Free Money Finance

When You Should Have Your Taxes Done

As tax season gets close to wrapping up, I thought this piece from Business Insider was timely

It gives a flowchart, decision-tree on whether you should do your taxes yourself or have someone else do them for you.

The times they suggest you should hire someone include:

• Household income over $200k
• Self-employed or own a business
• Extensive investments
• Make large charitable donations
• Had a major life change like baby or marriage
• Don't have the time and patience to DIY

Other than the major life changes, all of these pertained to my family for most of the past 20 years. That's why we've used a CPA to do our taxes for most of that time.

This year it took me a fraction of the time to get everything together for my CPA. Once I retired things did get a bit less complicated in some ways, but more complicated in others (like having a daughter in college.) So unless things shift drastically for us, we'll probably keep using a CPA for taxes for the foreseeable future.

How about you? Do you hire someone or DIY? Why did you decide to do it this way?

How to Maximize Your Tax Return

The following post is from FMF contributor Brad Richardson.

Two things in life are a given: death and taxes. No one looks forward to either, but there are ways to make the latter a little less painful. Obviously, seeking a professional opinion is necessary when considering your taxes, but here are some tips on how to maximize your tax return.

Jointly or Separately?

If you are married, you are most likely filing your taxes jointly. This may not be the best way. Calculate your taxes both ways, and see which method will give you biggest return.

Deductions

When it comes to figuring out what you can and can’t deduct from your taxes, many choose to err on the side of caution. While it is better than the alternative, it can also lead to you missing out on some returns.

Keep a record of your deductions, making sure you don’t forget any when the time comes. What you can deduct includes:

• Retirement contributions -- By putting money into your retirement fund, you will be increasing the amount you will receive when that joyous day arrives, and lowering the amount you will be declaring as income. This means your taxes will be lower.
• Health fund contributions -- Not only will having health insurance protect you and your family from exorbitant medical costs, but can save you from having to pay a fee. Sign up before the end of the financial year, and use the money as insurance revenue.
• Expenses incurred when moving for a new job
• Charity work and donations - for example, establishing a monetary value on items donated, or cost of ingredients used to make donated food
• Professional expenses -- If you are a teacher and have had to purchase supplies for your class; Necessary subscription costs not already reimbursed by your business; Union fees; Telephone costs - This can be a business-only telephone, or your personal phone, in which you will receive part paid; Uniforms and travel - These are sometimes deductible; Certain costs from your self-employed business
• Family-related costs -- A number of expenses you incur while looking after your children or elderly parents are deductible. This does not include child support; Alimony payments; Family healthcare expenses
• Eco-friendly expenses -- If you are renovating or improving your home, look for energy-saver appliances and services. Not only will this help the environment and lower your bills (i.e. electricity), but you can receive a deduction or credit for doing it.
• Education -- Those undertaking education courses (college or vocational school) can be eligible to receive a refund for items such as tuition, textbooks, and supplies.

Timing

In order to bolster the amount of money you will get returned to you from your taxes, consider the timing of paying your bills.

• Pay January’s mortgage payment before the end of December to get the added interest
• Have any medical procedures done to use in that year’s medical deductions

As previously stated, this information is inferior to that of a professional accountant, but hopefully they can help you get a back the money you deserve.

How's Your State Performing?

Not too long ago I received an email from WalletHub with a couple of survey results.

The first listed 2017’s states with the best and worst taxpayer ROI.

The best ten are:

1 - New Hampshire
2 - South Dakota
3 - Florida
4 - Virginia
5 - Alaska
6 - Colorado
7 - Utah
8 - Missouri
9 - Texas
10 - Nebraska

And the worst ten are:

40 - West Virginia
41 - Vermont
42 - Nevada
43 - Wyoming
44 - Delaware
45 - Arkansas
46 - New York
47 - California
48 - New Mexico
49 - Hawaii
50 - North Dakota

I was pleased with these results since my state (Colorado) was in the top ten. I guess I'm getting a good bang-for-my-buck tax-wise.

They also sent me a list of 2017’s most and least financially literate states.

The best ten are:

1 - New Hampshire
2 - Minnesota
3 - North Dakota
4 - Maine
5 - Virginia
6 - Maryland
7 - New Jersey
8 - Illinois
9 - Colorado
10 - Montana

And the worst ten are:

41 - Arkansas
42 - Nevada
43 - Tennessee
44 - New Mexico
45 - Alaska
46 - Oklahoma
47 - Mississippi
48 - Kentucky
49 - Rhode Island
50 - District of Columbia
51 - Louisiana

Some thoughts on this:

• My state is again in the top ten! Woo hoo!
• New Hampshire heads both top ten lists. Those people must have their act together!
• Virginia is also in the top ten for both.
• Arkansas, Nevada, and New Mexico were on both worst ten lists. Ugh.
• Alaska and North Dakota had split results -- once on the best ten and once on the worst ten.

Those are my thoughts and how my state performed. How did yours do?

Did You Do Your Own Taxes or Use a Tax Pro?

Yes, I realize this post is a couple months late for many. You can use it next year!

As tax season is close to an end, I wanted to share this tool from Dave Ramsey about whether you should do your taxes yourself or hire a tax pro.

It takes you through a series of questions and then recommends a solution.

My guess is that the simpler your taxes are, the more likely you'll get "do them yourself" and the more complicated they are the more likely you'll get "hire a pro."

I took the test and it came back with "hire a pro." Which is good since I've used a CPA to do my taxes for years. Why? There are tons of reasons why you should hire a tax pro, but here's one great reason from the end of Dave's survey. It's a quote from someone who hire a tax pro:

"I tried online software with no luck. The difference between the return I would have received and what your ELP was able to get for me was almost $3,000!"

Now it's worth mentioning that this tool is being used by Dave to identify those who may want/need to use a tax pro and then refer them to someone in Dave's network. Not saying there's anything wrong with that, but just want to be sure everything is fully disclosed.

That said, there's no doubt to me that my CPA saves me more in time (many, many hours) and money (by catching things I don't even know about) to pay for her fee. So it's well worth it to me.

How about you? Do you do your own taxes or does someone do them for you?

Fourteen Ways to Avoid Paying Capital Gains

The following is a guest post from Marotta Wealth Management. I've stripped out the political commentary (or at least I think I have -- hope I didn't miss anything) because it didn't really add anything, but am running the piece anyway because I think it lists some good ideas on how to avoid capital gains taxes if you really want to.

The capital gains tax traps wealth in an investment vehicle requiring special techniques to free the capital without penalty.

Multiple ways are available to avoid the tax. Here are 14 of the loopholes the government's gain tax unintentionally incentivizes.

1. Match losses. Investors can realize losses to offset and cancel their gains for a particular year. Savvy investors harvest capital losses as they occur and then use them on current and future taxes. Up to $3,000 of excess losses not used to cancel gains can offset ordinary income. The remainder of the loss can be stored and carried forward indefinitely.

This encourages investors to sell great investment vehicles during a temporary dip only to buy them back again 30 days later for a new cost basis.

2. Primary residence exclusion. Individuals can exclude up to $250,000 of capital gains from the sale of their primary residence (or $500,000 for a married couple).

Families who stay in the same home for decades suffer a tax that more mobile families avoid.

Smart homeowners who might move or need the capital move more frequently to avoid the tax. Needlessly selling and buying a home is the arduous cost to the economy.

3. Home renovation. Sharp real estate agents and home renovators make their under-market investment purchases their primary residence while they are fixing them up. They then flip the houses, selling for a better sales price but avoiding any tax on their gains via the primary residence exclusion.

4. 1031 exchange. If you sell rental or investment property, you can avoid capital gains and depreciation recapture taxes by rolling the proceeds of your sale into a similar type of investment within 180 days. This like-kind exchange is called a 1031 exchange after the relevant section of the tax code. Although the rules are so complex that people have jobs that consist of nothing but 1013 exchanges, no one trying to avoid paying this capital gains tax fails. This piece of valueless paperwork does the trick.

5. Stock exchange. Stock investors with highly appreciated securities can also do a like-kind exchange. Certain services offer investors with one highly appreciated security a way to trade it for an equivalently valued but more diversified portfolio. This expensive service can help investors avoid paying even larger capital gains taxes.

6. Exchange-traded funds. ETFs use stock exchanges to avoid triggering capital gains taxes when stocks move in or out of the index on which the ETF is based. Stocks moving out of the index are exchanged for stocks moving into the index. Investor cost basis transfers to the new securities.

7. Traditional IRA and 401k. If you are in the higher tax brackets during your working career, you can benefit from contributing to a traditional IRA or 401k. This both reduces your income while you are in the higher brackets and eliminates any capital gains as a result of trading in the account. Rebalancing by selling appreciated asset classes in a tax-deferred account avoids the capital gains tax normally associated with such trading. During the gap years, between retirement and age 70, withdrawals from these accounts could be made in the lower tax brackets.

8. Roth IRA and 401k. Traditional accounts can postpone taxes to a more favorable year, but Roth accounts can avoid them altogether. Having paid tax on deposits, a Roth account allows tax-free growth for the remainder of not only your life but also the lifetime of your heirs. Unless you are in the higher tax brackets and approaching the gap years, Roth accounts are usually an excellent tax strategy.

9. Health Savings Accounts. HSAs are one of the few accounts where you can receive a tax deduction for contributing to them, invest them and receive tax free growth and then not pay any taxes as long as you use withdrawals for qualified health expenses. Investing your HSA account to receive tax free growth is another way to avoid paying the capital gains tax.

10. Give stocks to family members. If you are facing a high capital gains rate, you can give your highly appreciated securities to family members who are in lower brackets. Those receiving the gift assume your cost basis for computing the gain but use their own tax rate.

11. Move to a lower tax bracket state. State taxes are added on to federal capital gains tax rates and vary depending on your location. California has the highest U.S. capital gains rate and the second highest internationally, with a top rate of 37.1%.

In the United States, seven states add nothing to the federal top rate of 23.8%: Alaska, Florida, South Dakota, Tennessee, Texas, Washington and Wyoming.

12. Gift to charity. Instead of giving cash to the charities you support, you can give appreciated stock. You receive the same tax deduction. When the charity sells the stock, it is not subject to any capital gains tax. The cash you would have given is the same amount you would have had for selling the stock and paying no capital gains yourself.

13. Buy and hold. Many investors buy good index funds that never need to be sold. Even if you rebalance regularly, rebalancing can often be accomplished by using the interest and dividends paid to purchase whichever investments need to be bolstered. The downside is that your capital is locked inside the investment vehicles and not free to be used for greater economic gain.

14. Wait until you die. Most people die holding highly appreciated investments. When you die, your heirs get a step up in cost basis and therefore pay no capital gains tax on a lifetime of growth.

Because most savvy individuals can decide the timing and amount of capital gains they choose to realize each year, the capital gains tax is considered very elastic. The amount of capital gains realized depends heavily on the favorability of the capital gains tax rate. As a result, over half of capital gains are never taxed.

Capital Gains Tax Gets More Complicated

The following is a guest post from Marotta Wealth Management. I have made my share of tax mistakes when selling assets, but have also used market downturns (like 2008) and charitable donations of stock (as he notes below) to strategically readjust my holdings. I should be in a place where I don't need to sell any assets for quite some time, but this is a topic that we all still need to be reminded of and consider from time to time. Not sure his "capital gains should be 0%" at the end is right, but it would make things much simpler.

How you deal with the new capital gains rates hinges on your tax bracket. The strategies to deal with capital gains differ for each level.

Capital gains taxes became very confusing last year. Before 2013, there were only two capital gains rates for assets held for more than a year. Now you may pay one of at least four different rates on market earnings, depending on how much income and gain you see in any year. But through strategic planning, you can chip away at even the harshest tax rates.

When you sell certain assets, such as stocks and bonds, you may incur capital gains. A capital asset also includes most property you own and use for personal or investment purposes. If the original purchase price of the asset plus associated expenses (collectively called the "cost basis") is less than the proceeds you receive from the sale, you incur a capital gain.

If you’re in the 10% or 15% federal income tax bracket, you are eligible for the 0% capital gains rate. You can realize capital gains equal to the difference between the top of the 15% income tax bracket and your current adjusted gross income without incurring additional tax. However, if you realize too many gains all in one year, you must pay a 15% tax on the amount.

In 2014, remaining in the 0% rate means keeping the sum of income and capital gains below $73,800 annually for married filing jointly and below $36,900 for single filing.

Most middle-income taxpayers pay the 15% rate. Trying to avoid paying this rate is not always worthwhile.

For example, when you sell $20,000 of stock with a cost basis (original value) of $10,000, you pay capital gains on the $10,000 of gain. If you are in the 15% bracket, you owe federal tax of $1,500 plus your state tax.

If you made the sale to rebalance your portfolio, this tax leaves you with only $17,925 of your original $20,000 to reinvest. When you reinvest, your new cost basis starts at $17,925 instead of $10,000. Since you have less to reinvest and earn a return, you need to earn a little more to make up for the loss from taxes. The extra amount you have to earn to break even is called the "growth hurdle." The size of the hurdle can be calculated using the percentage of appreciation and the amount of time you hold the new investment.

Any new investment you choose will need to overcome the hurdle. It can sometimes be accomplished by purchasing an investment with a lower expense ratio than the one you sold.

If you hold highly appreciated stock of a single company, the risk to your portfolio is not worth trying to avoid capital gains. Whenever a single company’s stock represents more than 15% of your portfolio, use a tax savvy strategy to trim your holdings in that stock bit by bit each year.

Should your modified adjusted gross income (MAGI) exceed $250,000 (for married filing jointly) or $200,000 (for single filing), you owe an additional 3.8% beyond the tax rate of 15% thanks to the Affordable Care Act (ACA). This created the new rate of 18.8%.

This tax rate always applies to the 35% federal bracket, those earning under $457,601 (if married filing jointly) or $406,751 (single) annually. This surtax may also apply to the brackets below it. MAGI can be significantly larger than taxable income because it is not reduced by "below-the-line deductions."

