Avoiding Audits After Tax Season

To paraphrase Jim Croce:

You don’t tug on superman’s cape
You don’t spit into the wind
You don’t pull the mask off that old lone ranger
And you don’t mess around with the IRS

At least, that’s how Al Capone would have sang it. The Department of Education, on the other hand… Go nuts. They’ve never educated a single person. And they have never put anyone in prison. The IRS has routinely done both. They have the power to give you an education in finance and consequences that you never wanted, and they can take you from your office directly to the penn without passing go, or collecting $200. These reasons should encourage you to avoid IRS attention in the form of an audit after tax season. Here’s how:

Give Yourself a Tax Education Before the IRS Gives You One

Before you even get to the EZ form, there are a thousand and one little things you need to know. I assure you; the things you don’t know about taxes far outweigh the things you do. Trouble lies in the vast area of things you don’t know. While an error of a few dollars is unlikely to trigger an audit, the IRS has no sense of humor–at least not one of which they are aware. They have nearly unlimited resources. And they have very little in terms of a sense of proportion. A little knowledge goes a long ways towards keeping their gaze away from you.

For example, a lot of people believe they can claim however many allowances or deductions on their W-4s as they like. This isn’t necessarily so, according to Natalie Cooper, who is in the field and familiar with the concept. She writes that “the deductions and credits that you qualify for each year may change based on your own situation and changes in tax code, so you should avoid simply copying the number of allowances that you were using from the previous year.” She goes on to point out that, if you are married, the number you can claim will change based on the number your spouse claims on his or her W-4.

Learn how your various forms and details are supposed to work and be calculated before you start plugging numbers into your 1040. The last thing you need is to be audited because you and your spouse accidentally claimed each other as dependents when turning in your annual W-4!

Let a Professional Do the Heavy Lifting

Since we’ve already established that you don’t know your way around the tax code, why not enlist someone who does? They will know right away if you are at risk of an audit. Anyone who is in the high-risk category should have a professional do their taxes for them. No need to inflict yourself with this slide show from Forbes.

Here are some of the risk factors therein:

  • Make a lot of money
  • Fail to mention off-shore accounts
  • Be a tax protester
  • Claim huge charitable contributions
  • Omit income reported by someone else
  • Take too many home-based business loans

This list goes on. But you get the idea. Any deviation from the standard will get you noticed. As the Japanese proverb goes: The nail that stands out gets hammered. There are a lot of risk factor lists out there. They all will have income near the top. Other factors aside, if you make a lot of money, you stand a good chance of being audited. Don’t fool around. Have a professional do your taxes for you.

Don’t Panic

In acknowledgement of the fact that there is no airtight method of avoiding an audit, I should say a few words about what to do in the event you find yourself in that situation:

  • Be prepared
  • Get help
  • Think compromise
  • Record it
  • Appeal it

Part of your preparation will be to immediately follow up and find out exactly what is at issue. The audit letter may not be very clear or forthcoming. Know exactly what you are dealing with. Hire a professional who specializes in audits. Understand that you are not dealing in absolutes. Even with the IRS, there is room for compromise and negotiation. If you don’t like the outcome, you can always appeal it.

While receiving an audit letter is not the end of the world, it is the start of a very bad day. Take all reasonable steps to avoid it altogether by educating yourself and letting a professional do the heavy lifting. Oh, and try not to make too much money.

Copyright 2017 Original content authorized only to appear on Money Beagle. Please subscribe via RSS, follow me on Twitter, Facebook, or receive e-mail updates. Thank you for reading.

Good Old Uncle Sam Will Be Getting Our Money This Year

The e-mail arrived this past week from our CPA (and family friend), and it started “Welcome to the world of No Tax Refunds.”  I knew it was coming as I had done a back-of-the-envelope calculation before turning our stuff over, but hearing the confirmation still was not something I really wanted to hear.

Our Normal Two-Part Refund

We typically get a refund from Uncle Sam.  For simple years, we have the proper amount taken out of my paycheck that would normally lead to a balanced return, but things like itemized deductions (mortgage interest, etc.), credits for having children, and other various components usually push us to get a refund.mb-money201308

On top of it, we always have a ‘refund’ fund running in our savings account.  Whenever we make any side income, we put a percentage aside.  In addition, if we sell stocks, or do other things that we know will be counted as income, we’ll put a percentage aside.

Typically, the two of these together makes for a nice chunk of change, though usually it just goes toward savings goals, having funded our new roof, built our ‘one day new’ car fund, car repairs, vacation funds, and things like that.

This Year, We Technically Still Get A Refund

Looking at the two part method above, this year we have our savings, and it more than exceeds what we will have to pay, as we’ve faithfully set aside money at every turn.  So, in the end we will still have money ‘left over’.  In all respects, it’s probably better that we did it this way as we basically took a loan from Uncle Sam and earned (paltry as it is) some interest, as opposed to the usual method which gives them an interest free loan until we’d get our refund back.

Still, the net size is smaller, so it’s still a bit less exciting!

