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Why writing the big check to Uncle Sam is the least of it.
By Brett Arends | SmartMoney – Thu, Apr 12, 2012 12:53 PM EDT
Have you got your schedule C in order? Have you hunted down all your receipts? Have you made sure to count the depreciation on your laptop and the percentage of your cable bill attributable to your home office expense? And what about those education credits?
After all, it’s not like you have anything else to do, right? It’s lucky it’s all so easy and painless. Ha!
Everybody hates Tax Day, which comes this year on April 17. And so do I. But not for the usual reasons.
This is the time of year when everyone seems to scream about just how much the federal government is costing us all. Weirdly enough, that’s not one of the things that really gets me. It’s the things that apparently no one else — at least no one else in the media — seems to notice.
Am I crazy? Am I alone? Maybe. You tell me.
Here are my top Tax Day hates.
Why isn’t there a riot about this? According to the National Taxpayers Union, we each waste about 12 hours a year, every year, filling out this crazy stuff. Schedule B. Schedule C. Above the line. Below the line. Deductions, exemptions, non-refundable credits. Medical bills over 7.5% of adjusted gross income.
It’s like we’re being mugged and held hostage. Every year.
The instruction booklet for the 1040 now runs to 189 pages. No kidding. Seventy-five years ago, says the NTU, it was two pages.
The U.S. tax code is insane and out of control. It’s tripled in a decade. It now runs to 3.8 million words. To put that in context, William Shakespeare only needed 900,000 words to say everything he had to say. Hamlet. Othello. The history plays. The sonnets. The whole shebang. But the IRS needs four times as many words? Really?
Your tax bill this year is a lie. You’re only seeing about two-thirds of the full cost of government services. Really. Taxes are $2.3 trillion. Government spending is $3.6 trillion. The rest is being put on the national credit card.
The tax bill is a lie every year. We’ve only paid our bills in full on April 15 five times in the last fifty years. The last president to balance the books every year he was in office? Calvin Coolidge — back in the 1920s. How pathetic is that?
Deficits are just future taxes. According to the non-partisan Tax Foundation, “Tax Freedom Day” falls on April 17 this year — but “Deficit Day,” which includes the full bill, won’t come for another month.
Taxes — to steal from Albert Einstein — should be as low as possible, but no lower. Stop lying to me.
3. How they treat investment income
Aunt Sally in Dubuque lives off her savings. Her taxes should be relatively simple. But good luck with that.
She has money invested in blue-chip companies like AT&T and Wal-Mart. Her stock dividends are taxed at 15% or less. Meanwhile her bond coupons are taxed at ordinary income rates up to 35%. It’s crazy.
Yes, I know the corporations get a break on their bond payments. But what’s up with that?
Now try this: Aunt Sally can pay lower taxes on the money she makes from bonds — but only if she sells them after a year for a long-term capital gain. If she hangs on and keeps clipping the coupons, she gets whacked with higher taxes.
The tax treatment of investment income is arbitrary and stupid. We treat debt and equity differently for companies and investors. It’s irrational. The rules encourage debt. And we treat long-term capital gains better than short-term ones. That’s absurd. We only buy securities because we think they are undervalued. Why is it better if they rise in price slowly instead of quickly?
It doesn’t end there. Why should you pay income tax on zero-coupon bonds last year just because they rose in value — even if you didn’t sell them or pocket any income? If that’s the rule, why shouldn’t you pay income tax on your Apple stock? Instead you don’t even have to pay capital gains tax, until you sell.
Make the rules simple, rational and clear.
4. The mortgage interest deduction
Uncle Sam should stop bribing me to borrow money I don’t have to buy a home that I cannot currently afford.
The mortgage interest tax deduction is wildly popular, but it’s a terrible idea. The logic is upside down. It rewards debt and real estate speculation. It rewards high earners who buy really pricey homes at the expense of everyone else.
Forget the idea of a “middle-class tax break.” If you’re a typical family, you’re lucky to save a few thousand dollars. But if you’re a bond trader buying a Park Avenue penthouse it could save you $20,000.
Until the recent housing collapse — caused, of course, by too much debt — this tax break helped drive up real estate prices. That priced many ordinary people out of the housing market. They had to borrow even more to get in. Cue the debt crisis. (Or they were forced to rent for longer — and their rents, perversely, weren’t deductible.)
According to various analyses, home owners “save” about $130 billion a year from this break. But that’s nonsense. Tax breaks like this drive up overall tax rates for everybody. To bring them back down, you have to borrow money and buy an expensive home so you can take the deduction.
Get rid of this stupid break and just raise the standard deduction for everyone.
5. Stupid retirement rules
Uncle Sam wants me to save for my retirement. But only under certain conditions. Sure, he says, I can put aside $17,000 in pretax income. But only if I save through my employer’s 401(k) plan. If I’m a regular salaried worker, I can’t go down to Fidelity or Schwab and open my own such plan.
For that matter, why am I allowed to invest $5,000 in a Roth IRA, but only if my income is below a certain threshold? Why are married couples filing taxes separately basically not allowed to invest in a Roth IRA at all? And why do the “catch-up” provisions, which allow people to save even more in their IRAs, only kick in once they turn 50? Isn’t that too late? Shouldn’t we be encouraging people to save more when they are younger?