The same surtax will also always apply to the topmost bracket as well. In the 39.6% federal tax bracket and making over $457,601 (married filing jointly) or $406,751 (single), you are subject to a 20% capital gains tax. Since your MAGI is automatically high, you are also subject to the 3.8% ACA tax, hiking your total capital gains tax to 23.8%.

Because of the ACA surtax, two financially successful people have little incentive to marry or remain married. A cohabiting couple each earning $200,000 can avoid the 3.8% surtax, whereas their married counterparts will face the full 18.8% rate in addition to other federal income tax penalties.

The tax rates, and therefore the growth hurdle, are higher for married couples simply because their incomes or the business profits stack on each other, pushing them into a higher bracket.

Some hurdle rates are so high, it is not worth selling well-performing appreciated investments. However, two options other than selling are available.

First, if you are charitably inclined, you can use your highly appreciated stock as gifts to the charities you support. You get the full deduction of the donation. The charity, as a nonprofit, does not have to pay the capital gains when it is sold.

Second, if you are charitable to your family, you can gift highly appreciated stock to family members who might be in a lower capital gains tax bracket. Children do not get a step up in cost basis, but selling the investment in their lower bracket may mean retaining more of the value.

Each donor can gift up to $14,000 per year per recipient without paying gift tax.

Thus a couple could gift $28,000 of highly appreciated stock to each of their children. If the sum of $28,000 and the child's income was below $36,900, the child would pay no capital gains tax. For a married child, you could gift $56,000, each spouse gifting the maximum to each spouse. If the sum was below $73,800, the child's family would pay no capital gains tax.

That all being said, the tax code leaves persons who are not charitably inclined or need the investment's value without a clear way to retain the value of their investments when rebalancing their portfolio or liquidating a part of their wealth.

Paying capital gains tax at rates of 18.8% and 23.8% hurts, especially after adding in your top state tax rate. In Virginia that top rate is 5.75%, but elsewhere it is much higher (e.g., California at 13.3%). Hurdle rates become particularly important for decisions regarding realizing capital gains.

Careless transactions in large portfolios can have huge tax consequences. It shouldn't be only those with a savvy financial advisor who are able to dodge this tax bullet. It would be far preferable if we had a capital gains rate of 0% for everyone.

Two Questions on Tax Refunds

Here are two questions about tax refunds:

• Are you going to get one this year?
• If so, what are you going to do with it?

I have not yet received my final tax return, so I'm not sure whether or not I will get one. My guess is that I will since I overpaid Social Security taxes (because I changed jobs). If I do, I'll simply save/invest the amount. I don't look at it as "extra" money and won't plan on going on a spending spree.

How about you? What are your answers to the questions above?

FYI, the average refund this year is over $3,000.

How Long Should I Keep Financial and Tax Records?

The following is a guest post from Marotta Wealth Management.

If you haven't been traumatized by an IRS audit, you probably don't keep much financial documentation. If you have, you are probably terrified to part with a single receipt.

The IRS is one of the few courts where failure to produce proof of your claims results in the assumption that you are guilty of tax fraud. Thus you must save all the financial documents you used to create your taxes to defend yourself in an audit.

First, retain a paper copy or receipt of any tax-relevant financial exchange. Scan these documents and archive them electronically, or acquire them in an electronic format. If the purchase has a manual or warranty, store all the documents in the same electronic and physical location.

Sadly, the IRS has ruled bank or credit card records to be insufficient documentation. As a result, just keep your statements long enough to reconcile your account.

If the purchase was a business or tax-deductible expense, record the expense and why it justifies the deduction. Store this information with or on the receipts. Second, keep brokerage statements indefinitely for taxable accounts. You are responsible for reporting the cost basis of any security you sell to calculate the capital gains tax. For a mutual fund with 30 years of reinvested dividends, each dividend payment is part of the cost basis. As a result, the cost basis can sometimes be computed only if you have the complete transaction history.

Without knowing the cost basis, the IRS could argue that the entire value of the investment be treated as gain.

If you have lost the record of how much you originally paid for an investment, instead of selling and paying 15% or more of the value in taxes, you can use that investment as part of your charitable giving. Gifting appreciated stock avoids the tax owed and still qualifies for a full deduction. Oddly enough, the IRS still asks for the original purchase date and price for gifted securities, but leaving these blank has no effect on your tax owed.

Many custodians keep several years of electronic copies of brokerage statements available. And they are now required to send any known cost basis electronically when you transfer securities to a new custodian. If your current custodian has the correct cost basis of your securities, you probably no longer need to keep brokerage statements. However, better safe than sorry is always advisable with the IRS.

Third, keep IRA nondeductible contribution records forever. You may need those records every year that you withdraw money in retirement to show that a portion of the withdrawal is not tax deductible.

Or to avoid the hassle, clear out nondeductible IRA contributions by converting all of your IRA accounts to Roth accounts.

Fourth, keep partnership documents, contracts, commission or royalty structures forever. This includes property records, deeds and titles, especially those relating to intellectual property. It also includes any transfers of value for estate planning purposes.

Finally, save all of your tax returns. After you file, save the paper and/or electronic copies with the rest of that year's financial documents.

Once a year, we scan and compile all the records that support our tax returns into PDF documents and send them electronically to the certified public accountant who does our taxes. Having the information scanned gives us an electronic backup of the paper records that we still retain. Storing financial records electronically is one of the only ways keeping them indefinitely seems realistic.

Tax returns and all the supporting documentation must be kept at least seven years. The IRS can audit your return for up to three years from your filing date. However, the three-year limit only applies to good-faith errors.

If the IRS suspects you underreported your gross income by 25% or more, they have up to six years to challenge your return. And because you may file for an extension at the October 15 deadline, you must keep your records for at least seven years.

Regardless of those rules, though, if the IRS suspects you filed a fraudulent return, no statute of limitations applies. Because the IRS has been proven to be malicious, we suggest keeping your tax returns and documents forever.

If you are unfamiliar with the federal tax courts, the interpretation of the law is anything but clear. Consensus grows gradually as practitioners interpret legal and accounting opinions and then wait to see if the IRS notices and subsequently chooses to challenge them. Then they have to wait for a taxpayer willing to go to court to see which interpretation wins.

It is unreasonable to tell people to settle for the most conservative government-always-wins interpretation. Collectively, trillions of dollars are at stake for individual taxpayers, especially small business owners. The annual differences between interpretations are in the hundreds of thousands of dollars.

Unfortunately, whenever the IRS challenges you, the burden of producing evidence that your claims are true rests entirely with you, so you better have your documentation in order.

Taxpayers collectively spend six billion hours or 8,758 lifetimes annually trying to comply with the tax code. That is, IRS legislation kills the equivalent of 8,758 newborns each year. Such an enormous waste of life is completely unnecessary. Were any private companies responsible for such abuse, we would make laws preventing it.

We could easily abolish the Fourteenth Amendment and replace the federal income tax with a tax on consumption or a poll tax. As an added bonus, in a world without the income tax, you would not be obligated to report your private financial matters to the government each year.

Average Tax Refunds

The Wall Street Journal lists the average tax refund as follows:

• Income: $25k-50k; Average Refund: $2,774
• Income: $50k-75k; Average Refund: $3,051
• Income: $75k-100k; Average Refund: $3,657
• Income: $100k-200k; Average Refund: $4,704

I'm wondering if these are too high or not. On one hand, it seems like a lot of money that's "loaned" to the federal government each year. The people making $25k a year are shelling out too much -- to the tune of 10% of their income (unless their refunds are based on earned income credits and the like which they don't have to pay for).

On the other hand, if you make $150k a year, $5k probably isn't that much off. You probably have a whole lot of tax issues to deal with and getting closer to $0 is difficult to do.

We owed money this year, so I guess the government gave us a loan. :) It seems to run in cycles depending on my annual bonus as well as (lately) investments in real estate -- we owe one year, then get a refund the next. No real pattern that I can see.

What's also interesting is what they say to do with the refunds:

1. Pay off your credit cards
2. Take a course
3. Increase your 401(k) contribution
4. Pay down your mortgage
5. Gamble on … Italy (Invest)

Can't say I disagree with any of these, though the last one seems like it was added to be "cute". Personally, I'd go with a stock index fund from Vanguard or save the cash to be used for investment in real estate.

What's your take on these numbers? Too high or are they "ok"?

How Will You Spend Your Tax Refund?

NBC News tells how Americans plan to spend their tax refunds this year:

A TD Ameritrade survey released last month found that 47 percent of those expecting to get a refund plan to bulk up their savings account with it, while 44 percent plan to use the money to pay debt.

About 28 plan to spend at least some on necessities and 15 percent plan to splurge on something discretionary. Respondents were allowed to pick more than one answer.

FYI, the average tax refund last year was around $2,900.

Here's what I'm planning on doing with my refund this year: nothing. I'm not planning on getting a refund. In fact, I'll likely owe a good amount. My CPA is still working the final numbers and there are lots of moving parts, but I'm anticipating having to pay.

How about you? Will you be getting a refund? If so, what do you plan to do with it (or what have you already done with it)?

How Are Your Taxes Prepared?

Business Week recently shared a chart that showed how Americans have their taxes prepared. 60% of people use an "expert" (their words) while 40% do it themselves. Here's the breakdown for each:

60% have their taxes prepared by an expert

• 45% by mom and pop tax preparers, CPAs, and lawyers
• 10% by H&R Block
• 5% by Jackson Hewitt and Liberty Tax Service

40% do their taxes themselves

• 20% use TurboTax
• 7.5% use pen and paper (old school!)
• 6% use H&R Block Digital
• 3.5% use TaxAct
• 3.5% use some other software product

Here are my thoughts on this information:

• I was surprised that a majority of people had their taxes done by someone else. I thought that most people did it themselves. Why? Because most tax returns are pretty simple, so why wouldn't people do them themselves?
• I was surprised that so many do taxes by hand. I guess that for very simple returns, it's no problem. But with simple things like "math" being a key reason there's a mistake on a return, I would think some software help would be prudent.
• I wonder what the breakdowns are between "mom and pop" preparers and "higher level" preparers like CPAs and lawyers.

I've detailed why I use a CPA to do my taxes, but the main reasons are that she saves me time, money, and frustration. And especially this year, when my taxes are complicated even more by an LLC with rental properties, I am glad I have a CPA working for me. (Note: You can read up on the new CPA I got last year by checking out I Hired a New CPA and How It Went with My New CPA).

What about you? Do you have someone else prepare your taxes or do you do it yourself? Why?

Smart Tax Planning for the Gap Years

The following is a guest post from Marotta Wealth Management.

Many families seek financial planning advice specifically for retirement. But if they wait too long, they miss an important tax-planning opportunity. A great strategy is to take advantage of the time between retirement and Social Security at age 70, the so-called gap years. With some planning for this gap, you can move income into the lower tax brackets.

Tax planning is a critical part of comprehensive wealth management. A dollar saved on taxes is worth more than a dollar earned. When you earn a dollar, the government taxes you, taking a portion of your earnings. But if you can choose when and how much you want to pay in taxes, you can apportion your tax burden as beneficially as possible.

Don't think only the very rich need tax planning. Every year you make decisions that delay or accelerate paying taxes. For example, you do nothing and fail to take capital gains. You fund your 401(k) and avoid paying tax. You do not fund your Roth IRA and lose the opportunity to move money where it will never be taxed again. You don't have a Medical Savings Account and miss using pretax dollars for medical expenses. You hold your bonds in a taxable account and pay ordinary income tax rates on your interest.

Thus either by action or inaction, our decisions have a long-term effect on our after-tax situation. Small changes have large effects over time, which is the basis of wealth management. Smart tax planning gives you significant opportunities to boost your after-tax net worth.

Imagine three families, each with wealth they amassed in different ways. The Roths have saved $2 million entirely in Roth accounts. Investments to a Roth account are contributed after having paid taxes. While in the Roth and during withdrawals, no tax is owed. Thus funding a Roth means safeguarding money from taxation.

You might think the Roths are in an enviable position. At age 65 their safe spending rate is about 4.36%, or $87,200 a year. They can withdraw this amount from their Roth account and none of it will be taxed. They have a $2 million portfolio and yet enjoy the lowest tax bracket possible. But they have missed an opportunity to realize some income in the lowest tax brackets. Had they planned they could have delayed paying tax on some of their income until retirement.

The IRAs delayed paying tax on all of their retirement savings. They were able to save more because each dollar of savings only reduced their take-home pay by about 70 cents. They saved over $2.8 million in qualified pretax accounts. At age 65 they retire and must start withdrawals because they have no other money to fund their lifestyle. When they withdraw 4.63%, it will be $124,571. They will pay 30%, or $37,371, in taxes and live off the remaining $87,200.

The Taxables chose not to use any retirement accounts. But their $2.3 million nest egg is now subject to a 15% capital gains tax. Each year they will sell $102,588 (4.63%), paying 15% in tax and leaving them $87,200 to live on.

I've made each family's position as equal as possible at age 65, but these options are rarely equivalent for more than a moment. I've assumed a total state and federal tax of 30% and a capital gains tax of 15%, but these are hardly fixed.

Young families are usually in a much lower tax bracket than they are later in life. For clients younger than 40, I recommend funding a Roth as their first priority. Many families find themselves in the opposite situation. They received a small tax deduction when they were in a low tax bracket only to find that required minimum distributions after age 70 place them in a higher tax bracket.

Senior citizens hold most of the wealth in America. And tax planning should project and minimize the future tax burden as well as the current year.

In 2012 the top capital gains is 15%, but next year it rises to 20% and 23.8%, respectively, for those in the highest brackets. In 2012 the capital gains tax is 0% for couples whose taxable income is under $70,700. This rate rises to 10% next year. All Americans must make capital gains decisions based on the likelihood that the Bush tax cuts will expire for their tax bracket. Doing nothing is equivalent to deciding to pay capital gains in future years at higher rates.

Those in the top tax bracket can choose to convert their traditional IRA accounts to a Roth. If they are already in the 35% tax bracket, they can convert a $2 million traditional IRA to a Roth account and owe $700,000 in federal taxes. Waiting until 2013 to convert would mean they would owe an additional $90,000.