One Other Gotcha

Since we had to pay this year, we’re now on the hook to make sure that we don’t underpay again for a second year.  As such, our guy advised that I bump up our contributions from each paycheck to make sure we hit the required amount so that we would avoid the possibility of an underpayment penalty when next year rolls around.

Why We Had To Pay This Year

A few things happened this year that were outside of our normal tax related activity.

  • Savings Bonds – I had some savings bonds that had been purchased years ago that had fully matured.  They were cashed out and re-invested, but the interest earned over the years was taxable income.
  • HSA Deductions – The plan that had previously allowed me to contribute to a health savings account was no longer offered.  The HSA contributions in the past were able to reduce our stated income, but we didn’t have that benefit last year.
  • Stock Market Gains – We have a small trading account that did well for a majority of the year, allowing for some capital gains.
  • Wash Sale Losses – Although we came out positive for the year, we had some losses as well that reduced our income, but because of silly (I could use a stronger word, but will refrain) rules, we couldn’t claim the losses.  Eventually we will once we close out the positions, but effectively, the IRS defers allowing you to claim losses regardless if you actually suffered the loss.  This is effectively what made us end up with a lesser net amount when adding together what we owe and what I had saved, as I did not ‘pay ourselves’ the tax on the losses, though in essence, not being able to claim the losses raised what the IRS sees as income.

What 2015 Holds

We should have a much easier 2015.  I don’t foresee us having to cash in bonds this year.  We’re back to contributing to an HSA plan, though that should really be negligable as my employer coordinates the deductions, thus capturing the effect on our tax rate.  And, as far as our investments, assuming I clear out the ‘wash sale’ stock, we’ll be able to capture all or least a portion of the effect of our deferred loss.  Combine that with the fact that we’re contributing even more via payroll deduction, and we could end up with a hefty return a year from now.

Readers, how did your 2015 tax return shape up?  If you got a refund, what are your plans?

Copyright 2017 Original content authorized only to appear on Money Beagle. Please subscribe via RSS, follow me on Twitter, Facebook, or receive e-mail updates. Thank you for reading.

Was The Payroll Tax Holiday A Good Idea?

By now, most people have probably received their first paycheck of the year and have seen the effect of the expiration of the payroll tax holiday.  As part of the economic stimulus packages during the throes of the Great Recession, the powers that be decided that giving a temporary break would help the economy.  Most Americans contribute 6.2% of their paycheck toward the Social Security Fund, and this was cut to 4.2% throughout 2011.

For someone making $52,000 per year, this resulted in additional take home pay of roughly $1,000 per year, with the hope being that Americans would spend that money, injecting spending into the economy.  Spending which, at that point, had been dramatically slowed.

At the end of 2011, the payroll tax holiday was extended for an additional 12 months, so Americans now had two years of extra spending money.

This is good and bad.

The pros

Here’s a couple of reasons that the tax holiday was a good idea:

  • It gave Americans more spending money – For many people (myself included), the 2% holiday was the only raise that they saw in their paycheck for multiple years.  At the time, many companies were cutting people, and if you were lucky enough to keep your job, many salaries were cut.  This squeezed paychecks, and an extra $40 or so per paycheck would certainly help many families pay the bills or pay off some additional debt.
  • It may have helped us out of the recession faster – This is up for debate, but the fact is that we did eventually work our way out of the worst of the recession, and the spending power given by this 2% cut is largely believed to have contributed, at least in part.

The cons

Here are a few reasons why it could be argued that the payroll tax may not have been such a great idea:

  • It didn’t help people who had already lost their jobs – The tax gave people a break from paying some of the taxes on their paycheck.  That’s all fine for people who have a paycheck, but if you were one of the millions of people that lost their jobs, you weren’t getting a paycheck, and the tax holiday didn’t benefit you at all.  Granted, they had other ‘measures’ which were supposed to address this, such as countless extensions to unemployment benefits, but regardless, there were a good percentage of Americans who didn’t see benefit from this at all.
  • The cut was temporary, but people didn’t see it that way – I can’t tell you the number of people I’ve seen complain on Facebook about how their paychecks went down (even though it technically was not a tax hike).  The fact is that everybody should have seen it coming, but two years is a long time to forget about the fact that the holiday wasn’t going to last forever.  Many people got used to the 2% additional income and baked it right into their budget.  If they budgeted their paycheck, if they did their household budget, over a two year period, that money was included.  To cut it out became a big shock.
  • Our economy is still fragile – I find it laughable that a huge piece of the negotiations that centered around ‘going over the fiscal cliff’ was to make sure that taxes didn’t go up for middle class Americans, with the logic being that the economy couldn’t afford that.  Yet, every middle class American who collects a paycheck just saw their income go down.  In fact, extending the payroll tax holiday for additional time was a non-starter on both sides of the political aisle (probably the one thing both parties agreed on, go figure).  It’s interesting that the same politicians who argued about the effects of tax rates going up and the impact that would have on the economy addressed the fact that by letting this expire, surely spending will be effected, leading to probable economic impact.  In six months when growth slows or certain sectors start seeing a slowdown, will anybody acknowledge the fact that diminished spending power might have a direct relation?
  • It added to the budget deficit – There were no spending cuts to match the decrease in revenue that resulted from this ‘holiday’, so the long and short is that this added to budget deficits.  Budget deficits that stand today at over $16 trillion dollars and are growing at over a trillion dollars per year.  Yikes.

