The Flawed Earned Income Credit

A single mom, whom we’ll call “Mary”, works hard without support from her ex to provide for her children, and makes about $35,000 per year.  Unfortunately, she “makes too much money” to qualify for the so called “Earned Income Tax Credit.”  During 2011, she lost her job due to company downsizing.  But, since she lost her job in October, her earnings for 2011 were still close to $30,000 – still too high to qualify for the EITC.  If she had lost her job in July or maybe August, her earnings would have been low enough to qualify.

Unfortunately, qualifying for the EITC has a lot to do with timing.

Mary is still unemployed and looking for a job.  It could be March or April before she lands a good job.  In other words, she could start working “just in time” to NOT qualify for the EITC again in 2012.  Even though she will have been out of work for 6 months, since those 6 months are split between 2011 and 2012, she doesn’t get the EITC for either year.  This is what you call a “wacky” system that only someone in D.C. could have come up with.

A single parent, claiming 3 dependents, can hit the “sweet spot” of EITC by earning between $12,750 and $16,650 during the year.  They can get EITC of up to $5,751 added on to their Income Tax Refund.  For 2 dependents the EITC is $5,112.

Another single mom that I know has supported 2 children on only about $17,000 per year for the past few years.  Unfortunately, last year she got a second job at a gas station and made an extra $5,000.  This extra income significantly decreased her EITC this year.  Only someone in D.C. could devise such a system that punishes a single mom for getting a second job.

The third situation is about two divorced parents living together with each having children of their own.  They each are providing for their own “household” and paying for each of their children’s expenses.  Thus, they both claim Head of Household and the EITC.  They each get $3,000 – $5,000 per year from EITC.  Then they get married.  Suddenly they no longer qualify for the EITC at all because together they make “too much money” to qualify for EITC.  Again, only a bureaucrat in D.C. could devise a system that encourages co-habitation and punishes married people.

All three of these situations are actual situations and I know all of these people personally.  The EITC is one of the many flaws in our current tax system that needs to be fixed.

Here is how it could be fixed:

1. If you’re going to have EITC at all, allow people to apply for EITC any time during the year using the past 12 months of income.  This could be done on an amended Form 1040X.  They would need to wait 12 months before applying again.

2. In order to not “punish” someone for getting a second job, allow people to take an average income over the past 3 years to determine their EITC.  Putting this in place would help those people who didn’t realize that they were going to be “punished” for working a second job and would allow them to decide going forward, after meeting with their tax professional, if they want to keep working the second job.  When you consider child care, social security and medicare taxes and the decrease in EITC it is hardly worth it for someone to work a second job.

3.  Allow married couples to file as “Single” if they so choose with only one being allowed to file as “Head of Household”.  And, no longer allow people living together to each file as “Head of Household”.  There should only be one “Head of Household” filing per physical address.

Use the Same Tax Professional for Personal and Business

Many taxpayers will hire a professional to prepare their business return, and then will prepare their personal return themselves.  I do not recommend this if you own an S-Corporation or a closely held Partnership.

The primary reason you should not do this is because of the way Bonus Depreciation and the Section 179 deduction is handled.  If you take more Bonus Depreciation or Section 179 than you need, it is lost forever.  When I prepare an S-Corporation return that is closely held and the owner’s personal return(s) I toggle back and forth between the personal and business returns.  This ensures that the taxpayer(s) pay the least amount of tax possible without forfeiting Section 179 or Bonus Depreciation.  Without doing both returns at the same time you really don’t know for sure if you are maximizing your tax savings.

I’ve had business owners tell me to “just take the max” of Section 179.  They say this without really understanding it.  Then they prepare their personal return.  It is possible that they could be forfeiting thousands of dollars of future deductions by taking more Section 179 than they really need for that year.  The future deductions would more than pay for the extra preparation fee.

Of course, one could always file amended returns going back three years.  But, how would you know if you needed to file amended returns unless you hired a professional to take a look.  Also, if you did realize that you took too much Section 179 or depreciation in prior years and went back and filed amended returns, you would have to amend both business and personal, which would result in more preparation fees.  The best option is to simply have your tax professional prepare both your business and personal returns from the beginning.

1 Down, 5 To Go

January 31st is finally gone!  The following items were due on January 31st:

W-2′s

1099′s

941′s, plus payments for those less than $2,500 in payroll taxes for the quarter.  You have until Feb. 10th to actually file the 941 if you made your deposits on time.  The payment, however, is due by Jan. 31st.

940′s, plus payments.  You have until Feb. 10th for this as well, if you made the payments on time.  If you owe more than $500, chances are you should have made a deposit during the year.  The payment is due by Jan. 31st.