Tax planning is complex with many moving parts to the equation. Roth conversions reduce your future required minimum distributions, which can lower the tax you owe during retirement years. But by inflating one year's income, it can also increase the amount you must pay for Medicare the next year.

This is the general principle for tax planning: move income from high-income years into lower income years and save the difference in marginal rates. If tax rates rise for everyone next year, moving income into this year by doing Roth conversions and realizing capital gains is the best bet.

Imagine a fourth couple, the Planners. They saved in their Roth accounts when they were in the lowest tax brackets. They also saved money in a taxable account. And when their income was at its peak or they could get a match from their employer, they saved in traditional retirement accounts. Now they are retiring at age 65 but not starting Social Security until 70. During those gap years they can convert some of their traditional retirement accounts to Roth accounts while staying in the lowest tax brackets. Expert planning means they have sufficient taxable savings both to pay the tax and continue to fund their lifestyle.

No one wants to pay more federal tax than legally obligated. Small changes in tax planning can have large effects in your after-tax net worth over time. And tax planning over your entire lifetime can have the greatest impact of all.

Are Investment Management Fees Tax Deductible?

The following is a guest post from Marotta Wealth Management.

I often get asked, "Are investment management fees tax deductible?" The answer is not a simple "yes" or "no." Like many tax questions, the answer is "It depends."

Investment management fees are a tax-deductible expense. They can be listed on Schedule A under the section "Job Expenses and Certain Miscellaneous Deductions." Line 23 includes investment expenses. These expenses get added into unreimbursed employee expenses, tax preparation fees, safe deposit boxes and other qualifying expenses.

Unreimbursed employee expenses can include professional dues, required uniforms, subscriptions to professional journals, safety equipment, tools and supplies. They may also include the business use of part of your home and certain educational expenses.

All of these miscellaneous deductions are totaled. You only receive a tax deduction for the amount that exceeds 2% of your adjusted gross income (AGI) from line 38 of your Form 1040. If your cumulative expenses are under 2% of AGI, you will not get a deduction.

For most of our working clients, their miscellaneous deductions fall far short of the 2% AGI threshold. But when clients retire, they are much more likely to qualify.

If your expenses are close, you gain from lumping most of your expenses every other year. For example, if your AGI is $100,000 and your miscellaneous expenses average $2,500 a year, in most years you will only get a $500 deduction. But if you can pay the same bills in January and December of one year, you might be able to have $5,000 in deductions one year and zero the next. That means you could have a $3,000 deduction every other year. In next year's 28% tax bracket, this would save you $560 more in taxes.

Even if you can't deduct investment management fees directly, you can still pay a portion of the fee with pretax dollars. Investment management fees can be deducted directly from the accounts for which they were charged.

Many fee-only advisors charge a percentage of assets under management. But they can also prorate those fees back to the accounts they are managing. For traditional IRA accounts, the fee is not considered a withdrawal and therefore is not a taxable account. The fee is considered an investment expense. Thus this fee is being paid with pretax dollars. And the cost is discounted to clients by their marginal tax rate.

I've seen advisors take their entire management fee from IRA accounts. I don't think that is warranted by the letter or the spirit of the tax code. Any fee taken from an IRA account should be justified as a fee for the management of a pretax account. You can't simply start paying your bills from an IRA as a nontaxable withdrawal.

Similarly, any management fees paid directly from an IRA account should not be listed as a miscellaneous expense on Schedule A trying to qualify for an additional tax deduction. Only expenses paid from a taxable account should be listed as a miscellaneous expense.

There is no advantage in trying to pay the entire fee from a taxable account in an attempt to boost your deductions. If you pay $2,500 in management fees, it is better to pay $1,000 from an IRA with pretax dollars than to pay for it separately to get a $500 tax deduction. Any amount paid from an IRA is equivalent to getting that same amount as a tax deduction.

Although getting money out of a traditional IRA tax fee is an advantage, taking management fees out of a Roth IRA is not. There are limits on getting money into a Roth account where it will never be taxed again. We recommend paying the portion of management fees prorated to a Roth account out of your taxable account. This allows as much money as possible to stay in your Roth.

One of the advantages of working with a fee-only financial planner is that fees can be taken from the accounts under management or paid separately, depending on which is more advantageous. If fees are stuck on commission-based products, you can't choose to pay the fees for a Roth account separately from a taxable account in order to allow the Roth to grow unimpeded.

This is another advantage to having fees based on assets under management rather than a separate fee or an hourly charge. Management fees are easily justified taken directly from accounts including IRA accounts where you can pay with pretax dollars.

Many advisors charge a percentage of assets under management and then offer comprehensive wealth management advice without an hourly charge. This is ideal. If these charges were separated, less of the fee could be paid with pretax dollars.

No one likes to pay fees. Hidden fees in many ways are easier psychologically. We recommend that when you need unbiased financial advice, seeking a fee-only financial planner makes sense. And it helps knowing there are tax-efficient ways to pay management fees.

The Eight Tax Rules

The following is an excerpt from Securing Your Financial Future: Complete Personal Finance for Beginners courtesy of Rowman & Littlefield Publishers. All Rights Reserved.

Taxes! Strong opinions abound on virtually every aspect of the subject—at least among taxpayers. Are taxes already too high, or are even higher taxes necessary to balance the budget? Is the burden fairly distributed, or are adjustments in order? Is the tax code complicated in order to ensure fairness across a wide variety of situations, or is the complication simply the result of privileged interests getting what they want? If you think of those as contemporary questions, they’re really not—they have been brought up and debated for as long as there have been taxes.

If you are interested in pursuing those kinds of discussions, you’ll have no trouble finding forums to do so. But we’re not going to engage in any of that here. Instead we want to take a realistic look at the effect that taxes have on your financial life and offer some practical advice about how to deal with them successfully. In our discussion, we’ll focus solely on the U.S. federal income tax. Even though that’s not the only type of tax that you’ll pay, it is likely to be the biggest, and many of the points that we’ll discuss are adaptable across the tax landscape.

Since taxes are all about rules, that’s the format we’ll take. Below are eight rules that I recommend you follow in dealing with taxes. The first four are principles that you should adopt, and the next four are specific areas of competency that I recommend you develop.

1.  Pay your taxes in full, on time, every time. Taxes are serious business, and they deserve your complete attention. A rule like this might seem obvious, but I’m including it to emphasize that taking a casual, haphazard, or last-minute approach toward complying with tax laws is an extraordinarily bad idea. The consequences of ever getting on the wrong side of the IRS, or any other tax enforcement body, are significant.

2.  Pay the minimum legal amount of taxes that you owe and not a penny more. Understanding rule #2 requires that you understand the difference between two similar-sounding, but vastly different, words: evading taxes and avoiding taxes. Tax evasion is a criminal offense. It refers to dishonestly or fraudulently misrepresenting your financial status to reduce tax payments. On the other hand, tax avoidance is perfectly legal. This refers to taxpayers making decisions explicitly to take advantage of specific rules in the tax code, to reduce their tax liability. The tax code is complex. Two taxpayers with identical financial situations can end up paying wildly different amounts, both perfectly legally. The taxpayer who pays less has done so by being more familiar with which specific elements of the tax code could be legally used to his or her advantage and then doing so. Legally and financially speaking, there is no virtue at all in paying more taxes than you are required to. Do not evade taxes, but avoid them to the greatest extent that you legally can.

3.  Commit to understanding the basics of the income tax and to keeping your understanding current.  This rule is a natural extension of rule #2.  If you don’t have a good working knowledge of the basics, or at least the basics that are most applicable to your own situation, you are very likely to end up paying more tax than you need to. To state it a little more forcefully—ignorance of the tax code is likely to be an expensive habit. You don’t need to become an expert, and you don’t need to build your knowledge overnight. But you can commit to improving your knowledge of the important basics, year after year.

4.  Have an effective record-keeping process. There’s no way around it—a fundamental part of financial responsibility is keeping good financial records. If you’re already following the recommendations made in recent chapters—doing all your spending using either a debit or credit card featuring summarized, downloadable transaction details—then you’ve already got the most challenging part of this under control. Keep this, and all your other financial records, secure (and remotely backed up, if applicable), and your tax preparation process will be significantly simplified.

5.  Know your marginal tax rate (your tax bracket) and your average tax rate. You probably know that tax rates are structured in a graduated, or progressive, way. This means that higher and higher levels of income are taxed at higher and higher rates. At the time of this writing, there are six brackets of income, with six progressively higher tax percentages levied on each one. The lowest bracket is 10%, ranging up to the highest rate of 35%. (I’m emphasizing “at the time of this writing” because the number of brackets, and the rates charged, can and do change from year to year. For example, the number of brackets has been as few as three and as many as fifteen. The U.S. Congress has proven very willing to adjust the structure in response to all kinds of economic and political forces and is likely to continue this practice.)

How do these progressive brackets work? Let’s say that you earn just barely enough to put you into the highest tax bracket: 35%. (Congratulations!) That doesn’t mean that your total tax bill is 35% of your income. Instead, you pay 10% on your first “chunk” of income, a higher rate on the next chunk, and so on; you only pay 35% on the very last chunk. In this example, by the time you add all that up, your total tax bill would average out to about 29% of your total income. In tax language, we say that your marginal tax rate is 35%, but your average tax rate is 29%. Both rates are important. The average tax rate is important because it determines your total tax bill. The marginal rate is also important because that’s the rate you’ll pay on any additional income you earn this year. For example, if you are considering earning some supplemental income, understand that you’ll pay 35% on that extra income, not 29%.

6.  Have a deduction strategy. Deductions are expenses that the tax code allows you to subtract from your income before your tax is figured. Examples of deductible expenses are mortgage interest paid on an owner-occupied house, charitable donations, a certain portion of your medical expenses, and a long list of others. The more deductions you have (in dollars), the lower your total tax bill is. The tax code gives you a choice: you can list all your deductions one by one and add them up (this is called itemizing) or you can take a single flat amount that the government offers everyone called the standard deduction—one or the other, but not both. Which do you take? Whichever is higher, because that’s how you legally pay the least tax.

It is in your interest to know whether your deductible expenses in any given year are likely to be higher or lower than the standard deduction. Early in your financial life, before you own a house, it isn’t unusual simply to take the standard deduction. But eventually your deductible expenses will probably begin to approach the standard deduction amount, and sooner or later it will make more sense to itemize. You don’t want to miss that crossover point because each year you take the standard deduction when you could have itemized could cost you in unnecessary taxes.

7.  Have a withholding strategy. Like most U.S. employees past and present, I am a veteran of many coffee-break debates about what the ideal tax-withholding strategy is. What is a withholding strategy? As Bobby Budget explained to Billy Bigshot, employees fill out a form with their employer called a W-4. Based on how it is filled out, the employer knows how much to withhold from your earnings toward your income tax. When you eventually file your return, if the amount withheld is greater than your actual tax bill, you get a refund check from the U.S. government. If your tax bill is higher than what has been withheld, you pay the government the difference.

Contrary to what a lot of the coffee-break debaters believe, getting a big refund check year after year is not an indication of financial genius—just the opposite! When you get a big refund check, it just means that the IRS has been holding your money on your behalf; and while they are holding it, they are earning interest on that refund money—and you’re not! In other words, you’ve just generously provided the IRS with an interest-free loan. On the other hand, if your employer doesn’t withhold enough, you get to earn interest on that difference, until you have to pay. In both cases, the amount of tax paid is identical—the only difference is who is earning interest.

So what is the ideal withholding strategy? It depends on your skill level at budgeting and tax bill estimation. If you are a rookie at both, then you should be conservative and aim for a zero difference between your tax bill and the amount withheld (zero refund, zero additional tax owed). Once your skill level is high, though, you can get more aggressive at reducing your withholding and earning interest on the money that you will eventually have to pay in taxes. The extra skill is required because you will have to be completely certain that when your tax bill is due, you will have the funds available to pay your taxes. How do you adjust your withholding? Work with your employer’s payroll department, or any tax professional, who can advise you on perfectly legal ways to adjust your W-4 to your advantage.

8.  Know when to seek outside expertise, and what kind. Here is a simple model, listed in the order of increasing expense to you:

• Level 1: Do all taxes and tax research yourself, using readily available resources. You can buy or check out one or more books, search online, and so on.


• Level 2:  Use tax software, carefully researching which product best meets your needs and ensuring you only use the most up-to-date version. Often it is possible to use software that can also be used in automating your budgeting process.


• Level 3: Engage a certified tax professional. Services can range from simply filing your return based on information that you provide to extensive consultation on tax planning for the current and future years.

When you are just starting out in your financial life, level 1 may be perfectly sufficient. Or you may be someone who is so comfortable with computing tools that you couldn’t imagine filling out a tax form when you know there are simple applications available that can do the job better than you can; if that’s the case, you might skip directly to level 2. Eventually, though, your financial life may get complicated enough that you’ll want to go to level 3. Each level costs more than the preceding one; but each level also offers a greater chance of spotting potential tax savings. The more complex your situation becomes, the more likely it is that it makes sense to move to the next higher level.

How It Went with My New CPA

A few months ago I told you that I had hired a new CPA to do my taxes. Now that the tax season is over and the dust has settled, I thought I'd list the pros and cons of working with the new firm. Let's start with the pros:

• They were much more involved in tax planning. While I hired them officially in late 2011, I had met with them earlier in the year and they had given me some tax-saving tips. Some I took and some I didn't, but they were pro-active on their advice -- which is something the other firm never was. In addition, the new firm has continued offering suggestions well into 2012.


• The process was initially smoother. I was able to drop off my information and meet with the owner personally to go through my records. This is because they are located much closer to my work, so I was able to pop over there during lunch to get things going.


• They were cheaper while doing more. The cost was 20% less than the other firm plus the new company included returns (very simple ones) for my kids. So they delivered more work for less cost -- that's what I was looking for!

But there were some cons. For instance:

• The process had a few bumps to it. I knew there would be some since this was our first year with them. But they complicated the effort. There wasn't clear communication between the owner (who I had all my previous dealings with) and the person who actually did my taxes. This caused some confusion and re-work on both sides.


• There was a big delay. I got them my information in late February and the owner told me they'd have the return done "in a week or so." Three weeks later I got and email saying they were just starting the return. It was finished and approved the first week in April.