My verdict

I personally never liked the idea of the tax holiday, not because I didn’t like the idea of getting more money, but because I knew that it was simply another method of kicking the can down the road, and that we would eventually have to let the ‘holiday’ run out, at which point it would be painful.

Once it was re-upped for a second year, I felt that the prudent way to act should have been with a clear and gradual exit strategy.  Rather than extend it and let it simply expire at some point (which is what happened), they should have set an end date, and also phased it out.  Maybe half a percent every six months, which would have given people a little more opportunity to get used to the reduction versus an all in one approach.  I knew that this was never going to happen, because people would have seen it as getting hit three times instead of one.

So, my verdict is that I feel they messed up twice.  They messed up by enacting it in the first place, then they messed up by letting it expire all at once after such a long time of having it in place.

How we handled it

I haven’t gotten a raise for several years, so I’m not going to lie, the extra money came in handy.  For us, we handled it such a way that we never actually saw a bump in take home pay.

The first year.  In 2011, our health care premiums were going up by an amount that would have impacted my take home pay by about 1%, so half of the 2% was accounted for right off the bat.  We also increased my 401(k) contribution by 1%, going from 10% to 11%.  With that, my take-home-pay was about the same.

In 2012 they kept our health care costs the same, so when they extended the holiday, doing nothing kept our pay the same (since once again, we did not get a raise).

Now that it’s going back up, our paycheck is definitely affected.  We actually made the switch to a High Deductible health plan with a Health Savings account.  The cost of this is actually less prior to making any HSA contributions.  However, the net difference for us after the premium decrease and the 2% Social Security increase is only about $40 per paycheck.  This means that, assuming we keep everything the same, we would only be contributing $960 toward our HSA plan, a number that would fall very short of my hoped for amount.

Had the 2% holiday not expired, we would have been able to contribute quite a bit more.

The obvious answer is to decrease our retirement contributions, since we used part of that as funded by the tax holiday.

But, I don’t want to do that.  If we do it will be a method of last resort.

For now, we’ll tough it out.  It’s been hard not getting a raise for as long as it’s been.  Every y ear, costs of goods have gone up.  Costs of health care premiums have gone up.  We’ve had two kids in that time frame, so costs there are way up.  In other words, the same paycheck four years ago went a lot further than it does today.

But, we still find a way.  And, it’s worth it.

For now, we’ll keep the retirement contributions the same, and as far as making sure our HSA is funded, there are several options.

I’d written in the past indicating that we had some flexibility in our emergency fund.  Bleeding off 10% of that could provide a comfortable padding in our HSA account and at least help ensure that we are keeping it well funded.  In the past, we’ve also contributed a portion of our tax refund toward paying down debt, with one of my goals being to pay the mortgage off before our kids started college.  Since re-financing in 2011, that’s already built in, so while it would be nice to advance pay some debt, extra payments are something I could postpone and still be comfortable with.

What do you think of the payroll tax holiday now that you had two years of living with it and the band-aid ripped off all at once?  Would you have handled anything different on a macro level (agreeing with it from the standpoint of the economy) or on a micro level (how you handled it within your household)?  What do you think the impact of the expiration will be on the economy?

Copyright 2017 Original content authorized only to appear on Money Beagle. Please subscribe via RSS, follow me on Twitter, Facebook, or receive e-mail updates. Thank you for reading.

Why I’m Glad I Have Someone Do Our Taxes

I’ve been lucky enough to have someone do my taxes for as long as I’ve ever had to file them.  How did I get so lucky? Because my dad has been lifelong friends with the guy that does them, and he’s always treated our family very well.

I’ve never questioned his ability, but whenever I see something I don’t understand on a tax return, I ask about it, for the simple sake that I want to understand things.

We re-financed our mortgage last year, so when I was estimating our tax return, I entered the closing costs, but when our tax return came back, this wasn’t on here.  Only a small portion was.

I knew he was correct.  He always is.  So, I didn’t sweat it and in fact I waited until after tax season was done before I dropped him an e-mail asking why the closing costs were nowhere to be found.

He wrote back explaining that for a re-finance, the deduction is spread out over the original term of the loan. Our deductible closing costs were roughly $1,200 for the 15-year mortgage, meaning that we’ll see roughly $80 written off each year for the next 15 years.  In fact, there was $20 written off in 201, which makes sense given that we re-financed with three months left in the year.

(FYI: For an original mortgage on the property, you can write off the entire closing amount for the year in which the closing took place.)

Good to know!

When it comes to doing taxes, I know that I could likely enter the big stuff.  But, honestly, it’s the little stuff like this which makes me really, really glad that we have someone do our taxes.

And not just any someone, but someone we completely trust.

Do you  have someone do your taxes?  Did you know about the re-finance amortization requirement when it comes to writing off the closing costs?

Copyright 2017 Original content authorized only to appear on Money Beagle. Please subscribe via RSS, follow me on Twitter, Facebook, or receive e-mail updates. Thank you for reading.