State Unemployment Taxes

There are six primary days a year that cause stress for tax and accounting professionals.

They are:

January 31st

February 28th

March 15th

April 15th

September 15th

October 15th

There are others as well.  But, those are my six.

Now we can move on to bigger and better things.  Like preparing tax returns!

Romney Releases 2010 Tax Return

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Mitt Romney released his massive 203 page 2010 tax return yesterday.  The big story is the 14% tax rate that he pays.  But, to me, as a tax professional, my eyes went to Schedule A, Line 22, Tax Preparation Fees.  I’m always curious what high profile individuals pay for tax preparation services.  And, guess what?  The line is blank.  Is this a mistake?  Did Pricewaterhousecoopers LLP do it for free?  He was way over the 2% threshold so the tax preparation fees would have been a dollar for dollar deduction.  Oh, well,  I guess I’ll focus on the 14% issue.

Here are the facts:

1) His income was about $21.6 million

2) The majority of his income was from Capital Gains ($12.5 million)

3) The next largest portion was from Dividends ($4.9 million)

4) The third largest portion was from Interest ($3.3 million)

Capital gains are taxed at 15%.  There is a reason for that.  It encourages investment.  Raise the capital gain rates and you discourage investment.

Dividends are also taxed at 15%.  The reason for this is because they have already been taxed at the Corporate Income Tax rate of 35%.  Corporations don’t get a deduction for dividends.

Interest is taxed as ordinary income which means Mitt Romney paid 35% on his Interest Income.  This is because Corporations DO get a deduction for interest payments and therefore don’t have to pay taxes on it.

5) He gave $3 million to charity.  This helped reduce his taxable income and, of course, his overall tax rate.

6) He earned $593K from speaking fees, director fees, etc.  He reported this on Schedule C and paid the FULL Medicare Tax on it.  He could have run it through an S-Corporation, paid himself a reasonable salary, and then taken the rest of it as a distribution, like Newt Gingrich did, but he didn’t .   Not that there is anything wrong with the way Newt did it.  I’m just pointing out the facts.  Romney should at least get some points for that.

There is a lot to this tax return and I’m not going to spend the time going through all the forms.  I’ll just stick with the basics.  But, I don’t see anything big here.  The only ammunition will be for those who want to play class warfare.

IRS Direct Deposit Refunds Will Be Getting Faster

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The IRS is working toward a real-time filing system.  They announced today that they are hosting a Second Real-Time Tax System Meeting.  This real-time system will allow instant matching on returns which should result in 24 hour refunds.

In my opinion this is long overdue, at least the refund part.  Under the current system you can receive your refund in 5-10 business days.  This is without any type of document matching.  Employers don’t have to file W-3′s  and W-2′s with the IRS and SSA until Feb. 28th so any matching that is done is way after-the-fact.  In fact, the IRS admits that “It is not uncommon for a taxpayer to receive a notice 12 to 18 months after a tax return is filed.  This after-the-fact compliance approach can create problems and frustrations for both taxpayers and the IRS.”  So, my question to the IRS now is, what happens in the 5-10 business days that people currently have to wait?  Why is there even a wait time at all if there is currently no matching done?

When I e-file a client’s return I get an almost immediate response from the IRS that the return has been accepted.  In a matter of minutes their computers have matched up the taxpayer’s name, SS#, spouses name, SS#, all W-2 company names with Tax ID#’s and some other various information.  Of course, they cannot match up any W-2 payroll information because they either haven’t received the information from the employer or they have and it hasn’t been processed (it will be 12-18 months later).  Then, they wait 5-10 business days before they directly deposit the money?  Why?  What happens in that 5-10 days?  It appears, nothing.  There should already be 24 hour refunds.  They don’t need a perfect matching system in order to implement that.

This real-time system should be done in two phases:

1) Start refunding taxpayers money immediately upon them filing.  This would be simple to implement under the current system.  Anything larger than $15,000 should require additional approval (or matching) to prevent extremely large fraudulent refunds.

2) Start improving the matching system.

A real-time system is great, but, the big question for me is, how much “matching” is going to be done up front?  All of it?  And, will it cause even greater delays for many taxpayers in getting their refunds?  Employers aren’t perfect either.  Many times the information that they file with the IRS is inaccurate.  Under the current system taxpayers receive letters 12-18 months later.  Then they have to either agree with the changes to the return or disagree and state the reasons why they disagree.  Sometimes it turns out the the employers filed inaccurate information.

I’m for a real-time system.  But, in what form?  I think it would be great if the IRS would match things up faster so that taxpayers aren’t accruing interest and penalties for 12-18 months before they find out that their return is wrong.  But, the IRS already receives the info by Feb. 28th, 30 days after the taxpayer’s receive their tax documents.  Why does it take so long to match things up?  If they can’t match things up within a few weeks after receiving the info how are they going to operate a “real-time” system?