Overall, I was happy with their performance and I'm looking forward to next year. I think the process will be better since they will be more familiar with my finances and I'll know what to expect from them. In particular, here's what I plan to do next year to help things go a bit smoother:

• I will meet with both the owner and the person doing my taxes when I drop off my information. This way there will be no miscommunication between them (or at least it will be minimized.)


• I plan to meet with the owner a couple times during the year to talk about basic tax issues. I'm at the point where there's not much I can do to save on taxes without jumping through hoops, and many of the hoops are not worth jumping through from time and cost perspectives. However, you never know what's looming around the corner, so I'll keep in touch with him just to make sure I'm on top of the situation.

How about you? How did your tax season go this year?

Turn Your Tax Refund Into a Solid Investment

The following is a guest post from Jon Stein, Founder & CEO of Betterment.

The factual, “figures” side of money, often has us confused. We can crunch the numbers and figure out the best way to build wealth, but it doesn’t make financial success a certainty. This is because there’s a profoundly psychological element to managing money, and human instincts are often irrational.

The fact is that Americans are struggling to manage their finances: in a recent Gallup poll, 66% of people ranked not having enough money for retirement as their top financial concern. At the same time, people aren't taking the necessary steps to save the amount needed for retirement: according to a survey conducted by the Employee Benefit Research Institute, 46% of American workers have less than $10,000 saved for retirement.

How did it come to this?

Let’s take a look at why, when it comes to money, humans don’t do what we should.

Windfall Gains

Take, for example, an unexpectedly large tax return. How does your brain make sense of this gain? Do you make the most of it and boost your investments? Or do you view it as "free" money to be enjoyed? Chances are it’s the latter…

Mental Accounting

According to Dan Ariely, Professor of Behavioral Economics and Author of “Predictably Irrational”, we allocate money to different categories and don’t see them as interchangeable. A study by Ariely shows that when contemplating the purchase of a $15 pen, the majority of people said they would drive to another store 15 minutes away to save $7 – but they would not make that same effort for a $1,015 suit. The amount saved and time involved are the same, but people make very different choices.

Make the Most of Windfalls

It’s a natural tendency to view unexpected financial gains as a bonus. That money hasn’t been allocated to anything, so why not splurge? But think of the boost that extra income could bring to helping you achieve your goals.

According to the Wall Street Journal, thinking of your goals in real world terms helps you get there faster. Adding $2,000 to a generic “investment” might not seem so appealing, but now imagine that you’re putting that towards a trip to Rome or a down payment on your dream home. It should become easier to find the motivation to stick to the plan.

Studies have shown that when humans are able to picture older versions of themselves, it's easier to save for the future. Think of the activities that you enjoy doing now -- traveling, dining, spending time with friends -- and think of retirement savings as a way to guarantee you can keep doing these things forever.

It Can Be Done

Regular readers of FMF’s blog will be familiar with his story of how he paid off his entire debt – including his mortgage. Each windfall gain – a pay raise, bonuses, income from a side business, and even gifts – went towards paying down the mortgage.

Regular contributions – no matter how small – will make a difference in your progress. Saving a million dollars towards retirement might sound intimidating, but with regular deposits and boosts from your windfall gains, it becomes that much more achievable.

So, when your big tax return comes in, how will you put it to work?

Review of Major Tax Software Products Reveals Limits

Since many of you are considering using tax software products this year, I'm re-running this piece from last year which provides some hands-on reviews of various products from FMF readers.

As regular readers are aware, I have been running a series of tax software reviews from readers. I was given free access by the software companies to their sites, gave away that free access to readers, and the readers agreed to use and honestly review the programs. In case you missed them, here they all are in one place:

• CompleteTax Review #1


• CompleteTax Review #2


• CompleteTax Review #3


• CompleteTax Review #4


• H&R Block's At Home Premium Federal Tax Product Review #1


• H&R Block's At Home Premium Federal Tax Product Review #2


• TurboTax Review

The reviews were from seven different readers all with different life situations and tax issues. And yet they all (in general) came to the same conclusion: the programs are great for basic, uncomplicated returns, but not-so-great if you have any sort of issue that's considered "unique."

This was interesting to me because it's the same conclusion USA Today came to when it tried out H&R Block At Home, TurboTax, and TaxAct. Here are their findings:

For taxpayers with straightforward returns, tax software gets the job done, at a fraction of the cost of a tax preparer. Most tax software programs are also adept at handling returns that claim common tax breaks, such as the deduction for mortgage interest and charitable contributions.

But this year's tax software review also revealed the limitations of these programs. Taxes have grown so complex that even those of us who don't invest in individual stocks, own rental property or run a small business could find ourselves in need of advice from a flesh-and-blood tax preparer.

The article then highlights two issues they discovered while testing the software -- converting IRAs to Roths and reporting miscellaneous income. Their conclusion on these:

If you converted a large IRA to a Roth last year, it may be worthwhile to consult with an experienced tax preparer.

You shouldn't have to upgrade to a premium software program to report a couple of hundred bucks you earned mowing lawns last year. But you may need to root around a bit to find the right place to enter this information.

Finally, here are their overall conclusions about each of the products:

As has been the case in past years, TurboTax provided the clearest instructions of all the programs we tested. However, if you're a longtime desktop user, you may want to consider making the leap to the online version. It's cheaper and updates automatically. In our test drive of the desktop version, we had to endure several updates, one of which lasted more than 10 minutes.

H&R Block At Home did a workmanlike job on our tax return — and costs about 25% less than TurboTax. Block has enhanced its data-import function, which lets you electronically transfer information from your W-2, mortgage statements and other documents, but it still lags behind TurboTax in this regard.

TaxAct continues to be the preferred choice for cost-conscious taxpayers. Its standard program is free. However, if you want any guidance, you'll need to upgrade. For that reason, it's best-suited for people with a good grasp of tax laws or those with simple returns.

My taxes are pretty complicated (and have been for several years) and that's why I use a CPA. I think that at some point things might become "common" enough that I'll be willing to tackle the time and expense of doing it myself, but for now I am quite content to have them do it.

Three Questions to Ask Yourself about Preparing Your Own Taxes

MSN Money gives you three questions you should ask yourself to determine whether or not you should do your own taxes. Their list:

1. Are you prepared to give your taxes your time?

2. Are you prepared to put up cash to hire a preparer?

3. Are you prepared to deal with the complexity of the federal code?

Here's my take on these three questions:

Time

The article says that the IRS estimates the average taxpayer needed 23 hours to do his 2010 tax return -- 32 hours if a Schedule C for business or a Schedule E for rental properties was filed. This assumes you have a fairly simple return with a limited number of deductions.

I don't have a simple return and I have a lot of deductions. So I'm way past the 32 hours estimate.

That said, even if you hire someone to do your taxes, there's still a lot of work to do. I have to get all my files and paperwork together to give to my CPA. I then summarize everything (Quicken helps tremendously with this) and type out specific thoughts for him to consider as he does the taxes. I'm guessing this takes 20 hours. Assuming completing my taxes from start to finish takes 40 hours, I'm saving 20 hours by having a CPA handle them. At $20 per hour (plug value of my personal time), that's $400 in time-savings alone by hiring a CPA.

Cost

Paying a preparer isn't really an issue for me. It's not like we're talking $10,000 or something here. It's a few hundred dollars and can be deducted as a business expense.

Complexity

I am NOT prepared to deal with the complexity of the federal code (not to mention our ever-changing state tax code). In addition to the time noted above, there's the frustration factor. 20 hours lying on a beach, watching TV, enjoying your family, playing video games, etc. is one thing. But 20 hours sorting through the tax code, trying to decipher what number goes where, is more akin to 20 hours of water dripping on your head. Or 20 hours of screaming endlessly into a pillow. Or 20 hours of holding your breath. You get the idea. Those 20 hours I get rid of are very unpleasant hours.

Yes, tax software can help. And I've tried it in the past. But sometime software makes assumptions to make things "easier" for you -- and those assumptions aren't always true. So I found myself checking and re-checking what the software was putting in each box. This, of course, added more time to the entire process.

Other Considerations

Then there's the planning/advice/feedback part of tax planning that you don't get unless you have a preparer. And you have to have the right kind of preparer at that.  My former CPA didn't offer any sort of help, but my new CPA does, and without charging me any extra.

In the end, it all comes down to the same thing every purchase comes down to: is it worth the cost? For me, the time savings, frustration factor, accuracy of the return, knowledge of the code (which can lead to extra savings), and planning issues make using a CPA to do my taxes a no-brainer.

How about you? How do you prepare your taxes and why?

How to Decide Which Tax Preparation Method is Best for You

Here's a comment a reader recently left on my post titled Why I Use a CPA to Do My Taxes. It addresses the topic of how to decide which tax preparation method -- CPA, mass market firm, or do-it-yourself -- is best for you. His thoughts:

If you really want to know which tax preparation mode is best for YOU, do all three ... ONCE.

When it’s tax time, buy TurboTax, and do your return; then go to H&R Block and let them do it; finally, go to a CPA and have it done. Now you have the data to compare: Ease of use, accuracy, timing, sweat equity required, etc. Make your choice and stick with it unless or until you have a major life change. Done.

It would be a long, hard grind (can you imagine doing your taxes THREE times in a year?), but you'd certainly know the pros and cons of each method by the time you were done, huh?

What do you think of this idea? Is it a good one or just overkill?

Key Tax Numbers for 2011

The following is an excerpt from J.K. Lasser's Your Income Tax 2012: For Preparing Your 2011 Tax Return. It is reprinted with permission of John Wiley & Sons, Inc.

Here are the key tax numbers for 2011 (along with the section in the book where extra details are provided):

Exemptions

• Each allowable exemption (21.1)    $ 3,700
• No Phaseout for 2011 (21.12)

Standard Deduction (13.1)

• Joint return/Qualifying widow(er)    $ 11,600
• Head of Household    $ 8,500
• Single    $ 5,800
• Married filing separately    $ 5,800
• Dependents-minimum deduction (13.5)    $ 950
• Additional deduction if age 65 or older, or blind (13.4)

• Married-per spouse, filing jointly or separately     $ 1,150 ($2,300 for age and blindness)
• Qualifying widow(er)    $ 1,150 ($2,300 for age and blindness)
• Single or head of household     $ 1,450 ($2,900 for age and blindness)

Long-term Care Premiums (17.15)

Limit on premium allowed as medical expense

• Age 40 or under    $ 340 
• Over 40 but not over 50    $ 640
• Over 50 but not over 60    $ 1,270
• Over 60 but not over 70    $ 3,390
• Over 70    $ 4,240

IRA Contributions

Traditional IRA contribution limit (8.2)    $ 5,000

• Additional contribution if age 50 or older    $ 1,000
• Deduction phaseout for active plan participant (8.4)

• Single or head of household    $ 56,000 – $ 66,000
• Married filing jointly, two participants    $ 90,000 – $ 110,000
• Married filing jointly, one participant

• Participant spouse    $ 90,000 – $ 110,000
• Non-participant spouse    $ 169,000 – $ 179,000

• Married filing separately, live together, either participates    $ 0 – $ 10,000
• Married filing separately, live apart all year

• Participant spouse    $ 56,000 – $ 66,000
• Non-participant spouse    no phaseout

Roth IRA contribution limit (8.20)    $ 5,000

• Additional contribution if age 50 or older    $ 1,000
• Contribution limit phaseout range

• Single, head of household    $ 107,000 – $ 122,000
• Married filing separately, live apart all year    $ 107,000 – $ 122,000
• Married filing jointly, or qualifying widow(er)    $ 169,000 – $ 179,000
• Married filing separately, live together at any time    $ 0 – $ 10,000

Elective deferral limits

• 401(k), 403(b), 457 plans (7.18)    $ 16,500
• Salary-reduction SEP (8.16)    $ 16,500
• SIMPLE IRA (8.17)    $ 11,500
• Additional contribution if age 50 or older

• 401(k), 403(b), governmental 457 and SEP plans (7.18, 8.16)    $ 5,500
• SIMPLE IRA (8.17)    $ 2,500

Education

• American Opportunity credit limit-per student (33.8)    $2,500
• Lifetime Learning credit limit-per taxpayer (33.9)    $2,000
• Phaseout of American Opportunity credit (33.10)

• Married filing jointly    $ 160,000–$ 180,000
• Single, head of household, or qualifying widow(er)    $80,000–$ 90,000

• Phaseout of  Lifetime Learning credit (33.10)

• Married filing jointly    $ 102,000–$ 122,000
• Single, head of household, or qualifying widow(er)    $ 51,000–$ 61,000

• Student loan interest deduction limit (33.14)    $2,500
• Phaseout of deduction limit

• Married filing jointly    $120,000–$150,000
• Single, head of household, or qualifying widow(er)    $60,000–$75,000

• Coverdell ESA limit (33.11)    $2,000
• Phaseout of limit

• Married filing jointly    $190,000–$220,000
• All others    $95,000–$110,000

• Tuition and fees deduction (33.13)
• Tuition and fees deduction-tier 1 limit    $4,000
• Income cut-off

• Married filing jointly    $130,000
• Single, head of household, or qualifying widow(er)    $65,000

• Tuition and fees deduction limit-tier 2 limit    $2,000
• Income cut-off

• Married filing jointly    $160,000
• Single, head of household, or qualifying widow(er)    $80,000

Capital gain rates-assets held over one year (5.3)

• If otherwise subject to 10% or 15% rate     0%
• If otherwise subject to rate over 15%    15%
• Collectibles gain-maximum rate    28%
• Unrecaptured Section 1250 gain on depreciated real estate-maximum rate    25%

Qualified dividends tax rate (4.1)

• If otherwise subject to 10% or 15% rate     0%
• If otherwise subject to rate over 15%    15%

IRS mileage rates

• Business (43.1) 

• 1/1/2011 through 6/30/11    51 cents/mile
• 7/1/2011 through 12/31/11    55.5 cents/mile

• Medical (17.9) and Moving (12.3)

• 1/1/2011 through 6/30/11     19 cents/mile
• 7/1/2011 through 12/31/11    23.5 cents/mile

• Charitable volunteers (14.4)

• 1/1/2011 through  12/31/11    14 cents/mile

Exclusion for employer provided transportation (3.8)

• Transit passes and commuter vehicle transport    $230/month
• Qualified parking    $230/month
• Qualified bicycle commuting    $ 20/ month

Taxes: What's New for 2011, Part 2

The following is an excerpt from J.K. Lasser's Your Income Tax 2012: For Preparing Your 2011 Tax Return. It is reprinted with permission of John Wiley & Sons, Inc.

