Tax Breaks to Take Before They Go

Part of what lies at the heart of the heated debate in state capitals and Washington over the last couple of weeks is a legitimate concern about a pretty simple question: have governments made too many promises about what they should provide without collecting enough money to fulfill them all?

The discussion of this question often leads to a look at income tax rates. Not enough of it, however, focuses on income tax breaks.

So amid all the hubbub, it’s worth stopping to consider how many of these deals you are eligible for (and if you’re old enough, recalling how many of them didn’t exist a few decades ago). On the state level, for instance, it’s possible that a tax deduction or credit for your child’s college savings account is contributing to a shortfall.

At the federal level, the money from 529 savings accounts can come out tax-free as long as they are used for education expenses. Then there’s the $5,000 or $10,000 you might have managed to shield from the tax man in health care, dependent care and commuter accounts, if you’re lucky enough to work for an employer that offers them.

And if President Obama gets his way, the income tax deduction for mortgage interest and charitable contributions for people in the highest tax brackets may get smaller.

If you’re upper middle class and above, take a look at your tax return and consider just how many deductions, set-asides and other breaks you took advantage of. I added up mine and found tens of thousands of dollars, leading to many thousands in tax savings.

Then look at the income figure on your tax forms and ask yourself this: Isn’t it likely that a bunch of legislators are going to figure out how much this is costing and take some of the benefits away? And if so, shouldn’t you be trying to take advantage of them before they disappear?

Reading between the lines in President Obama’s introduction to the 2012 budget, it’s clear how he feels about the policy decisions that gave rise to this crazy quilt. “For too long,” he wrote, “we have tolerated a tax system that’s a complex, inefficient and loophole-riddled mess.”

In fairness, it’s not as if there was some master plan here. Who, after all, would have declared that there should be income caps on taking deductions for student loan interest but that the wealthy should still get all sorts of tax incentives to save for college?

Take those 529 plans, for example, because the tax breaks exist on the federal level and in many states. The tax rules here did not emerge fully formed from the head of some legislator either. Instead, they began mostly as a way to prepay tuition at state universities and evolved into investment accounts that anyone, of any income, could use for any higher education, public or private. Federal taxes on the growth in money that people deposited into these accounts were simply deferred at first; years later, the rules changed and families suddenly did not have to pay any taxes on the gains as long as they used the money for qualified educational expenses. And it didn’t matter how much the money had grown.

As of June 30, 2010, 529 plans contained about $135 billion, according to the College Savings Plans Network, with just $21 billion or so in prepaid plans. And according to the Joint Committee on Taxation, which took a careful look at the plans when it last addressed the rules governing them in 2006, the federal tax waiver on the gains was going to cause a nearly $1 billion annual hit to the federal budget by the middle of this decade.

That number may end up being lower because of the roller-coaster stock market of the last four years. But the amazing thing about 529 accounts is that they often offer tax benefits on the way in as well as on the way out.

How does this work? As of today, most of the states that levy an income tax offer a deduction or credit of varying size to families when they make deposits in their own state’s (and sometimes any state’s) 529 plan. While the deduction generally has an annual dollar cap, you can almost always take advantage of it no matter how much money you make.

In Indiana, for instance, the 48,167 taxpayers who took the credit on their 2009 returns saved about $33 million.

The more you make — or the more a kind grandparent has given to you for your child — the more you can save. That means more opportunities to max out the state tax deductions. Moreover, wealthier people who can save more money earlier in their children’s lives benefit from the compounding of earnings over 15 or 20 years before tuition bills come due. (And by the way, the 15 percent capital gains rate they don’t have to pay upon withdrawal today will probably be higher before too long.)

Joseph Hurley, who runs savingforcollege.com, the leading resource for people doing research on 529 plans, understood why many states offered tax deductions. They needed to increase total balances to get economies of scale so they could drive down the 529 program fees that state residents pay. “But states cannot afford to offer these deductions now,” he said. “It’s free money to people who can take advantage of it, and it is higher-income families who can.”