Can You File Your Tax Return Using Your Last Pay Stub?

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One question tax preparers frequently get asked is “Can I file my return using my last pay stub?”

There are really two questions here:  1) Can an individual file their own return using a pay stub instead of a w-2?  And, 2) Can a paid tax preparer prepare and file a return based on a pay stub instead of a W-2?

First, let me deal with the issue of paid preparers.  The IRS states that it is “against e-file rules” for preparers to file with a pay stub instead of a W-2.  This is on their web-site here.  When they say “against e-file rules” I’m not sure exactly what rules they are talking about or if they are specifically referring to paid preparers or individuals filing their own return.  I’ve read through the entire Handbook for Authorized e-file Providers and the only mention of preparing returns from a pay stub is on page 48 where it talks about advertising.   But, on page 30 it states that paid preparers must retain “Copies of Form W-2, W-2G and 1099-R”.  How can you retain a copy of it if you never saw the W-2 in the first place?  Do you really think that the client is going to bring back the W-2 later just so that you can keep a copy?  I don’t think so.  Paid preparers need the W-2 up front in order to protect themselves.  In addition, one of the questions that must be answered in all professional tax software when e-filing is “Check if this is hand written, altered or appears not to be a true W-2″.  So, how would you know if you haven’t seen it?

Now, the issue of an individual filing their own return.  I cannot find any specific rules against this.  However, here are a couple of things to keep in mind:

1. Not all information is on the pay stub.  The Employer EIN, for example, isn’t.  Got it on last year’s W-2?  Not so fast.  Sometimes employers change their EIN.  Also, the categorization of retirement contributions isn’t clear on the last paystub.  For example on the W-2 in Box 12A, 12B, 12C or 12D it usually has the letters A,B,C,D, etc. denoting what kind of retirement contribution it is.  There are other items as well that might appear on the W-2 that are not on the last pay stub.

2. Your YTD info on your pay stub might be wrong.  This could be for a variety reasons, like your employer changing software or payroll services during the year.  Sure, they should have reconciled everything and made it accurate but they may not have done that yet when you got the last pay stub.  Some payroll preparers double check all the numbers before sending out W-2′s and if they find an error and then correct it on the W-2 it would be different from the last pay stub.

In summary, paid preparers definitely need to see the actual W-2 and taxpayers filing their own return would be best served to wait for it as well.

Soda tax could prevent 26,000 premature deaths, study finds

The LA Times reports that the Health Affairs Journal has determined that “a penny-per-ounce tax would reduce soda consumption by 15%” which would result in “95,000 fewer instances of coronary heart disease, 8,000 fewer strokes, 26,000 fewer premature deaths, and more than $17 billion in savings from medical expenditures averted across the U.S. population,”.

No, this is not a joke.  They really did study this.  It amazes me that there are people in the world that spend time and money on a study like this.

I have a better headline, “History Has Determined That Free Market Capitalism Causes Millions and Millions Fewer Premature Deaths”.

Or, “The North Korean Department Of Health Has Determined That Big Government Intrusion On the Free Market Causes Millions and Millions of Premature Deaths.”

Why Do We Demand To See Presidential Candidates Tax Returns?

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As you know, it has become commonplace for presidential candidates to release their tax returns to the public.  Of course, they are under no obligation to do so.  But, if they don’t, they are accused of hiding something.

The real question for me is, why do we feel like we have a right to see their private information?  Let’s think about the possible reasons for this.

1. We want to make sure they know how to prepare taxes.  Ummm, no.  They don’t prepare their own taxes.

2. We want to make sure they give money to charity.   This seems silly to me because any politician who is planning on running is going to make sure that they give to charity in advance, right?  Unless you’re John Kerry, Al Gore or Joe Biden.  John Kerry hardly ever gave anything to charity until 2003, the year before he ran for president and then he suddenly gave over $40,000.  Al Gore gave $353 to charity in 1997, while he was VP.  I guess things were just that tight for him.  And, of course, Joe Biden gave less than $1,000 per year to charity the ten years leading up to 2008 when he ran for president.  He didn’t bother bumping it up in 2007.

3.  We want to see how much their medical expenses are so we can make sure they are healthy.  This information is probably whited out and most people don’t go over the 7.5% threshold anyway, but even if they did and it wasn’t whited out you wouldn’t be able to tell for sure if the medical expenses were their’s, their spouse’s or their dependent’s.