Here's a summary of what's new in the 2011 tax year (and the section of the book where the information is listed in detail). For previous items listed, see part 1:

• First-time homebuyer credit. -- For 2011, the credit for a home purchase by a first-time homebuyer or long-time resident is allowed only to members of the U.S. uniformed services or Foreign Service, or employees of the intelligence community who bought their home before May 1, 2011 (beofre July 1, 2011 if in contract before May 1, 2011) and who were on qualified official extended duty outside the United States for at least 90 days between January 1, 2009 and April 30, 2010 (25.23). Credits from 2008 must be repaid under the 15-year schedule that began in 2010. Unless an exception applies, credits from 2008–2010 have to be repaid in full on a 2011 return if the home for which the credit was claimed was sold in 2011 or the home was no longer used as a residence (25.23).


• IRA and Roth IRA contribution phaseout. -- For 2011, the contribution limit for traditional IRAs (8.2) and Roth IRAs (8.20) remains $5,000, or $6,000 for those age 50 or older. The deduction limit for 2011 contributions to a traditional IRA is phased out (8.4) for active plan participants with modified AGI (MAGI) of over $56,000 and under $66,000 for a single person or head of household, or over $90,000 and under $110,000 for married persons filing jointly. The phaseout range is MAGI over $169,000 and under $179,000 for a spouse who is not an active plan participant and files jointly with a spouse who is an active plan participant. The 2011 Roth IRA contribution limit is phased out (8.20) for a single person or head of household with MAGI over $107,000 and under $122,000, and for married persons filing jointly with MAGI over $169,000 and under $179,000.


• Reporting 50% of 2010 conversion to Roth IRA -- If you converted a traditional IRA to a Roth IRA in 2010, and you chose on the 2010 Form 8606 to use the special two-year deferral rule for 2010 conversions (rather than reporting the entire taxable conversion amount as 2010 income) you must report half of the 2010 conversion income as a taxable IRA distribution for 2011. The other half will be reported as a 2012 distribution (8.21).


• Eligibility for saver’s credit. -- The adjusted gross income brackets for the 10%, 20%, and 50% credits are increased for 2011. The AGI limit for claiming a 2011 saver’s credit is $28,250 for single taxpayers,  $42,375 for heads of households, and $56,500 for married persons filing jointly (25.16).


• Two-year limit for claiming equitable innocent spouse relief eliminated. -- In response to opposition from Congress and the National Taxpayer Advocate, the IRS withdrew its requirement that a request for equitable relief be made within two years of the first IRS collection activity (1.9). 


• Late election to aggregate real estate activities. -- The IRS will allow qualifying real estate professionals to make a late election to aggregate rental real estate activities on an amended return if there was reasonable cause for not making the election on the original return and other conditions are met (10.3).


• Partial exchange of commercial annuity. -- New IRS tests apply for determining whether a partial transfer of a commercial annuity on or after October 24, 2011 is a tax-free exchange (6.12).


• Restriction on health FSA reimbursement of over-the-counter medications. -- Starting in 2011, a health flexible spending arrangement cannot make a tax-free reimbursement of an over-the-counter medication other than insulin unless a physician has provided a prescription for it (3.16).


• Higher deduction limits for long-term care premiums. -- The maximum amount of age-based long-term care premiums that can be included as deductible medical expenses for 2011 (subject to the 7.5% of AGI floor) is $340 if you are age 40 or younger at the end of 2011; $640 for those age 41 through 50; $1,270 for those age 51 through 60; $3,390 for those age 61 through 70; and $4,240 for those over age 70 (17.15).


• Hybrid vehicle credit no longer available. -- The credit for hybrid,  advanced lean burn technology, and alternative fuel vehicles expired for vehicles purchased after 2010.


• MWP credit not allowed. -- The Making Work Pay credit is not allowed on 2011 returns; it expired at the end of 2010.


• Foreign earned income and housing exclusions. -- The maximum foreign earned income exclusion for 2011 is $92,900 (36.3). The maximum housing exclusion is generally $13,006, but the IRS may increase the exclusion for high cost localities (36.4).


• High-low reimbursement method. -- The IRS announced its intention to discontinue the “high-low” method of reimbursing employees for travel expenses but after opposition from business groups it relented and provided new high-low rates effective October 1, 2011 (20.32).


• Additional child tax credit. -- The child tax credit is refundable for 2011 to the extent of 15% of earned income in excess of $3,000, the same as for 2010 (25.3).


• Annual exclusion for gifts. -- For gift tax purposes, the per-donee exclusion for gifts of present interests in 2011 is $13,000, the same as for 2010 (39.2).


• Advanced earned income credit not allowed. -- 2010 was the last year for which advance payments of the earned income credit could be made (25.13).

Taxes: What's New for 2011, Part 1

The following is an excerpt from J.K. Lasser's Your Income Tax 2012: For Preparing Your 2011 Tax Return. It is reprinted with permission of John Wiley & Sons, Inc.

Here's a summary of what's new in the 2011 tax year (and the section of the book where the information is listed in detail):

• Mid-year mileage allowance increase -- The IRS standard mileage rate is higher for the last six months of 2011 than for the first six months. The business mileage rate is 55.5 cents a mile for miles driven from July 1, 2011 through December 31, 2011 and 51 cents a mile for the first six months of the year (43.1). The rate for medical expense (17.9) and moving expense (12.3) deductions is 19 cents a mile for the first six months of the year and 23.5 cents a mile for the last six months. For charitable volunteers (14.4), the mileage rate of 14 cents a mile does not change; it is fixed by statute.


• Lower Social Security rate and self-employment tax. Deduction for self-employment tax. -- The 2011 tax rate for the employee share of Social Security is 4.2%, 2% less than for 2010, making the maximum 2011 employee Social Security liability $4,485.60, 4.2% of the first $106,800 of wages (26.9). For 2011, the self-employment tax of 13.3% consists of the following two rates: 10.4% for Social Security (4.2% employee share and 6.2% employer share) and 2.9% for Medicare. After multiplying the net earnings by .9235, the combined 13.3% rate applies to a taxable earnings base of $106,800 or less; the 2.9% rate applies to all taxable earnings exceeding $106,800 (45.3–45.4). In prior years, 50% of the self-employment tax was the amount of the above-the-line deduction that could be claimed on Form 1040 (Line 27), but for 2011, because of the 2% reduction in the self-employment tax rate, a special computation applies (45.3–45.4).


• Higher standard deductions. -- The standard deduction (13.1) is $11,600 for married persons filing jointly or qualifying widow(er)s, $8,500 for heads of households, or $5,800 for single taxpayers or married filing separately. The additional standard deduction (13.3) for being 65 or older or blind is $1,450 if single or head of household ($2,900 if 65 and blind). If married filing jointly, the additional standard deduction is $1,150 if one spouse is 65 or older or blind, $2,300 if both spouses are at least 65 (or one is 65 and blind).


• Tax rate brackets and preferential rates for capital gains/qualified dividends. -- Tax rates on ordinary income are extended to 2011 and 2012: 10%, 15%, 25%, 28%, 33% and 35% (1.2). The 0% and 15% rates on long-term capital gains and qualified dividends also are extended through 2012 (5.3).


• New Form 8949 for reporting sales of capital assets and revised Schedule D. Broker reporting of basis on Form 1099-B. -- Form 8949 is a new form for reporting 2011 sales (and other dispositions) of capital assets that is attached to Schedule D. After entering short-term transactions in Part I of Form 8949 and long-term transactions in Part II, the total sales price and basis amounts are transferred to Schedule D. where net gain or loss is figured (5.8). If you acquired stock in 2011 and sold it before the end of the year, the broker must report your cost basis for the securities in Box 3 of Form 1099-B. In Parts I and II of Form 8949, you must enter a code to indicate whether your basis for sold securities was reported to you by your broker in Box 3 of Form 1099-B (5.8).


• Bonus depreciation and first-year expensing for qualified business investments. -- Bonus first-year depreciation at a 100% rate is allowed for qualified property purchased new and placed in service in 2011 (42.21). If bonus depreciation is not available, first-year expensing (42.3) is allowed for qualifying property up to a limit of $500,000, of which up to $250,000 may be applied to the combined cost of qualified leasehold improvement (42.15) property, qualified restaurant property, and qualified retail improvement property. If the total cost of qualifying property placed in service during 2011 is over $2 million, the $500,000 expensing limit is reduced dollar for dollar by the cost of qualifying property exceeding $2 million.


• Vehicle depreciation limit. -- If a new car is placed in service in 2011 and used over 50% for business, bonus depreciation allows an $11,060 first-year depreciation limit. The limit is $3,060 if bonus depreciation is not allowed (43.4). For a light truck or van, the limit is $11,260 if bonus depreciation applies and $3,260 without the bonus (43.5). The limits are reduced for personal use.


• Alternative minimum tax (AMT) exemption for 2011 -- The AMT exemption for 2011 is $74,450 for married persons filing jointly and qualifying widow(er)s, $48,450 for single persons and heads of households, and $37,225 for married persons filing separately (23.1).


• Estate tax reinstated with stepped-up basis. Special rule for estates of 2010 decedents. -- Under the reinstated estate tax for estates of those dying in 2011 and 2012, up to $5 million of assets (this may be increased for 2012 by an inflation adjustment) are exempted from tax (39.10), and the heirs of individuals dying after 2010 receive a stepped-up basis for inherited property (generally equal to fair market value at death (5.18)). Executors of estates of individuals dying in 2010 had an option: (1) applying the 2011–2012 estate tax rules including the full step up in basis for heirs, or (2) avoiding estate tax entirely, regardless of the size of the estate, but applying modified basis rules for the heirs under which a step-up in basis would be limited. The election to opt out of estate tax and apply the modified carryover basis rules had to be made on Form 8939 by January 17, 2012 (39.10).


• Revised home energy credit -- For 2011, the credit for energy efficient home energy improvements such as storm windows, insulation, furnaces, and water heaters is reduced to 10%, with an overall limit of $500 that is reduced by prior-year credits, plus specific property limits such as $200 for exterior windows and $150 for a furnace (25.21).

Click here to read part 2.

I Hired a New CPA

As most of you know, I use a CPA to do my taxes (click the link if you want to know why.) Recently I made a change from one CPA to another and thought I'd explain the situation to you all.

I had used my former CPA for 10 years or so. Actually, it was the firm that I had used for 10 years or so. During that time I had three different CPAs at the same firm.

The firm was originally referred to me by a friend who I knew to be a pretty good money manager. He used them to do his taxes as well. I interviewed a partner at the firm, and they were good. I signed on despite the fact that they were pretty pricey (again, look above if you want to see the reasons I use a CPA.)

The firm handled my taxes for 10 years and did a decent job. We had our problems, but in the end things always worked out. That said, I wasn't completely happy. The reasons I went looking for another alternative are these:

1. Expense. The firm is a big accounting firm in the area (they've grown substantially over the years), have lots of overhead (very nice offices), and their fees have ballooned to match.

2. Offers no advice/planning. They simply do my taxes. That's it. No advice on "do this" or "do that." All my planning is on my own. Even when I ask a question, they seem to know less about it than I do, they go do some research, and come back with a half-developed answer.

3. Location. It is not convenient for us to stop by their offices when need be. They live in an entirely different part of the city than we do (though it's all relative, our city isn't really that big.)

4. Importance. I'm a miniscule part of their business -- and feel like I get service commensurate with that status.

This summer I was introduced to a different CPA at a party of friends. As we talked business, I asked him several questions about taxes and liked his responses. He had ideas on steps I could take to reduce my taxes (and offered ideas to others as well -- for example, to another friend who invests in real estate) as well as plan better for the tax consequences of future events.

I asked for his card and met him for lunch a month later. My interview was a bit more intense this time. It turns out he was one of two partners in a small firm of 12 people (they are growing -- hiring one new person a year). He has been a CPA for a couple decades now and seems very knowledgeable, personable, and willing to put some effort into helping me. I agreed to let him review two years' of my tax returns. I made copies and dropped them off at his office a few weeks later.

A couple weeks after that, we had lunch again. He had three pages of tax-related suggestions for me. We discussed them and again I was impressed (this time with the work he had put in). I agreed to have him do my taxes this year. We'll see how that goes and evaluate the situation afterwards.

Here's how he's going to address my concerns:

1. Expense. He'll be a few hundred dollars cheaper than my former CPA. Lots less overhead with this firm.

2. Advice/planning. He's already offered several ideas and has agreed to keep doing so each year.

3. Location. His office is nearby where I live and work. Easy to run to during lunch if need be.

4. Importance. I feel more important to him than I was at my other firm. Not sure that's the case, but I suspect it is simply based on the size of the firm.

I'll let you know how the relationship develops and if anything noteworthy happens this tax season.

How Long to Keep Old Tax Records

Wise Bread offers the following advice when it comes to dealing with old tax records:

The basic period for IRS tax review is three years. Yes, that means that even if you filed your taxes this year, got your refund or paid your taxes due, the IRS can audit you for up to three years. If it is suspected that you filed a fraudulent claim, or you owe more taxes, there is a chance you could be asked to show some documentation. So a good rule of thumb is to keep everything related to your taxes for at least three years.

They then go on to discuss situations where you may need your returns for longer periods of time -- up to seven years.

Personally, I have kept all of our tax records since we were married 20 years ago. They don't take up much room and serve as historical documents in case I want to go back and check something out (which doesn't happen often, but can from time to time.) I guess if I wanted to I could scan everything, save it on a computer, then shred the old stuff. But that seems like it would take FOREVER to do and wouldn't really accomplish much.