According to Joan Marshall, who runs Maryland’s 529 savings plans and is chairwoman of the College Savings Plans Network, the states can’t afford not to offer the deductions. Without them, she says, people wouldn’t save in the first place, as is evident from the fact that so many deposits arrive late in the year, near the tax deadline. “And if we have a culture of savings, there is less need for aid later,” she said. “There is a real gain to be had down the road as we help to change behavior. It’s not only a negative drain on state budgets.”

Ms. Marshall added that if 529 plans were truly a tax-free plaything for the well-to-do, it wouldn’t be the case that just 0.67 percent of accounts had more than $100,000 in them. (That said, it’s possible that some wealthy families have more than one account.)

Legislators in North Carolina may have a chance to debate all of this soon. The state once had income restrictions on who could take state tax deductions for contributions to its 529 plan. The cap went away but is scheduled to return in January if elected leaders do not act before then.

This is just one front in the larger battle, though. There has already been plenty of discussion about the possibility of reducing the amount of deductions that higher-income people can claim for charitable contributions and mortgage interest. This is where many of the big budget opportunities lie. In fact, the changes are already coming. One new one is in health care flexible spending accounts, where people can set aside money free of income taxes to pay for expenses that insurance does not. Starting in 2013, you’ll only be able to put $2,500 in those accounts each year. This will hurt middle-class people with chronic conditions; an income cap on who could participate would have made the change more progressive.

But at least this is one sign that legislators are taking government debt seriously. And until more changes arrive, I’d take advantage of every last break and max it out if you’re affluent enough to do so. Because pretty soon, many of them may no longer be available to you.

By RON LIEBER

New York Times

Want to Know About Your Refund?

You owe the IRS 99 days of hard work

Stuart Rohatiner, CPA, JD

By Blake Ellis, staff reporter

NEW YORK (CNNMoney.com) — This year, it’s going to take the average American 99 days to earn enough money to pay the IRS. That’s one day longer than last year.

“Tax Freedom Day” marks the date that most Americans have earned enough money to pay their federal, state and local taxes, and this year that day arrives on April 9, according to the Tax Foundation’s annual calculation, which is based on government tax and income data.

Tax Freedom Day arriving one day later than it did last year means most Americans will have to work that much harder — for more than three months — just to pay their 2010 taxes.

The number of days Americans have to work to pay off their taxes has declined steadily since 2007. That’s due to a handful of tax cuts, certain income tax provisions that were repealed for 2010 and because the recession has reduced tax collections faster than it has cut income, according to the Tax Foundation.

But while it will take people less time to earn the money this year than it did in 2007, Americans will still spend more on taxes in 2010 than they will on food, clothing and shelter combined, the Tax Foundation said.

State-by-state:

Each state has its own Tax Freedom Day. The day arrived earliest in Alaska and Louisiana — on March 26 — because of “modest incomes and low state and local tax burdens,” the Tax Foundation said.

Mississippi, South Dakota and West Virginia celebrated soon after, on March 28, March 29 and March 30, respectively.

Connecticut, the state with the highest per capita income, will be the last to celebrate. Tax Freedom Day won’t arrive until April 27, the 117th day of the year.

New Jersey, New York, Maryland and Washington will join Connecticut as the last states to celebrate. In these states, Tax Freedom Day will fall on April 25, April 23, April 19 and April 15, in that order.

Business Tax Tip of the Day Apil 9 2010

The amount of investment interest expense deduction is limited to the amount of the taxpayer’s net investment income. The excess is carried forward and treated as an amount of investment interest expense incurred in the next year.

Don’t Have Enough To Pay Your Taxes?

What do you do when you finally get all of your information together to file your income taxes, and you find out that not only aren’t you getting a tax refund, but you actually have to pay taxes?! It’s not a problem if you have enough money set aside to pay it off, but for people who don’t have enough money in their bank account to pay their taxes, this can be a very scary experience.

