then immediately flown off to the islands for a week and a half of sun and honeymoon fun. You can bet that of all the things on her mind for that week and a half, filing her taxes was not one of them.

My friend’s unique situation—being just married with a child of her own already—got me thinking about the upcoming tax season and how she and her new husband would deal with their new tax situation. Because I’m nosy, I went ahead and did a little bit of research to come up with a handful of tips that could be useful to her and her husband, as well as to any other newly married couples out there getting ready to file their taxes. If you can think of other tips, please feel free to include them in the comments section!

Have a Financial Talk with Your New Spouse

This is perhaps the most important tax tip I could find. Across the board, webmasters of tax and financial sites unanimously advised that new couples should have a financial talk as soon as possible. Having this talk is important not only because it can help you figure out your new tax situation, but also because it will encourage you to establish financial goals and roles as a new couple. In my friend’s case, she and her husband could use this talk to figure out a financial plan for her daughter’s education and how that might affect the tax credits they take.

Reassess Your Withholding Status

During the tax discussion with your spouse, you should reassess both of your withholdings statuses on the W-4 form that you filled out when you both first took your jobs. You need to figure out as a couple if you should continue to withhold at the single rate, which is a legal option, or if you should change your status. Many factors will influence your decision here, which means there is no right answer for every couple. Generally, if you can afford to withhold throughout the year, then it will help reduce the taxes you have to pay come tax time; of course, you do not want to loan too much, as you’ll essentially be lending your money to the government interest-free. You’ll get a bigger tax return, certainly, but you’d be better off using that money for expenses throughout the year. You should consider meeting with a tax professional to help you find the perfect withholding balance.

Consider Filing a Joint Return

You should also meet with a tax professional to talk about the benefits and/or disadvantages of filing a joint tax return. As a couple, you have the option of filing a joint return or separate returns, but, as with most financial decisions, there are good and bad results of both that you will have to weigh against your financial situation and goals. For example, in the case of my friend, filing jointly would allow her to take educational credits on her taxes. Other couples might deal with unpaid student loans, for which jointly filing might allow them to deduct interest. Again, you will have to examine how filing jointly or separately can directly affect your specific financial situation before you can make a decision.

Fill Out a Name Change Form

If you have changed your name after getting married, then you should file a change of name form with the Social Security Administration as soon as possible. This is, of course, a common sense move, and most likely you will have already been advised to do this; however, it is very important regardless of how logical it may seem. Without your correct personal information, the Social Security Administration cannot credit your earnings to your payroll record, nor can they make sure you pay your Social Security and Medicare taxes as required. If the information is incorrect, it can create quite the headache around tax season, which is why it’s important to take care of as soon as possible.

About the Author:

This guest post is contributed by Raine Parker, who particularly enjoys writing about accounting degree.  Questions and comments can be sent to: raine.parker6@gmail.com.

How will your taxes be affected by McCain and Obama?

An article from CNN Money shows the breakdown of the average increase/decrease for the various income brackets.

In a nutshell: McCain wants to cut taxes for everyone. Obama wants to cut taxes for the majority of the people and only raise taxes for the highest income earners.

Average Tax Savings Table

The numbers on the tables show that if you make between $66K and $161K, you would not see much difference between McCain’s and Obama’s plans. If you are in the $161K – $227K bracket, you are paying slightly more taxes under Obama’s plan. But if you are in the $227K+ bracket, you will be paying significantly more taxes under Obama’s plan.

However, if you are on the bottom of the income bracket table, making under $66K, you will see more tax savings under Obama’s plan.

I would think a majority of the people in U.S. would fall in the $38K – $112K brackets. If you take the average tax savings of those two brackets, you would get a tax savings of $1,048 under McCain’s plan and $1,191 under Obama’s plan, a difference of about $114. It looks like that most people will have roughly the same amount of tax savings in either administration.

The tax savings are more significant for the people on the top and bottom of the tax brackets. For the lower income earners, they would fare better with Obama for taxes; for the higher income earners they would fare much better with McCain.

“How much are you getting back?” is the common question that I hear around the office and on the streets. That is the question people asked to inquire about the tax refund amounts from the IRS. I hear answers like, I am getting back $1000, $1500, or $2000, and these people are filled with excitement. But the question is, why are these people so excited? I know they are happy to receive money, but I beg to differ that receiving a tax refund is good news, especially a large one. Getting a tax refund means that these people had overpaid their taxes by $1000, $1500, or $2000. I think it is foolish to have a large tax refund and I will explain why.