Perhaps I'm doing something wrong by keeping so many records (more potential that they are stolen?) What are your thoughts? What do you do?

Would You Move to Lower Your Taxes?

Yahoo has a piece on people who have moved to low-tax states to save a bundle of money. Their thoughts:

Of course, changing your life just to save on taxes is extreme. But it could happen more and more in the future, as some states aim to fix their budgets with dramatic tax increases, as Illinois did earlier this month.

Many of the states with large population gains in the 2010 Census are well-known low-tax havens, such as Florida, Texas and Nevada.

Of course there are other costs besides taxes to consider. You're not going to make progress if you move somewhere because taxes are low and yet housing and other costs are higher. And there are other issues in living somewhere than cost (as we've hashed out and re-hashed here.) That said, you can see why people might want to move -- especially from "less desirable" to "more desirable" states.

For instance:

• I live in Michigan. I'll let you decide whether you think it's a "less desirable" or "more desirable" state, but I think we both know the answer.
• Let's say when I retire I have enough savings/investments as well as part-time work to earn $100,000 per year.
• The Michigan state income tax rate is 4.35%. So I'd owe $4,350 in income taxes.
• Florida has no state income tax. So I'd save $4,350 in income taxes alone by moving from Michigan to Florida.

No, that's probably not enough to get someone to move but this is savings in income taxes alone. What if there were other tax savings? Here are some examples that are much more compelling:

"There can be pretty big dollars involved," said Lisa Osofsky, a CPA and financial adviser who helps clients from New Jersey, New York and Connecticut figure out their pre- and post- move finances. "A wealthy individual who could be earning several million dollars could save $50,000 or $100,000" by living in a lower-tax state, she said.

A family of four with $150,000 in income would save $13,368 in state and local income taxes if they traded in New York for Florida, according to calculations prepared by Bob Meighan of TurboTax. That doesn't even count additional savings in property taxes, estate taxes, or the cost of winter coats and boots. (Though some of those savings would be shaved when the state taxes were deducted from their federal taxable income.)

A couple with $85,000 in retirement income and Social Security benefits could squeeze out an extra $112 a month in income tax savings if they moved from California to Michigan, Meighan said. And get a lower cost of living, too.

Ha! Cost-of-living is probably even a bigger savings than taxes (taxes are a subset of costs) -- but let's stick to the subject.

Back to my example. Let's say that I'm a wealthy individual and make $1,000,000 a year. Now look at the numbers:

• The Michigan state income tax rate is 4.35%. So I'd owe $43,500 in income taxes.
• Florida has no state income tax. So I'd save $43,500 in income taxes alone by moving from Michigan to Florida.

Now does it look a bit more compelling? The impact is the greatest (of course) on those people who make the most money. Now is $43k enough to get someone who makes $1M a year to move? Maybe.

I'm not sure what we'll do. Our family is in different states and while we have friends here, I'm not sure we'll stick around once we retire. Then again we may opt for the "home in Michigan, condo in Florida for the winter months" that so many people here go with.

How about you? Anyone considering a move based on taxes either now or in the future?

Review of Major Tax Software Products Reveals Limits

As regular readers are aware, I have been running a series of tax software reviews from readers. I was given free access by the software companies to their sites, gave away that free access to readers, and the readers agreed to use and honestly review the programs. In case you missed them, here they all are in one place:

• CompleteTax Review #1
• CompleteTax Review #2
• CompleteTax Review #3
• CompleteTax Review #4
• H&R Block's At Home Premium Federal Tax Product Review #1
• H&R Block's At Home Premium Federal Tax Product Review #2
• TurboTax Review

The reviews were from seven different readers all with different life situations and tax issues. And yet they all (in general) came to the same conclusion: the programs are great for basic, uncomplicated returns, but not-so-great if you have any sort of issue that's considered "unique."

This was interesting to me because it's the same conclusion USA Today came to when it tried out H&R Block At Home, TurboTax, and TaxAct. Here are their findings:

For taxpayers with straightforward returns, tax software gets the job done, at a fraction of the cost of a tax preparer. Most tax software programs are also adept at handling returns that claim common tax breaks, such as the deduction for mortgage interest and charitable contributions.

But this year's tax software review also revealed the limitations of these programs. Taxes have grown so complex that even those of us who don't invest in individual stocks, own rental property or run a small business could find ourselves in need of advice from a flesh-and-blood tax preparer.

The article then highlights two issues they discovered while testing the software -- converting IRAs to Roths and reporting miscellaneous income. Their conclusion on these:

If you converted a large IRA to a Roth last year, it may be worthwhile to consult with an experienced tax preparer.

You shouldn't have to upgrade to a premium software program to report a couple of hundred bucks you earned mowing lawns last year. But you may need to root around a bit to find the right place to enter this information.

Finally, here are their overall conclusions about each of the products:

As has been the case in past years, TurboTax provided the clearest instructions of all the programs we tested. However, if you're a longtime desktop user, you may want to consider making the leap to the online version. It's cheaper and updates automatically. In our test drive of the desktop version, we had to endure several updates, one of which lasted more than 10 minutes.

H&R Block At Home did a workmanlike job on our tax return — and costs about 25% less than TurboTax. Block has enhanced its data-import function, which lets you electronically transfer information from your W-2, mortgage statements and other documents, but it still lags behind TurboTax in this regard.

TaxAct continues to be the preferred choice for cost-conscious taxpayers. Its standard program is free. However, if you want any guidance, you'll need to upgrade. For that reason, it's best-suited for people with a good grasp of tax laws or those with simple returns.

My taxes are pretty complicated (and have been for several years) and that's why I use a CPA. I think that at some point things might become "common" enough that I'll be willing to tackle the time and expense of doing it myself, but for now I am quite content to have them do it.

And one more piece of food for thought. Here's a great comment from my post asking if you need a professional to do your taxes:

My taxes (state+federal) are fairly straightforward and I used to do them myself. But about 10 years ago I started using a paid tax preparer because it was included in my job's compensation package. I was surprised that the guy found more deductions that I did. I always see the same guy and he gives me advice every year about upcoming rule changes and if he sees me approaching a tax bracket or something like that--very useful for planning ahead. Definitely worth it.

Interesting point-of-view, huh? And one of the reasons I use a CPA -- I want to be sure I get all the deductions I can.

Do You Need a Professional to Do Your Taxes?

I recently ran into a couple of articles on whether or not you need a professional to help you with your taxes and I thought they would make a good basis for a conversation. Let's start with a piece from Money Talks News that says you probably do not need a tax professional:

For the vast majority of people, software is the perfect solution for taxes. Because while income taxes may seem exceedingly detailed and complicated to you, doing math and remembering a few thousand rules is exactly what computers were invented to do.

If that doesn’t convince you, maybe this will: Virtually every human tax preparer is also using software to prepare your return. You’re giving them your information, and they’re doing the same thing you could be doing: inputting it into a software program that spits out a completed return. In other words, in many cases when you’re sitting across the desk from a tax professional, what you’re really doing is paying someone from $50 to $500 an hour to do your typing for you.

In other words, they think that most of us do NOT need professional tax help. That is in contrast to what's happening (the piece simply says that a majority of Americans use a professional to help them file their taxes.)

Then again, there are times when you may need some help:

So why go to a human preparer? There’s only one reason: Sometimes human beings can do things that software can’t. For example, by asking the right questions they can ferret out deductions that software might have missed. Or by getting to know your situation, they might help you formulate a strategy to minimize future taxes, or answer other financial questions you might have. So don’t be penny-wise and pound-foolish: If a pro can really help you, buck up. But if you don’t need or receive valuable personal advice, don’t pay for it. Use software and do your own typing.

On the other side of the argument, the Wall Street Journal says it's worth paying a tax pro. Their thoughts:

This tax season, entrepreneurs operating on a tight budget may be tempted to forgo professional help in preparing their companies' returns. But experts say the investment is typically worthwhile -- at least for those just starting out -- to maximize deductions and avoid penalties. Tax specialists can help ensure that business owners don't pay Uncle Sam too much or too little and help identify all the tax breaks they're eligible to receive.

Really though, this advice isn't for the Average Joe -- it's for a business owner. So the point is really the same for both articles: if you have specialized or complicated tax returns, it's probably worth it to pay a professional. Otherwise, you're better off doing it yourself.

This is the same sort of reasoning I used when I explained that I use a CPA to do my taxes. That said, my returns are fairly consistent and I think I have them down now -- even though they can be a bit complicated. I'm guessing that in the next year or two I'll be doing them myself instead of using a CPA.

How about you? Do you use a tax professional? Why or why not?

TurboTax Review

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader Nate and contains his thoughts about TurboTax's Premier 2010 product.

Free Money Finance generously offered me a license for TurboTax in exchange for an honest review of my experience with the software.  I jumped at the opportunity with a slightly ulterior motive! I had been planning on preparing my own tax return AND having my CPA prepare the return in parallel to see if there were any discrepancies. I couldn’t decide if I wanted to spend the money on a license for tax preparation software if I was also going to pay someone else to do the return.  So with the free TurboTax license, I figured I had no excuse – I had to give this experiment a try!  So I made copies of all my paperwork and completed my taxes using TurboTax; meanwhile, my CPA was working on the same return.  I was anxious to see how the two returns matched up...

I am a 25 year old technology consultant and my wife is a special needs teacher.  Between both of us we worked at 5 different companies in 2010 as employees (5 W2-s) in two different states.  In addition, I had a significant amount of job related expenses, including a home office and a road-warrior’s amount of travel to my various clients. This made itemizing my return a no-brainer.

I had used TurboTax before, but that was with a “simple return”, including the standard deduction. I was a little skeptical that the software would be able to walk me through all of the complexities of my tax situation without any issues; at the very least I was sure that I would be concerned I missed something due to a software inaccuracy.  I was wrong. TurboTax is a highly competent piece of software with what can only be described as a delightful user experience.

There are many versions of the software (Free Edition, Deluxe, Premier, Home & Business, Business etc.), each costing progressively more.  If you use the online version of the software (which I totally recommend), and start with the Free Edition, TurboTax will automatically choose the version of software appropriate for you tax situation as you input your data.

TurboTax started by gathering my personal information, which was super easy to input into the program.  Then by continuing to ask a series of questions about my personal tax situation, TurboTax guided me through the business income and expenses portion of the federal return.  At some point, the software realized I didn’t have a business; it then went straight into questions concerning my personal (employee) income and expenses.  The questions it asked me were written in very clear and concise business language.  For new users of TurboTax, you can have the software guide you through the entire database of questions to make sure you don’t miss anything.  However, experienced users will want to skip this (albeit extremely helpful) hand holding and select the “Explore on My Own” option for each section to save some time.

Once I was done entering the information to populate the federal return, TurboTax automatically (yay!) imported the data into the two state returns I also had to file.  So basically, I only had to answer a few questions in the state returns because TurboTax already had most of the information.  The process was painless.

Because I had done my taxes with TurboTax last year as well – the software offered to show me a detailed comparison of my return from this year against last year’s data.  This was actually very helpful and it was nice to see a breakdown of how my income, deductions, credits and tax liability changed year over year.  I appreciated the attention to detail.

TurboTax ran a series of checks for errors at the end of both my federal and state returns.  The first time I ran it there were no errors.  I went back in and purposefully “broke” some of the data to see what would happen; the software caught the errors and walked me through correcting them.  In some cases this was easy – in others, the software was a little less helpful in making the correction (it required a little research on the TurboTax Help Center forums).  Speaking of the TurboTax Help Center, it contains a wealth of helpful information including: FAQs, IRS publications, and the option to call a TurboTax representative directly.

I have only minimal qualms with the product, and I think even in many of those cases my discomfort was better attributed to the complexities of the tax code.  I didn’t love the fact that they tried to up-sell me additional products throughout the return preparation process (audit protection, speak to a tax expert etc.).  If I were to have purchased each of these up-sell products they offered, my total tax filing could have easily cost a couple hundred dollars (which is getting close to what I would pay to have an expert file the return for me).  I feel that in general, the TurboTax prices are pretty steep when you consider all the costs involved in filing the returns (the state returns alone cost nearly $40 apiece).  But it’s a darn good product (and I felt as though the cost was justified).

What was my favorite part about TurboTax?  I’m so glad you asked that question!  The tool is a fantastic way to quickly run a variety of scenarios to minimize your tax liability.  If you use the online version of TurboTax, you can enter all you information into the software FOR FREE throughout the year – you only pay when you actually file the returns.  Ever wondered how much you could save in taxes if you owned a side business that had a variety of tax deductions and credits associated with it? Curious how much you would save if you donated that old car you have to charity?  These are some of the scenarios I quickly ran by plugging a few numbers into the software – it recalculated my tax liability for any of the scenarios I could think of in an instant. I plan on running projections throughout this next year using TurboTax in order to plan my tax strategy and minimize my tax liability.

As I mentioned in the introduction, just for peace of mind, I also had a CPA prepare my returns to make sure I didn’t miss anything.  Everything matched up perfectly!  However, the time associated with preparing my taxes reminded me once again why some things are worth paying for; I believe a good tax professional is one of those things.   That being said, if you plan on preparing your own taxes look no further than TurboTax.  The software is very intuitive and easy to use – the user experience is top notch!  I would highly recommend TurboTax to anyone who asked my humble opinion!!!

H&R Block's At Home Premium Federal Tax Product Review #2

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader TB and contains his thoughts about H&R Block's At Home Premium Federal product. Here's review #1 if you're interested.

When FreeMoneyFinance offered the opportunity to get a review copy of a tax program and all we had to do was write a review of it, I have to say that I jumped at the opportunity.  Not because of the price, but more from the thought that the exercise would motivate me to get this task done sooner (as I have been known to be in the April 15th, midnight parade at the post office) and it would allow others to get something out of this otherwise thankless routine.  My history with tax software is long, looking through my archived files I can find tax files back to 1996.  There was one year, the first year that we owned rental real estate, where I thought an accountant would be a good idea…$1,100 later and I was determined to be using tax software the next year and going at it alone again!  I keep detailed and organized records, it is just a matter of filling in the blanks, so that fee seemed way out of bounds…  So, I knew this year was going to be another tax software year, might as well help out too.