First of all, you don’t need to panic. You are not the first (or the last!) person to owe the IRS money and not have access to the money immediately to pay them back. These are some tips for paying your taxes when you don’t have the money to pay on time.

File your taxes on time.

Even if you owe a ton of money and have no idea where you’ll get it, you need to file your taxes on time (including filing for an extension). If you send your information in late, you’ll be adding fees and penalties to the amount you owe. If you decide not to file your taxes at all — you’ll be looking at criminal charges.

Check all resources.

Take a look in all of your savings accounts and investments to see if there is any way you can come up with the money to pay your taxes. Think about friends or family who may be able to lend you the money.

Get an installment plan.

The IRS can also help you set up a payment plan if you can’t pay for your taxes in one lump sum. When you file your return, you’ll receive a letter from the IRS that states how much you owe. Begin saving money and looking for ways to pay your taxes. If you know for sure you won’t be able to pay your taxes in a lump sum, ask the IRS for the installment plan. You can indicate how much you feel you can afford and as long as you will pay off the balance in a 12 month period, the IRS will usually grant you an installment plan. Having an installment plan will cost you additional money in fees, but it gives you an opportunity to pay it over time.

Apply for Offer of Compromise.

If you get turned down for the installment plan with the IRS, you might consider the Offer of Compromise. This lets you make a one time payment or schedule several payments over time but is a much more involved process than asking for an installment plan. It also costs $150 to apply and each person is evaluated individually based on their financial situation. You are not guaranteed approval even if you pay the $150 application fee so you will want to try the installment plan option first.

If you owe money to the IRS, the worst thing you can do is sit back and hope it goes away. The longer you wait, the harder it will be to pay it because the penalties and fees will continue to add up. The best you could hope for after waiting and hoping it will all go away is a tax settlement of some sort! You need to establish a plan of action that works for your financial situation right now, and follow through with it until the amount you owe is paid in full.

12 Different Ways to Cut Your Taxes:

Looking to cut your taxes this year? You can if

1. You bought a house. Congress extended the valuable homebuyer break beyond first-timers. If you already owned a home but bought a new one after Nov. 6, 2009, you may be entitled to a credit worth 10% of the purchase price, up to $6,500. Even if you buy in 2010 — you have until April 30 to sign a contract and until June 30 to close — you can claim the credit on your 2009 return. The fine print: You have to have lived in your old home for five consecutive years of the past eight. Plus, the new home must be your principal residence and must have cost $800,000 or less. Of course, first-time homebuyers also benefit, with a credit of 10% of the price up to $8,000. So if a child or someone else you know finally kicked the renting habit in 2009 — or plans to in early 2010 — have him or her check irs.gov for dates and income restrictions.

Income Limits (for repeat homebuyers)

Full credit up to $225,000

Partial credit up to $245,000

2. You’ve got a kid in college.  New for 2009 and 2010, the American Opportunity Tax Credit. With it, you can claim $2,500 per student per year for the first four years of college.  Still on the books are the Hope Credit, which provides $1,800 per student for the first two years of college, and the Lifetime Learning Credit, which offers up to $2,000 per return. But you can’t take more than one of them in any given year for any one student. So most people should go with the more valuable AOTC, which also has higher income caps.

Income Limits

Full credit up to $160,000

Partial credit up to $180,000

3. You got a new set of wheels. If you bought a new car, light truck, motor home, or motorcycle after Feb. 16, 2009, you can deduct the sales taxes you paid on up to $49,500 of the vehicle’s price. You don’t need to itemize to take this special one-year write-off — making it especially valuable for high earners who typically have their itemized deductions clipped or who might otherwise get hit by the alternative minimum tax (AMT). Traded in a Junker through the Cash for Clunkers program? You can take this break too. If you normally opt to deduct your sales taxes in lieu of state and local taxes on your Schedule A — a choice made by many people in low-income tax states — you would have been allowed to write off auto sales taxes anyway. But you should run the numbers to see if you’d be better off using this new provision vs. itemizing, as many itemized deductions are subject to being added back in with the AMT.