Uncle Sam has some good instincts, but he is like your worst boss or your most annoying aunt. He just can’t stop meddling. He just can’t leave people alone.
Most 401(k) plans are mediocre, because employers run them. They have to protect themselves from costs and liabilities. So they limit the choices, and shunt you into one-size-fits-all investment plans. Yet amazingly they often include one of the riskiest investments you can make — their own stock.
It makes no sense. If Uncle Sam wants me to save $17,000 off the top of my income, he should just let me do so, and get out of my way. And the “catch-up” provisions should affect everyone.
Are you unable to complete and file your federal individual tax return by the April 17th deadline? If so, you can request an extension of time to file, which will automatically give you until Oct. 15, 2012, to submit your tax return to the Internal Revenue Service.
An extension gives you an additional six months to file your tax return. But keep in mind that an extension of time to file is not an extension of time to pay. All outstanding balances are due on April 17, 2012.
Numerous Ways to Get an Extension
In order to get an extension, you need to file Form 4868 with the IRS.
Taxpayers can electronically file Form 4868 through IRS Free File or Free File Fillable Forms. Using Free File to prepare and electronically submit Form 4868 is free to everyone, regardless of income.
Paid preparers can also electronically file Form 4868 as can tax software that you run on your computer.
Finally, a paper version of Form 4868 is available for download from IRS.gov. However, the IRS will only provide an acknowledgement of your extension request if you e-file or Free File the request.
When you request an extension, you need to estimate your tax liability and pay any balance due bu the April 17th deadline. If you are unable to pay the total balance due, you should pay as much as possible and apply for an installment agreement.
By David Wessel | The Wall Street Journal – Thu, Apr 12, 2012 12:01 AM EDT
“People want to have a ready way to save,” says Michael Barr, a University of Michigan law professor and a former Obama and Clinton Treasury official. “For some families, tax time is a good time to do so.”
In the mid-2000s, Mr. Barr and colleagues surveyed about 650 low- and moderate-income families in the Detroit area who had filed tax returns in 2003 or 2004. About 82% received refunds—either because they had overpaid or because they qualified for the federal Earned Income Credit, a federal cash bonus to low-wage workers that is paid through the IRS. The average refund exceeded $2,000, a significant sum for people who say they have trouble making ends meet.
Retailers often target refund recipients, and half the Detroiters said they spent all the refund, most often to pay bills or debts or to buy appliances or cars.
Half the recipients saved at least some of the refund. “There is a desire to save,” Mr. Barr says. “The saving is not for retirement. It’s for short-term goals, for financial stability, so if tough times hit, they don’t have to go see the payday lender or go to family and friends or stop eating.”
In fact, Mr. Barr and co-author Jane Dokko of the Federal Reserve Board, found these folks don’t want smaller tax refunds. In the survey, researchers offered them choices: Withhold $100 a month more and get a bigger refund (an option favored by 35%), withhold the same amount and get the same refund (46%) or withhold less and get a smaller refund (only 19%). This and other survey findings appear in a coming Brookings Institution book, “No Slack: The Financial Lives of Low-Income Americans.”
Behavioral economists have found that people respond better to a nudge than a simple up-or-down choice, an observation that has led many employers to automatically enroll workers in retirement-savings plan (and allow them to opt out) instead of asking if they want to enroll or not. A 2005 academic experiment in which some H & R Block customers were offered a 20% or 50% match when they learned the size of their refund if they put money into an Individual Retirement Account proved more successful than the little-understood Saver’s Credit in the tax code that offers much the same incentive.
Pushed by the Treasury and outside academics, the IRS has been experimenting with ways to nudge people to save at refund time. In the mid-2000s, it began allowing taxpayers to split tax refunds between, say, a checking account and a savings account or an Individual Retirement Account. Last year more than 750,000 people took the option, an increase of 36% from 2010.
But that requires the person to have a pre-existing savings account or an IRA; a lot of low-income people don’t. Last year, the Treasury mailed letters to 808,000 taxpayers likely to have low or moderate incomes and offered to load their refunds on a debit card; only 239 took the offer, according to the inspector general for tax administration.
Another experiment appears a bit more promising. Two years ago, the IRS began asking taxpayers if they wanted to use some or all of their refund to buy a U.S. savings bond. Last year, about 30,000 people bought $11.5 million in savings bonds. The program is very small, but growing. So far this year, sales are running 60% above year-ago levels.
While the Treasury is doing away with paper savings bonds for everyone else, it has made an exception for these savers, figuring making the savings tangible is important.
The goal is “to create as many avenues as possible to make it easier to save,” Mr. Iwry says. “Someone who begins saving at least part of their tax refund might acquire the habit and start saving in other ways as well.”
None of this is going to solve the national savings dearth. Most personal saving in the U.S. will continue to be done by people with lots of money to spare. These experiments, instead, are aimed at making individuals a bit more financially secure, a creative attempt to promote a culture of saving in a country with too little of it.
