Saturday, February 22, 2003

Oh my. Danny Sullivan makes an example of me. Speaking frankly, I would naturally like it very much if Google were to privilege my "content" here in its searches, although I think that would also be against almost everything that Google stands for -- and so I will diminish, and go into the West, and remain Galadriel Tax Observer.

I've also been spotlighted by someone on the ATXers community site, which is just full of us rollicking, fun-loving tax preparers (at least those who use the ATX software for professional preparers and CPAs). Again speaking frankly, the average poster there may well know more than I -- I claim no particular expertise, and this isn't really my career. But if you find my blog deeply fascinating, you'll doubtless get a kick out of their forums.

Thursday, February 20, 2003

Reader Question #5: Ed writes: Are there any IRS guidelines that can help me in my current situation? I cashed out a big part of my 401k plan in order to come up with the down payment on a home purchase. My understanding is that the IRS (and hence the form I was sent by the 401k administrator company) treats this is income. Any helpful suggestions to reduce or defer the tax bite here?

Unfortunately, there's a phrase investors know all to well, the like for like exchange. This means that if you use the proceeds from one kind of investment to buy another investment like the first -- for example, selling a house to buy a new home, or selling stock and buying more -- then the IRS lets you defer the capital gain (the increase in value, on which you will be taxed) for that investment. The trouble is that too much of this and the IRS never gets to tax you -- so they catch theirs when you sell an investment to spend the money on other things, or even to buy another unlike investment.

In your case, you're exchanging a tax-deferred investment instrument, the 401(k) money, for a real estate investment. What this means is that you've socked away money before taxes for several years, and this is the first opportunity the IRS has to treat it as income and assess a tax. The whole structure of a 401(k) assumes that you'll hold onto the money until retirement, or at least a time when you're in a lower tax bracket, and thus avoid the high taxes of your peak wage-earning years.

There really are few breaks the average person can get here. The better way to handle this, when possible, might be with a loan against the 401(k), rather than cashing out. That can offer its own problems -- for instance, the need to make a loan good when you leave your current company -- so isn't a universal panacea. But it's worth considering when you look at the potential tax savings. In particular, people often view their 401(k)s as a money stash for emergencies, but it really isn't intended for that -- and the early withdrawal penalties make it probably the most expensive emergency stash you can tap. I guarantee you that with this recession a lot of people are finding that out this tax season: if you fall into the highest tax bracket, the marginal tax rate on your early withdrawal (including regular income taxes, early withdrawal penalties, and state tax) can approach a whopping fifty percent. Bet they didn't tell you that up front, huh?

There's one bolthole here for you, though, and you didn't make it clear. Was the down payment on a house for your first home (or was it more than 36 months since you were part owner of a home)? The government does explicitly permit 401(k) money to be applied for that purpose.

A big hearty thanks! to the guys at About Politics, who've named Tax Observer the Political Site of the Day for 2/20/03. (They even have a blog -- welcome to the blogosphere!) As I've said before, this blog won't focus on the political end of taxes, advocating one plan or another, much beyond the general observation that anybody would prefer to pay less taxes. But taxes are certainly political through and through, so I'm pleased to get this honor (I actually received it over two years ago for another more overtly political site, so this is doubly pleasing).

Wednesday, February 19, 2003

Reader Question #4: I still have reader questions to get to! This is the part I really like, helping people.

Phil writes: My company gave us a bonus for the first time last year. My last paystub reflects the bonus in my income and the federal tax that was paid in (like 40%) yet my W-2 does not have any of this on there. Is there supposed to be another W-2 or do I not get the taxes back because it was a bonus check?

That's interesting, Phil. Bonus income is supposed to be properly included with the W-2 for employees and in a 1099 for non-employees, and that paperwork is supposed to be complete and delivered to the taxpayer by the 31st of January, otherwise some pretty substantial fines start to kick in.

Sorry about the lack of actual blogged tax news or information. I'm physically out at a corporate site where internet access is heavily filtered, and I'm actually unable to visit most "Financial/Investing" sites -- and as of today, "Government" is blocked as well, which means I can't even look up tax questions for my clients. Sheesh! Put it this way: they have a sales staff they need to keep motivated.

Anyway, I hope to have this solved in a day or two -- among other things, I have to get the taxes done for a bigwig here and then maybe I'll have sway to get what I need. Technically, I have justification based on my company's needs, but maybe not my host's needs. For now I count myself lucky I can still get my Yahoo and AOL mail, and use Blogger.

Tuesday, February 18, 2003

Reader Question! Sorry for the delay in posting I've actually written this up twice now for the blog and lost the post (once due to the tremendous traffic on Blogger due to the Google buy-out -- which has given Tax Observer great exposure since I'm still a Blog of Note on the front page.)

Procrastinator writes: I have not filed income taxes since 1995. I have, however, had taxes withheld from my checks for all of those years except one, in which I worked as an independent contractor. I would like to file my taxes because I hope to buy a home soon, but am unsure about the best way to proceed. I have been told to file all years; to file only the past year; or to file only the past three years, for which I am told I can still get a tax [refund]. I have all of my W-2 forms, and decent records of expenses from my stint as an independent contractor, but I am unsure of the best course of action.

Take heart! This situation is far more common than you might think. The first thing you need to realize is that there are different goals here -- satisfying the bank, satisfying the IRS, and satisfying yourself. The bank, certainly, cares little whether you have kept up to date, as long as it doesn't mean a potential lien hanging over the property they're going to loan you money for. Getting their approval may well require no more than N {say, 3} years of paper returns to show.

Second, you should be aware that you may only claim a refund within three years from the time the return was officially due. (Extensions, when properly applied for, do count.) This means that you have until April 15, 2003 to claim any refund to which you're entitled for Tax Year 1999. Any earlier refunds are gone for good, sorry to say. On the other hand, and you knew this was coming, tax liabilities never expire; and they do accrue interest and penalties, which can make your 18.9% credit card interest look like easy terms. (Penalties have a ceiling of 50% of the liability; but interest continues to grow indefinitely.)

Third, you may have paperwork telling you that the IRS has figured your tax liability for you. Essentially, you didn't file, but they did the paperwork as if you did file. What you need to know about this is that the IRS will do this in the form that is most advantageous to them. The worst example of this is married couples, who will be filed separately -- which for 99% of taxpayers is less favorable than filing jointly. In other words, the IRS figures your maximum possible tax liability and bills you for that. If you do your taxes yourself,.though, you may well find that you don't really owe nearly that much.

Here's the tricky part for you: that year you were independent, you were not only supposed to figure and pay your own tax, but you were supposed to do it quarterly (unless your income was in a certain range of the year before). The IRS will actually figure penalties not from April 15 of the next year, which is normal for everyone else, but from the first quarterly filing date of that tax year, which was April 15 one year earlier. In other words, the taxes due on 1/4 of your contractor income potentially had an extra year to accrue penalties and interest. The sooner you deal with that problem, the better. It's good that you have decent expense records from that year, because you'll need those to reduce your Schedule C liability.

Monday, February 17, 2003

Tax software surging, indicate the stats from the IRS through the first part of February. Only three weeks into the filing season, electronic filing is up -- and most of that is taxpayers running software themselves, rather than using a paid preparer. The touch-tone Telefile system -- which lets you punch in a 1040EZ, and other forms if your finger flesh is up for the punishment -- is starting to decline in use, though. End of season stats may not show such a surge, but it does seem as if the proliferation of cheap tax software options, both in a box and on the web, is having an impact.