Income Limits

Full break up to $250,000

Partial break up to $260,000

4. You were out of work. You collected unemployment:  This income is usually taxable, but for 2009 only, the first $2,400 of it is tax-free. Households in which both spouses collected unemployment can exclude $4,800. So if you chose to have taxes taken out of your weekly benefits, you may end up getting a better-than-expected refund. Potential savings:  $672 per recipient

5.You looked for a job: As long as you’ve been seeking work in the same field as your last position, your expenses — including those for travel, career coaching, and résumé services — qualify as miscellaneous deductions, and you can write them off to the extent that they (combined with other deductions like safe-deposit fees) exceed 2% of your adjusted gross income (AGI). You can take this break even if you weren’t out of work.

Potential savings: $840 if you had a $140,000 income and $5,800 in these and other miscellaneous expenses. You paid the full tab for health insurance: Most taxpayers don’t have enough out-of-pocket medical expenses to meet the steep threshold for deducting them: You can write off these costs only to the extent that they exceed 7.5% of your AGI. But if you were out of work last year and had to pay for COBRA or other health insurance, there’s a good chance those costs may have put you over the limit — especially if your income fell too. (The average family paid $4,776 for COBRA last year, even with the subsidy that was part of the economic relief package, according to data from the Kaiser Family Foundation.) Aspirin and eyeglasses count toward the write-off; see IRS publication 502 for a list of other qualifying expenses.

Potential savings: $132 if your income was $70,000 and you paid average COBRA costs plus another $1,000 in medical bills

5. You helped those in Haiti. Though the earthquake occurred in 2010, you don’t have to wait until next year to deduct your contributions to nonprofits providing disaster relief. Congress fast-tracked a bill that lets you deduct donations made before March 1, 2010 on your 2009 tax return.

6. You had investment losses. The average stock was still down 29% from its October 2007 peak. If you sold securities at a loss in 2009 and you had owned the shares for more than a year, those losses can come in handy now. You can use them, as well as any losses you carried over from 2008, to offset capital gains you may have reaped by selling investment winners as the markets recovered. You can also use up to $3,000 in net investment losses to offset ordinary income. And any leftover losses can be carried forward to reduce your 2010 taxes.

7. You weathered a disaster. There were 59 federal disasters declared in 2009. If your house was damaged in one of them and your homeowners insurance didn’t pick up the full bill, you have money coming back to you — and you don’t need to itemize to get it. There is no limit on what you can claim (typically you can deduct only losses greater than 10% of AGI). And you can also retroactively apply any losses you can’t use to 2008 taxes. File amended returns to get your money quickly. One hitch: You must subtract $500 from the loss before writing it off.

8. You made energy-efficient home improvements. You can take a credit worth 30% of what you spent on energy-saving skylights, replacement windows, water heaters, and the like. (Go to energystar.gov to see what qualifies.) But instead of the $500 cap previously on this benefit, you can now claim a combined $1,500 for 2009 and 2010.

9. You own property but don’t itemize. Those who itemize their deductions typically get credit for their property taxes. But those who didn’t itemize missed out on this break in the past. For the 2009 tax year (as in 2008), joint filers who don’t itemize are allowed to deduct as much as $1,000 of those taxes.  Use the new Schedule L to nail down this deduction.

10. You picked up a second job. Many Americans took freelance work in 2009 to make up for smaller paychecks and shrunken investment accounts. Whether you spent time selling old baseball cards on eBay or consulting for a former boss, you probably have a business by IRS standards. And that gives you a whole host of write-offs, including costs of supplies, equipment, and work-related errands (55¢ a mile for business use of your car).

Better yet, if you’re running this side operation out of a home office — and not also using it as a TV room/guest room/playroom — you can deduct a prorated share of your utility bills and even your mortgage payments.