NEW YORK (Reuters) – It’s one of the worst tax time scenarios: You discover while doing your taxes — or you just know without even doing them —that you owe taxes, and you don’t have the cash. What should you do?
You may be tempted to ignore the problem. Don’t do it. The worst thing you can do is put off filing your return because you’re afraid of the bill. The Internal Revenue Service (IRS) penalties for not filing are more punitive than the ones for not paying.
The failure-to-file penalty runs to 5.0 percent a month that your return is late, up to 25 percent, with a minimum penalty of $135. The failure-to-pay penalty is just a fraction of that, at 0.5 percent a month of the unpaid tax at April 17, and even that is cut in half for taxpayers who set up a formal installment plan with the IRS. Either way, you’ll also owe interest, currently at a modest 3.0 percent a year.
Consider the case of a taxpayer who owes $2,000 and won’t have the money until the end of June. If she files a return or an extension by April 17, the total penalties and interest due would be just $43, according to an analysis run by The Tax Institute at H&R Block for Thomson Reuters.
But if she puts off filing until June 30, and pays then, those penalties and interest would multiply to $314, said H&R Block. The longer this taxpayer waits to file, the more those fees would balloon.
“That’s a lot of money for late filing,” says Allison Shipley, a partner at PricewaterhouseCoopers in Miami. “And, in my experience with clients who have had a difference with the IRS, they tend to be more lenient if you’ve always filed your returns on time.”
So the first step to consider if you’re not ready to file is the simplest: File for a six-month extension, using Form 4868. As long as you’ve paid 90 percent of the taxes you owe by April 17, you will not owe the late-filing penalty. You will, however, still owe interest on any unpaid taxes.
If you have the cash, but have run out of time to deal with the paperwork, you can send in an estimated amount to avoid some or all of that interest. Similarly, if you owe taxes, but can’t pay all that you owe, you could send in a partial payment to cut the interest and penalties due.
The IRS does offer a few hardship breaks for cash-poor filers. The big one in effect this year is called Fresh Start, and lets those who were unemployed request a six-month extension to pay this year’s tax bill without being charged any penalties.
You would qualify if you did not have a job for 30 straight days in 2011 or in 2012 until April 17, or if you were self-employed and saw your income drop by at least 25 percent in 2011 due to the economy. You would file Form 1127, and automatically get until October 15 to pay. While you would get out of the penalties for six months, you would still owe interest.
Those who have survived a natural disaster or who are on active military duty may also qualify for penalty-free extensions for varying amounts of time.
FINDING THE CASH
If you are not in one of these special categories, and you owe more than you have, you may want to weigh your various options for finding the money you need. You could: (1) put your tax bill on your credit card; (2)Use a home-equity line of credit; (3)just pay late and swallow the penalties and interest; or (4)ask the IRS to accept a formal installment agreement.
While the standard advice is to pay the IRS first, that may not make sense this year. IRS rates are so low, compared to credit card rates, that it may make more sense to deal with the tax agency directly. A tax installment payment plan, even with penalties, costs around 6.0 percent a year.
“This is an interesting time for strategy because of those low rates,” says Larry McKoy, a certified public accountant at Dickson Hughes Goodman in Glen Allen, Virginia.
Not only is the average rate on credit cards currently 15 percent, according to CreditCard.com, but when you pay taxes on a credit card you also have to pay an added “convenience fee” that could add as much as 2.0 percent to your transaction. That’s because the IRS is prohibited from paying the interchange fees most retailers pay on card transactions.
If you have access to a home equity line of credit, it may be worth tapping that because the rate is likely lower and you do not have to worry about those taxes hanging over your head, says Gregg Wind, a certified public account with Wind & Stern in Los Angeles.
INSTALLMENT PLAN COMPLEXITITES
There’s no hard-and-fast rule for when to do an installment plan, but the higher the amount you owe and the longer it will take you to pay it, the better off you are to request one rather than simply paying late. An installment plan will put your payments on a monthly schedule and cut your penalty on unpaid taxes in half, to 0.25 percent.
To set one up, you will file Form 9465 and pay an application fee of between $43 and $105, depending on your income level and whether you are willing to pay through automatic deductions from your checking account or paycheck.(The instructions to Form 9465 are available at the IRS website (http://www.irs.gov/pub/irs-pdf/i9465.pdf)
The IRS can reject an installment agreement, but usually does not, unless filers owe an astronomical sum or request a overly lengthy payment period. In fact, acceptance is guaranteed if you owe less than $10,000, request a payment period of three years or less, you have paid all your taxes for the last five years and the “the IRS determines that you cannot pay the tax owed in full when it is due,” according to the IRS’s rules on installment agreements.
For larger tax liabilities, the process gets more complex, though there is a streamlined application process for those who owe no more than $50,000. Taxpayers who owe larger amounts must file Form 9465-FS.
“If it’s under $50,000 you are not going to be asked to file a lot of financial information,” says Wind. “A lot of people are overwhelmed by the thought of compiling a lot of financial information, but they don’t need to be.”
Better to fill out a few extra forms than get stuck paying 5 percent a month, every month, for not filing them.
(The author is a Reuters contributor. The opinions expressed are his/her own.)
(Amy Feldman; Editing by Linda Stern)