My Form

My personal (tax) situation is filing the 1040 long form.  We file married, jointly, with kids and all of the deductions, exemptions, and allowances that this offers us.  I am employed, so there will be W-2 income, 401k, and Dependent DayCare Plans.  My wife was working part of last before embarking on the noblest choice of becoming the Chief Operating Officer of our Home, so she will have W-2 income, and 401k as well as a 401k rollover to contend with.  (As a sidenote, this has been a great blessing to our family and I would actively encourage anyone with a family to at least explore the idea of having one parent at home!)  I have a print design and prepress side business focusing on trade association magazine layout that generates 1099/Schedule C income.  We also have Schedule K-1s from a family real estate limited partnership.  On the deductions side, we do itemize to take advantage of savings offered mainly by mortgage, property taxes, charity, and sales tax deductions (as we live in a state without income tax and do not have to make the choice of the state income tax deduction or sales tax deduction).

The Program

The program sent over was H&R Block At Home Premium.  I sit down to download the program, and right after I sign into H&R Block’s website it takes me to the Welcome screen to start doing taxes!  It is right here that I realize that this is an online program, not a download…

I almost did a U-turn and ask out of the opportunity.  I am basically a control freak, I just do not like having my data stored outside of my system.  Clouds are great--when you need rain, not when finances and computing are involved.  As I went round and round with the notion of the online tax system, I eventually got over my reservations by rationalizing that it was one less resource hogging program running on my computer (especially considering I would only be using it for a few days), updates would happen automatically on their servers instead of constantly having to check and download them to my system, and let’s face it, so much of our data is already out there, are we really kidding ourselves thinking that we can control it?  So off I went on the adventure!

Step 1 – Start Up / General Navigation • 2 minutes

H&R Block At Home Premium presents with a polished, clean interface that one expects from one of the market leaders.  Maybe it shouldn’t, but having a high-quality look and feel serves to reinforce that this is a financial tool and it does speak to their experience and professionalism in the world of tax preparation.  As I mentioned above, being an online version, there is no time spent downloading, installing, setting up, and then updating the software, so I am already several minutes ahead of where I would be in past years.  I also have to mention that I REALLY appreciate not having a bunch of video answers and ‘tips’ to navigate through!  Competing products have done this in the past, I guess they think that it adds value to watch someone read the comment to you. I find it slow and boring, and I am sure that it is resource intensive, especially when streamed over the internet connection required.

The navigation look and feel is very similar to installed tax software that I have used in the past and navigating through the various sections is easy—Clicking the “Take Me To” link produces a map with links that allow you to jump other sections.  One functional ‘deficiency’ - I was not able to ‘jump ahead’ in the program, in essence skipping parts that I may not have been ready for (like the K-1s).  You have to go through the section in the Interview first.  This may be good in that it avoids situations where you skip ahead and then never return to the skipped over portion.  But when you have everything ready to go except the K-1s (which happen early in the income section), it tends to stop you dead in your tracks until this missing information is secured.  This situation is noted and addressed in the “Get Answers” section, but I still found it to be suboptimal.  There is also a progress bar at the bottom, right above the copyright information, which will give you an idea of how close you are towards completion.  I will note however, it seemed to spend all of its time at 75%, so it was not much of a help or motivator, your mileage may vary.

Step 2 – Import • 6 minutes

The first task offered is to import last year’s tax file.  I was able to import my TurboTax 2009 file.  I thought that this was an added bonus, importing competitor’s files types.  The system also offered to import my 2010 W-2 information.  It was the weekend and I could not find (or figure out) what the login/password combination was for my work, and I had to enter my wife’s manually anyway, so I ended up just skipping this feature.  I did try to import the information from my brokerage, but was not successful.  Not sure as to the reason behind this, but it did strike me as odd.  It did mention that importing can be done during other steps of the program, as you come to them.  For my experience, I did not come across opportunities to import within the details sections, but I was not searching them out either.

Step 3 – Personal Info • 4 minutes

Quick and Easy!  Mainly this was verifying the import of last year’s return was successful.  Curiously, on the dependents page, SSN was not showing, just their name, like it had not completely imported.  Clicking on edit to add this (as it is required by the IRS) and all of the information is suddenly populated.  It is almost like H&R Block wants you to click on edit to validate this info, but it is not well documented and not as intuitive as the Self/Spouse info page.

Step 4 – Income • 50 minutes

Ahh, the part everyone likes, money made.  And here is where you get to tell Uncle Sam how much you earned in 2010.  This section follows the now typical interview format, with the system having you fill out the information received on W-2s, 1099s (with all varying suffixes), business income, rental income, K-1 information, etc.  There is a running total in the upper right that shows your refund or owe amount.  I personally am not real fond of this running total feature, as it causes a bit of freak out until deductions are entered in, but others like it and I cannot say when exactly would be a good time to start showing it, so for now I just am not a fan.  Also, as you go through the various screens, there is a “Get Answers” section just below the Owe or Refund box that has content appropriate questions that you can click on and get quick answers.  It is like a quick FAQ for each section that you are working on.  Most of the time the process is straight forward and these can be ignored, but it is nice to have a quick answer when you are feeling unsure.

For me, much of the same information used last year was able to be transferred through the import process, and it found (and checkboxed) my small business information, so that came through.  Surprisingly, the import routine did not pick up the K-1 information from last year and I had to check that box to enable the entering of information in this section.  Additionally, none of last year’s K-1 information came through during the import process and it had to be entered manually.

While not a complete list, other noted and disclosed deficiencies listed by the system that may affect a number of users were the absence of handling:

• 1031 Exchanges
• Installment Payments from Property Sale
• Net Operation Loss Carry Forward
• Passive Activity Loss Limits/Carry Forward (Form 8582)

Unfortunately, I do have Form 8582 Carry Forward Losses from Prior Years.  The program notified me that it could not account for this form and offered a referral link to a “Tax Professional” in one of their H&R Block offices.  Not really my cup of tea.  Fortunately, the program does allow you to proceed forward with the understanding that the IRS may determine that the return is “incomplete” or “incorrect”.  I did do some research later and found that the H&R Block installed software product allows a more complete set of forms, which then struck me as odd why they would try so upsell a self-service user to the office environment rather than just upselling the downloaded product (perhaps with a little conversion routine to bring the online data into the downloaded software?).

At the end of the income interview section there is a quick recap of where your income is coming from and in what amounts.  There are buttons to jump to any of these sections to revisit and make changes if needed, or if they are good to go, then it is time to move on to Deductions.

Step 5 – Deductions • 29 minutes

Finally!  Here is the section where we can start chipping away at what seems like an enormously large figure that I “owe”.  This portion continues in the interview format and tends to be more straight-forward than the Schedule portions of the tax form, so overall it feels easier and goes quicker.

The one section that, while technically handled correctly, was not presented in a way that added to the believability factor was the sales tax deduction.  In this section you choose your state from a dropdown list.  The next step has a dropdown for county (locality) and a place to enter your local sales tax rate.  First, the county dropdown just shows “N/A” for my location.  Okay, then don’t image it on the screen, it just adds to the potential for confusion.  After entering my local rate and clicking the next button, it brings you back to the summary page, where you can add a second state if need be (move situations).  The issue here was that it shows my state and then my local sales tax rate next to it, all on one line.  This made it appear that it was only calculating the local portion of the sales tax deduction.  A quick trip to www.irs.gov and using their sales tax deduction calculator showed that H&R Block At Home Premium was, in fact, correctly calculating the entire sales tax deduction.

Step 6 – Credits • 10 minutes

The holy grail of taxes!  Credits are dollars for dollar reductions in your tax bill, versus deductions just getting a portion of the dollar to remain in your pocket.  These are also tougher to qualify for and tend to be narrower in focus.  For our situation, portions of the Child Daycare, Child Tax Credit, and Making Work Pay Credits were in play.  The only one that I was really aware of at the start was the Daycare, because of the Daycare Flex Account, so taking some time exploring and using the assistants and interview topics provided in this section is very worthwhile.

Step 7 – Taxes • 2 minutes

Coming into the home stretch now, with just a few odds and ends to tie up.  This section looks at Taxes, Penalties, and Payments that can affect your return.  Did you have estimated payments during the year?  Did you have a refund last year that you ask to have credited to this year’s taxes?  IRA or pension penalties for excess contributions, early withdrawals, minimum distributions, and HSAs as well as Tax for children under 24 with more than $1,900 of investment income appear in this section too.  Luckily, none of this applied to our situation, so it was on to the next page which consisted of a table showing the breakdown of the taxes you are being assessed and what have you paid to date.

Step 8 – Federal Wrap-Up • 4 minutes

Just some final details on this page.  Standard questions in check-box format like, Do you want to donate $3 to the Presidential Election Campaign fund for yourself or your spouse?  Will you allow someone else to discuss this return with IRS?  Do you need a change of address form?  Do you want to setup estimated tax payments for 2011, or use a refund toward 2011 taxes?  Quick and easy, and then on to error checking.

As for error checking, it came back quickly with no errors, which one would hope as the program is guiding you through it is calling attention to errors as they happen, not waiting until the very end.  From this standpoint the program succeeds, there were a couple times that error messages prevented me from proceeding beyond the specific activity I was working on when I was in those particular sections.  The one cause of concern here is that I do have Passive Activity Loss Carry Forwards (Form 8582) that the program warned me that it could not handle when I was identifying that this was an issue.  I would have expected another call to action that the return may be incomplete or incorrect without that additional information at this ending point, as a friendly reminder.

Hitting next brings you to a page with your high-level figures, Income, adjustments, deductions, taxes, amount owed or amount of refund.  From there you have the opportunity to transfer all of this data into the state package and continue processing your state version…for $34.95.  As I mentioned at the beginning, I am in a state without an Income Tax, so I immediately clicked the link to do my state taxes.  My state was not one of the choices in the dropdown, so that is about as much as I can say about that.

Final Step – Filing • 8 minutes

Following the State, there is a screen attempting to sell an added service of a professional review, and then it is on to the filing.  You can choose to efile (1 federal efile is included) or print and mail.  From here you now pay for the program and choose how to receive a refund (Direct Deposit or Mailed Check) or print the payment voucher.  Mailing the return requires printing and mailing, where efile requires submitting your return to the IRS through the program and then checking on the acceptance in a day or two.  Either way, returns will have you waiting 10 days to 4 weeks depending on how you want to receive your refund.  Payments to the IRS will probably process faster.

Conclusion

All said and done in just under 2 hours.  Granted that does not include time to gather the records (I like to keep a folder in filing cabinet for tax documents, so that I have them all collected together and handy when it is time to sit down to start doing taxes), and it does not include the two days of my life that I will never get back from doing the partnership return (the K-1s, which for some reason seemed harder this year).

The MAJOR disappointment was that I was not able to file with this version because of the Form 8582 Carry Forward Losses from Prior Years that are not supported.  I am impressed enough with the product that I am willing to go through the process again with their installed product.  Form 8582 is supposed to be supported within their installed software product, and it seems odd to me that one product would be ‘more complete’ than the other.

In the end, I would give it a solid B+, with the caveat that the return needs to be just a little less complex than my situation.  There were a few nuances that could have been improved in the user experience, but nothing that was a show-stopper.  I feel that my tax situation is somewhat complex, gave it a good workout, and the program almost made it.  I would (and will) definitely recommend H&R Block At Home Premium to friends and family.

CompleteTax Review #4

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader Lynn and contains her thoughts about CompleteTax’s Premium MVP product. Here are CompleteTax Review #1, CompleteTax Review #2 and CompleteTax Review #3 if you're interested.

Recently FMF selected me as one of several readers to review the CompleteTax Premium MVP Product.  For a little background about my tax preparation habits, I am a “semi-retired” lawyer, working approximately twenty hours per week.  My husband is fully retired.  We always itemize and in addition to my salary, we have dividend and interest income, capital gains (or losses), and a very small amount of farm income from owning some farmland in another state.  We don’t operate the farm ourselves.  We don’t have any self-employment income so I did not review that aspect of the program.

For many years we have used the Turbo Tax desktop version to prepare our taxes.  I have generally been happy with Turbo Tax except that every year I have difficulty in preparing the forms for our farm income.  Last year we were in between computers when it was time to file so I did our taxes by hand.  I was happy to get a chance to review new tax software to see how it compared to our recent experiences with tax preparation, both using Turbo Tax and by hand.

I had never heard of CompleteTax before receiving it from FMF and initially wondered whether it was a reputable company.  I was pleased to learn that CompleteTax was developed by CCH which is a long-time major provider of accounting and tax information to accountants and lawyers.  If anyone knows taxes, it should be CCH.

CompleteTax is an online tax preparation program.  There is no desktop version.  It was easy to start the program, just pick a login name, password and get started.  A first time user would be able to select which of three levels of program (basic, deluxe or premium) to use because the different programs are well described.  After getting started, there is an option to import your information from other tax software which would have been helpful.  I decided to do the return entirely from scratch to get the full review experience.

For the most part, completing the interview process was straightforward.  What I particularly liked was that there were a lot of interview questions per page, more so than Turbo Tax and so there were fewer pages to scroll through.  Another good support feature is that each page has a “help” section that directs you to more detailed information about that page’s topic.  I used that feature a lot.

I also think the program is thorough – it found a deduction for our family that I missed last year when I did our taxes by hand – yikes, I will be amending last year’s return!

However, there were enough questions that were confusing that I grew increasingly concerned whether the information I was inputting was correct.  For example, CompleteTax does not adequately address the topic of timing of the contribution to a health savings account (HSA).  The form requests the following: “Enter the amount of after tax contributions you made to your health savings account in 2010.”  I could not find any information on CompleteTax regarding whether later contributions (those made in 2011) which I plan on making, were to be included in the response to that question, whether later contributions were actually deductible or not, or whether a later contribution would be covered elsewhere in the program.  I ended up going to the IRS website to determine that yes, contributions up to April 18, 2011 to a HSA could be deducted on the 2010 return, but I’m still not 100% sure I entered this information correctly.