11. You moved for work. If you ended up relocating for a full-time position that’s at least 50 miles farther from your old home than your last job was, you can deduct your moving expenses on Form 3903. That includes the cost of the moving company or truck rental, boxes and tape, shipping your car or your pet, storing your things, starting and stopping utilities, and traveling to the new location.

12. You’re a high earner. This year anyone who doesn’t fall into the AMT zone will get some personal exemption for claiming their children as dependents. In previous years that exemption — $3,650 for 2009 — phased out at higher income levels. This year it phases down to $2,433, but not out. (Potential savings:  $852 per kid, assuming you’re in the 35% tax bracket) Typically, high-income-tax filers have to reduce their itemized deductions by 3% of the amount their AGI exceeds a certain threshold ($166,800 for single and joint filers in 2009). But for 2009 that reduction comes down to 1%.

(Potential savings: $142 for the average itemizer in the 28% bracket).

How $1 trillion hides in plain sight

By Jeanne Sahadi, senior writerMarch 5, 2010: 7:30 AM ET

Stuart Rohatiner, CPA, JD

NEW YORK (CNNMoney.com) — The government does without roughly a trillion dollars a year because of a slew of tax breaks — everything from the mortgage-interest deduction, to education and child credits, to low rates on investments.

The irony is that all those breaks can translate into higher tax rates and a federal budget that is much bigger than advertised, according to tax experts Len Burman, a professor at Syracuse University, and Edward Kleinbard, a professor at University of Southern California.

Anyway you slice it, a cool trill is not chump change. In fact, it’s equal to nearly a third of the federal budget.

But you won’t actually see that highlighted in the federal budget process every year. That’s because lawmakers focus on the money the government will spend and how much it will raise in taxes. But “total revenue passed up” doesn’t really come up.

Burman and Kleinbard think tax breaks should be treated as a form of spending.

“Like direct spending programs, tax expenditures crowd out other spending and require higher tax rates than otherwise needed,” Burman wrote in a paper co-authored with Eric Toder and Christopher Geissler.

Even though tax breaks lower the tax bite for eligible individuals and corporations, they end up raising taxes on others.

“Targeted tax relief is just another name for government spending, in which taxes extracted from those of us who are not targeted fund hidden spending on those who are,” said Kleinbard, who used to run the Joint Committee on Taxation, in a speech last fall.

If lawmakers did treat tax breaks as spending, the size of the federal budget — defined by how much the government will spend in a year — would be more like $4.6 trillion, not $3.6 trillion.

Tax breaks on auto pilot

The number of tax breaks has quadrupled since 1972. No one advocates that all tax breaks be abolished. But Burman has suggested lawmakers cap how much they spend on them.

Done right, such breaks can advance government-favored activities such as giving to charities, boosting retirement savings or purchasing health insurance.

But even when the mission is clear, lawmakers’ aim isn’t always dead-on. For example, a tax break might encourage behavior that would have happened without a government subsidy.

Done wrong, tax breaks can squander resources that could be put to better use.

“These revenues could be used to lower marginal tax rates, fund more social programs, improve infrastructure, eliminate budget deficits, or promote various other purposes,” Burman and his colleagues wrote.

The problem, Kleinbard and Burman say, is that most tax breaks don’t get much scrutiny once they become law. By contrast, Congress each year must review discretionary spending, such as that on defense, education and infrastructure.

Some tax breaks, of course, have expiration dates. But even then they’re often lumped together with other expiring tax breaks and renewed en masse.

“If we can force tax expenditures into the sunlight, by subjecting them to the full rigor of the budget process, we can make better choices,” Kleinbard said.

Aiming for fiscal stability

In view of the country’s looming fiscal shortfalls, the discussion about tax breaks isn’t just academic.

Tax experts have been saying for years that streamlining tax breaks and simplifying their rules is key to reforming the tax code. And let’s face it, you’d have to pay someone an obscene amount of money to say without laughing that the code, with its mind-bending complexity, is just fine.