Employees on W-2 have their federal tax withholding deducted from their pay check by their employers based on the employee’s allowance filled out on the Form W-4 Employee’s Withholding Allowance Certificate. The federal tax withholding is calculated based on the allowance number – the higher the total number of allowances and the lower the federal tax withholdings will be deducted from the pay check.

If you fill in a zero on your total allowance claim (line 5), then you will be subjected to the maximum federal tax withholding. It is easy to just write zero on the allowance, alleviate your worries, and receive a huge tax return check from the government, but that is not a financially smart move.

[ad#square]A zero on the total allowance claim, while most likely covering total amount for taxes owed at the end of the year, may result in a huge overpayment for the taxes. This extra money paid to the government, although would be return to you, becomes a missed opportunity for you to profit from it. The government holds on to the extra money until the end of the year and pays it back it to you without interest, and thereby the government has taken your extra money for an interest-free ride.

Instead of giving the extra money to the government, you can withhold fewer taxes. The fewer taxes withheld will increase the net amount on your pay check, but the gross amount on your pay check remains the same. The extra money that comes from this increase should be deposited directly in a high-yield interest bearing account for making maximum guaranteed profit. At the end of the year, you may not receive a $1000, $1500, or $2000 tax refund check, but you will be earning interest on the extra money.

A more advanced strategy is to withhold fewer taxes than supposedly owed at the end of the year, causing an underpayment to your taxes owed. This will substantially increase the net amount on your pay check, however you will be owing taxes at the end of the year. The increase in the net amount on your pay check should be deposited directly to a high-yield interest bearing account and will allow you to earn more savings interest. It is important to note that the extra money should be reserved for paying back the taxes owed for this strategy to come to fruition.

Also, there is one catch to this advanced strategy. Too much underpayment may result in a tax penalty (see also http://www.essortment.com/all/taxespenalties_rlcx.htm). Be careful not to fall into the tax penalty zone or else this will defeat the purpose of making extra money.

One last factor to this whole tax withholding strategy is that it involves not only the financial component, but also the emotional/mental component. Tax penalty aside, most people do not feel comfortable owing taxes at the end of the year.

The best strategy, which compromises the financial and emotional/mental components, is to calculate your withholding so that you will receive a small refund at the end of the year. This allows you to have peace of mind while also knowing that you are reducing the amount of money lent interest-free to the government.

I remembered that when I was an employee on W-2, I would bump up my personal allowance on the Form W-4. I saw a marginal increase in the net amount on my next paycheck. I was careful not to spend that extra money and deposited it to a high-yield interest savings account.

Since I was withholding fewer federal taxes, I ended up owing federal taxes at the end of the year. When my friends asked me to tell them how much I was getting back from my tax refunds, I told them that I had to pay taxes out of pocket.

Their reaction was, “Oh, that sucks”

And I replied, “It’s okay, I did it on purpose. I’m making money.”

Then they showed me that confused and what-the-hell-am-I-talking-about face. I sat down and explained the whole tax withholding strategy.

In short, I did not give the government an interest free loan. Moreover, I took part of the money I owed the government and earned interest on it before returning the funds I owed to the IRS. Therefore, while my gross amount on the pay check stayed the same, I increased the net amount and made more money with the same pay check.

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I still haven’t filed my taxes yet. I have been receiving a lot of tax statements in January and February. It’s now March 1st and the bell is ringing. I have to do a lot of preparation before I can send my tax statements to my tax accountant. This year’s 1040 is going to be the most complicated since I started filing. Gone are the days when I just filed online by myself and filled out my W-2 income.

I received a dozen tax statements from various financial institutions. I have my own company, my rental property, my stock investments, my CDs, my bank interests, my student loan statements, and my mortagage statements. I am going to file as a sole proprietorship this time, so I’ll be paying self-employment taxes. I have a lot of stock transactions for 2006, it’s going to be a pain to fill out the Schedule D, especially when I stopped keeping track in MS Money. The thought of matching all the transactions manually scares me enough to procrastinate until near the deadline.

But I don’t want to wait until the last minute. I have a lot of paperwork to prepare for my tax accountant so he can process the 1040. I can’t delay it any longer. I’ll have to get everything ready by next week.

Have you filed your taxes yet?