4. We want to make sure they aren’t cheating on their taxes.  This also doesn’t make sense because how would you know?  You can’t tell by looking at someone’s tax return whether or not they cheated.  You would have to audit them and ask for backup documents.  Also, anyone who is planning on running for Governor, Senate, etc. is most likely not going to cheat on their taxes.  And, when they decide to run for President they certainly aren’t.  Most of these candidates have been in the public eye for years and years and know better than to try and cheat.  And, of course, they don’t do their own taxes anyway so in order to cheat they would have to lie to the tax preparer.

5.  We just want to know how much money they make.  Aha!  That’s it.  We want to know how much money they make compared to the percentage of tax that they pay so we can play class warfare.  But, does a presidential candidates income have anything to do with their potential ability to be president?  If success in your career is determined by the size of your income, wouldn’t we want a president to be extremely successful and have a very high income?  If that is the case, then why is it viewed as such a negative thing by the left that Mitt Romney has a high income?

I don’t really care how much money Mitt Romney makes, what percentage of it he paid to the U.S. Treasury, how much he gave to qualified 501(c)(3) charitable organizations, how much he spent on medical expenses or anything else that is suppose to be private.  I do care about what positions he takes on issues.

Change Things Up In 2012

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My family and I just got back from a fun and relaxing trip to Snowshoe Mountain, WV.  There is something special about being on the ski slopes high up in the mountains that is unlike any other vacation.  The freedom and excitement of choosing your own route down the mountain.  The coziness you feel in front of the fireplace at night with your family.  The removal of all of the daily distractions that we all experience.  The memories you create with your family make it well worth it.

Taking vacations also helps you to re-focus on your business with a new energy.  I think one of the reasons that vacations help you to re-focus and dive back into your business with excitement and energy is because you have changed up your routine.  For me this is especially important to do right before tax season.  The next few months are going to be very busy so getting renewed and refreshed is a great way to start off the year.

One of the worst things you can do in your business is the same thing – over and over.   Successful businesses are constantly changing and adapting.*

We all fall into the trap of redundancy.  We’re just wired that way.  Most of us do the exact same things, the exact same way, day in and day out.  The problem is, doing this causes us to create blind spots which makes it hard for us to improve.

Take your web-site for example.  How many times have you looked at your web-site/blog?  Hundreds, thousands?  At some point, you can’t tell anymore if it looks good.  You’ve looked at it too many times and you can no longer be objective.

Or, if you own a restaurant or a salon, you’ve walked through it hundreds, maybe thousands of times.  You are there so much that you can no longer see what the customer sees when they walk in.  You are blind from overexposure.

Change Things Up 

In 2012 one of my resolution is to Change Things Up.  I’m going to start doing things differently.  My goal is to do one thing differently each day.  Maybe I’ll take a different route to my office.  Maybe I’ll start off my day differently.  By doing this, we train out brains to think differently.

Another way to change things up is to ask for objective opinions from independent parties about your web-site, business cards, marketing materials, store image, etc.  And, the more people you ask the better.  For example, let’s say you own a restaurant and you are wondering what your customers think and feel when they walk in.  Find at least 5 – 10 people who would be willing to help you by coming in to your business and writing down everything that they notice, good and bad.  Then compare the results and you might be surprised by what you find out.  Make sure that you tell them that you are open to constructive criticism.  You could also offer them a gift card for $25 or something like that for their help.

These are some things I plan to do in my business in 2012 and I hope you do to.  Have a Happy and Prosperous New Year!

*This seems to work even with successful products, like whenever Coke changed to New Coke.  At first, the people at Coke looked like complete idiots.  But, when they changed back to Coca-Cola Classic their sales increased dramatically.  It was as if the whole thing was just a marketing ploy.

New Year’s Resolutions

Happy New Year everyone!

The “In Thing” right now is to not do resolutions.  Instead we hear things like “goals”, “words for the year”, etc.  That is fine.  Whatever works for you.  Personally, I think the problem with most New Year’s resolutions is that they set you up for failure.  For example, if you say, “I’m going to go to the gym at least twice a week in 2012″, that is great.  The problem is, the first week that you don’t make it twice, you feel like a failure.  Once you feel like you’ve failed the “resolution” seems pointless from that point forward.  I think a better idea for your resolution would be something like, “I’m going to make it to the gym 100 times in 2012.”  That way you have all year to do it and the average will still be about 2 times per week.

One of my resolutions for my business is to talk to 250 business owners this year, in person, about using my firms services.  That may sound like a lot but in reality it is only 5 per week.  In the second half of 2011 I spoke to nearly 100 business owners in person about using my firms services so I know I can speak with 250 in a full year.

Another resolution for my business this year is to “Change Things Up.”  I’ll be sharing more specifically what that means in the coming days.

Stay safe and God bless!