As it is, tax breaks can increase the sense that the tax code is unfair and make people feel better about cheating. It’s always the other guy it seems who’s getting more breaks and the wealthiest corporations getting the sweetest deals.

Among the benefits of rethinking tax breaks: it could lead to a broader base of people paying into the federal income tax system.

Today, because of the multitude of tax breaks, nearly half of all tax filers will end up owing no federal income tax, according to Roberton Williams, a senior fellow at the Tax Policy Center.

With fewer tax breaks, more people will end up with some federal income tax liability. But with more people paying in, that could also mean tax rates wouldn’t need to be as high as they otherwise might be.

To learn about more tax breaks, and how to do this year’s taxes, visit my website, StuartRohatiner.com.

Stimulus surprise: 15 million may owe IRS

Treasury report estimates many may be getting paid more of the Making Work Pay credit than they should. Their refunds may be cut or they’ll have to cough up the overpaid amount.

By Jeanne Sahadi, CNNMoney.com senior writer
Last Updated: November 17, 2009: 9:45 AM ET

The recovery from the Great Recession has likely started. But many economists are worried about falling into another downturn. Here’s what has them concerned.

NEW YORK (CNNMoney.com) — Nothing with taxes is ever simple, even when you’re getting a tax break.

An estimated 15.4 million tax filers may be getting paid more of the Making Work Pay credit than they should, according to a report from a Treasury Department inspector general publicly released Monday.

And that means they either will get less of a refund than they expected, or will actually owe money to the IRS on their 2009 taxes.

The IRS said in a written response to the report that the agency believes far fewer people than the inspector general estimates would be affected, and that the majority who might be would see less of a refund but would not have an out-of-pocket tax liability come April 15.

The taxpayers most vulnerable are those in two-earner couples; those who have dependents who earn wages; single or married filers who have more than one job at the same time; and filers who get pension payments or have a job and receive Social Security benefits.

The Making Work Pay credit, created as part of the stimulus legislation enacted in February, is equal to 6.2% of earnings up to $400 per person (or up to $800 per couples who file jointly). The full credit is paid to people making $75,000 or less ($150,000 per couple per household). A partial credit would be paid to those making above those amounts but no more than $95,000 ($190,000 for couples per household).

Bailout Tracker: Understand the rescues

For most who qualify, the 2009 credit is being paid in advance incrementally through their paychecks. And it’s been automatic – meaning employers, based on what they know of a worker’s income and using IRS withholding tables, automatically reduce the amount of taxes withheld from a worker’s paycheck.

But an employer doesn’t know the income of the worker’s spouse or whether the worker is claiming a dependent who also is earning money, or whether the worker has income from other jobs.

So, for instance, two spouses might be receiving the full credit at their jobs when their joint income only qualifies them for a partial credit or none at all. Another scenario: A single person with more than one job might be receiving the full credit at each of his jobs, when in fact he’s only entitled to $400 total.

You get the picture.

Such taxpayers could have increased their withholding to account for the possibility that they might receive more of the credit than they should. Indeed, when the credit was first passed, the IRS put out statements and created a calculator to help taxpayers in such situations figure out how much tax they should have withheld. But that doesn’t mean that everyone did.

Those who have had too little tax withheld this year will either face a reduced refund or owe money to the IRS. The money primarily would be the amount of the credit overpaid to them. But a much smaller group might also owe a penalty if they were significantly under withheld.

“More than 1.2 million taxpayers included in these groups may be subject to: 1) paying back some or all of the Making Work Pay Credit and 2) being assessed the estimated tax penalty or an increased estimated tax penalty as a direct result of the Making Work Pay Credit,” the inspector general’s report said.

The good news is that the IRS is likely to waive penalties for filers who may have to pay an estimated tax penalty or who would see their estimated penalty increased as a result of the Making Work Pay credit, according to the report.

The inspector general’s report also recommended that the IRS embark on an expanded effort to publicize this issue more and specifically target the message to those tax filers most likely to be affected.

First Published: November 17, 2009: 3:55 AM ET