Another example where I had trouble understanding the program is miscellaneous deductions.  In the deduction section, the program covered some of the possible miscellaneous deductions, but not our biggest, which is our investment expenses.  I couldn’t tell from the instructions whether or not to enter our investment expenses in the miscellaneous deductions section.  After searching for a while, I learned that investment expenses are actually covered in the income section, with investments.  While it’s not wrong to do it that way, it simply makes more sense to me to keep all deductions in one place, in the deduction section.  The result was that I seemed to spend too much time just trying to figure out how and where to enter information.

My opinion regarding these lapses is that CompleteTax assumes that the user has more knowledge about tax preparation than I think most people have.  I have been preparing our own returns for over twenty years and yet I thought that too many questions were confusing to be able to recommend this program for the average user, that is, someone who wants to quickly prepare his or her taxes and then forget about it until next year.

There are a couple of drawbacks that are related to CompleteTax being an online version.  First of all, I like being able to look at the actual IRS form as I go as it gives some reassurance that I am answering the questions correctly or lets me determine before getting to the end that I’ve made an error somewhere.  This feature is available on the Turbo Tax desktop version although not on the online version.  Another advantage of the desktop version is that you can purchase one CD but complete multiple returns.  With the Turbo Tax desktop version I can prepare returns for my children and parents for no additional cost.  However, at least currently that cost savings may not be significant as CompleteTax has some favorable pricing for many people as mentioned below.

CompleteTax would be great for someone who is very knowledgeable about the tax laws and can understand the questions better than I could.  I think a more knowledgeable person would appreciate the streamlined question process.  Overall I think CompleteTax is a good product for the right user, someone who is knowledgeable about tax returns or has the time and the willingness to research the questions thoroughly.  I, on the other hand, need a bit more handholding.

There’s just not enough advantage to me to switch to CompleteTax, and I actually prefer our usual provider.  Also I like the desktop version for the advantages I previously mentioned.  Certainly, however, CompleteTax was far better than trying to do my taxes by hand since it found deductions I would have missed, not to mention the time savings in getting calculations right the first time.

I do want to note that CompleteTax has some very advantageous pricing right now.  It obviously is making a play to gain new customers with free software for those who owe the IRS, those who lost their jobs last year or those switching from three of the big tax software providers out there.  I don’t know how long these offers will last; you can check it out at www.completetax.com.

H&R Block's At Home Premium Federal Tax Product Review #1

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader Jill and contains her thoughts about H&R Block's At Home Premium Federal product.

I recently had the opportunity to review H&R Block’s At Home Premium Federal tax preparation software. In the past, I have used both Turbo Tax and TaxAct to prepare my returns. H&R Block’s program is similar to the other two.

About Me

I’m unmarried and in my mid-20s. I have one full-time W-2-type job and also do some freelance writing for which I receive a 1099. I also earn a small amount of interest from various bank accounts and Lending Club loans, and claim an interest deduction for student loan interest. I have very little in the way of additional deductions since I have limited medical expenses and don’t have children or maintain a home office for my freelance work. Because of that, I do not itemize deductions.

My taxes are straightforward enough that I could probably do them myself by hand if I really wanted to. I have some background in taxation so I am pretty aware of the credits and deductions that apply to me. Even still, I like using some kind of at-home internet-based software to double check my math, calculate different scenarios to figure out the best ones for me, and actually file my return.

Product Overview

If you are a returning user you can start with last year’s return and make edits/additions as needed. If you are a new user, it first asks you to enter the basics like your Social Security number, birthday and marital status. You also enter information about the state(s) you will file state returns for. It then gives you the opportunity to select life events that may impact your taxes – did you buy or sell a house, start or lose a job, get married, have a child, start college, etc. Once you have entered background information, the program walks you through five additional sections to help prepare your federal return: Income, Adjustments and Deductions, Credits, Taxes and Wrap-Up. After you have completed the federal return, you can choose to complete applicable state returns. The program moves your information from the federal to state return so that you only have to answer any state-specific questions. After you have completed all of the information, you can either print and mail your tax forms or e-file.

The Good

• Check boxes at the beginning of the income section allow you to select the portions of the return that actually apply to you – if you only have W-2 income, you will only be asked to enter your W-2 information. If you tell the program that you have income from, for instance, renting out a house, then it asks you the related questions. This helps ensure that you get all information entered without wasting time reading questions that do not apply to you.
• The program clearly displays the amount you will either be refunded or have to pay for both your federal and state returns. The amounts change as you enter additional information, so you can see how each section impacts your bottom line.
• The program walks you through the return preparation process one step at a time, allowing you to save your work and come back later.
• The program provides answers to common tax questions on the right side of the screen. As you move through various sections, the questions displayed change to reflect that particular topic.
• The various income sections allow you import forms like W-2s and 1099s from certain institutions. While there are still many, many institutions that are not on the list, popular financial services institutions like E-Trade are listed. As this list expands, which I imagine it will over time, this feature could potentially save you loads of time, especially if you maintain accounts at multiple institutions.
• When you complete each section, the program summarizes the dollar amounts you entered. An “explain this amount” button explains any adjustments that were made to the amount you entered, such as for deductions that are phased out above a certain income level.

The Bad

• Unlike the income section, the deductions section asked me questions that didn’t apply to me and were kind of a waste of my time. For instance, when I told the program that I was 24 and did not say that I received disability income, it probably should have known to skip the questions about social security income or IRA distributions taken after the age of 65.
• The program was extremely helpful when it came to entering information from forms I had received in the mail or online. It was less helpful when there was not a form – for instance, I have two sources of freelance writing income. One was over $600, so I received a 1099 and entered the information when the program asked me about 1099s. But the other one did not send me a 1099 since the total amount they paid me was less than $600. I wasn’t sure where to report that income, since the program never asked me about income for which I did not have documentation.
• State filing is an additional $34.95 per state return. Many other programs include one state for free with the federal filing.

The Bottom Line

I liked the program and thought it was pretty easy to use, but feel that I can get similar services/results at a lower price. Perhaps those with more complicated tax situations such as more complicated investments, a business or rental properties might get more value out of this version.

CompleteTax Review #3

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader Andy and contains his thoughts about CompleteTax’s Premium MVP product. Here are CompleteTax Review #1 and CompleteTax Review #2 if you're interested.

I work in the financial services industry, where I frequently reference and analyze personal tax returns.  It is not uncommon for these returns to be fairly complex, as my customers are generally owners of small businesses.  Some of the documents have amounted to more than a ream of paper!  In other words, I am fairly accustomed to navigating tax returns.

I have almost always prepared my own returns, although I can’t remember the last time I simply filed a 1040-EZ.  This means that I normally spend a considerable amount of time each year—maybe four or five hours—getting my taxes ready.  One year, I had earned income while living overseas; another year, our son (who was one year old at the time) incurred capital gains taxes based on a gift of stock from my parents.  Such factors tend to complicate the preparation process.

This year, things were somewhat simpler.  We had:

• W-2 income
• A number of itemized deductions
• Income from interest and dividends
• Capital gains income

I am pleased to say that I spent only a touch over an hour on the preparation and filing process this year!

To me, the CompleteTax software seemed user-friendly enough.  While there may be some room to upgrade the user experience as far as visuals, the flow from one page to the next felt very logical.  Also, the act of inputting the data seemed relatively natural.

Though the whole experience was very good, there were some elements that might be improved.  I did notice one formatting issue while inputting phone numbers.  While that incident did not detract from the functionality of the software, it gave an impression of unpolished or untested work.  That was a touch disconcerting, especially since that issue is encountered so soon into the process.

Also, I was unsure at first whether my progress was being saved automatically since I did not see an obvious “save this page” type of button.  When I took a quick break, I was relieved to log back in and find that my progress had, in fact, been maintained.

Finally, it would have been nice to have more direct help with some of the forms.  For example, I found myself checking the IRS website frequently while working on the Schedule D (Capital Gains and Losses) to make sure I was accounting for my capital asset transactions correctly.  For example, CompleteTax did not give abundant guidance on working with capital loss carryovers, which we had due to the sale of our previous residence two years ago.  If there was more substantial assistance available without going directly to the IRS site, I did not find it.  Such issues did not slow me down inordinately; however, I would anticipate some potential frustration for a user who was not quite as accustomed to the ins and outs of tax returns.

In all, I was satisfied with the product.  With CompleteTax, I spent a total of just over an hour to prepare both federal and state taxes.  This was a significant time savings.  Based on the time saved versus preparing the returns on my own, I could envision paying the $49.99 cost for the Premium MVP product next year.  I wasn’t blown away, but I did have a very positive experience.

Are You Expecting a Tax Refund?

Last year the average tax refund was over $3,000. I haven't heard whether it will be higher or lower this year, but it's likely to be in the neighborhood of $3k. Which brings us to the questions of the day: are you planning on getting a tax refund and how much will it be?

I am planning on getting one, though I'd like not to. I try to plan to receive zero back (and have zero to pay) each year, but in bonus years that's a problem. Why? Because they take out an unusually large chunk of money from bonuses. Translation: they are going to owe me a good amount back. I'm not sure what it will be, but I'm guessing it will be more than $3k.

How about you? Are you planning on getting a tax refund and if so, how much?

CompleteTax Review #2

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader CB and contains her thoughts about CompleteTax’s Premium MVP product. Here's CompleteTax Review #1 if you're interested.

Unlike most sane, rational Americans, I do not dread tax season. Quite the contrary, actually. For me, tax season is one of the few times of year I take to sit down and go through all of my financial records and assess the big picture. I am the type of person that keeps meticulous records of my finances throughout the year, budgets, plans, and thrives when calculating how well my estimates stack against Uncle Sam’s. This year my taxes were no small challenge – I made a major work-related move and thus had to file multiple state-returns, I was enrolled in college full-time for a portion of the year, paid interest on student loans, invested in a 401K and Roth IRA, and had income reported on nothing short of seven W-2s. Needless to say that when Free Money Finance offered the opportunity to review CompleteTax MVP, I jumped at the chance to test run the program.

For those of you unfamiliar with the program, CompleteTax is a guided, at-home tax software program similar to TurboTax and H&R Block at home. The MVP edition provides additional tax resources for those that are self-employed or that also need to file for a small business. Unlike other programs that I have used in the past, CompleteTax allows you to work through your return online rather than requiring a disk or a download.  I found this to be a huge advantage that allowed me to work on my return at the office as well as at home.

Initially, I was excited to see that CompleteTax offered the option of importing tax information from a previous return (regardless of what software you had used to file previous returns). However, I was disappointed to find out that the software was unable to process my information. To CompleteTax’s credit, the program interface was simple and easy to follow, so manually putting the information in wasn’t a terrible ordeal. Unlike many other tax programs, CompleteTax’s online form looks identical to your W-2, a feature that makes it simple to quickly input your information without having to take extra care you are putting the right information in the right box.

They offer tabbed selections which classify each area of information and provide helpful “check when complete” boxes at the end of each section. The check-boxes are particularly useful in guiding you through areas of tax regulation that do not apply to your situation – for example, it allowed me to entirely skip over tax sections related to dependent information. This allowed me to skip through several sections and speed up the process. The downside to using the “check when complete” boxes is that they can be misleading. Rather than keeping track of the information you have completed, they are merely for your own records so that you can more easily determine which fields you should revisit.

CompleteTax provides a wealth of tax knowledge throughout the program. The software has a very developed FAQ section, database of searchable information, and also offers customer support through e-mail, phone, and live chat. I used both the database as well as the phone support to address several concerns that I had about using the appropriate information. I found the phone support to be the most helpful resource of the two. Both customer service reps that I spoke with were knowledgeable and friendly. I had a wait time of less than 5 minutes for each, which contributed to the positive experience.

In addition to this support, CompleteTax offers informative notes throughout the program. While sometimes useful, overall I found them to be confusing and cumbersome. The notes often link you to resources housed in other areas of the website which can make it difficult to understand how they apply to the area you were working on. In a few cases, the informational notes made it unclear whether information was necessary or not, which in turn, made me question the accuracy of my return. Unlike other software programs, there were no checkpoints or error alerts to inform me if the information was being input correctly. Similar to other programs, CompleteTax offers a running calculator at the top of the screen to inform the user how new information will affect your return. After putting in several significant pieces of information (such a several thousand dollar moving deduction and an additional W-2), the calculator did not adjust at all. This furthered reservations I had about its ability to appropriately calculate my taxes.

In general, one of my biggest sources of frustration was the poor job that CompleteTax did with explaining the difference between how standard vs. itemized deductions would affect my return this year. With the way their program is set up, I had to thoroughly research each deduction the mentioned using their additional information system (as well as other resources) and make what I felt was at best an educated guess before moving forward. Given this aspect of the program, CompleteTax is probably a little more time-intensive than other programs that I had used in the past.

While there were several redeeming areas of the program (the information available, customer support, web platform, and pricing structure had I been paying for this program), ultimately I ended up filing my taxes with another program. In addition to the reservations I had about the accuracy of my filing, part-year or nonresident state tax filings are not supported by CompleteTax. It was easier for me to file using a program that could handle the complexities of my return this year. Additionally, I felt more comfortable that another program would provide checks for accuracy that CompleteTax did not seem to offer. Overall, I would say that CompleteTax is a program that would best benefit someone with a fairly straight-forward return or someone with preexisting extensive tax knowledge. I would recommend giving the free version a try to anyone interested in the program and upgrading to the appropriate level if it meets your needs.

How to Get Back Tax Dollars You Paid Years Before

The following is an excerpt from Julian Block's Tax Tips for Marriage and Divorce: Savvy Ways for Couples to Trim Their Taxes.

Everyone makes mistakes. That’s why pencils have erasers. And that’s why there’s no need to  panic if you recheck a Form 1040 after it was filed and discover an error—say, an overlooked deduction, exemption or credit, overstated or omitted income, an incorrect filing status, or some other miscue that could affect tax liability. Opportunities for errors abound because Congress continually changes our already complex Internal Revenue Code. And making amends can bring rewards.

The normally unforgiving Internal Revenue Service wants to help taxpayers who file their 1040 forms and subsequently spot errors. Those who decide that their returns were actually just first drafts can confess their errors by filing amended returns. More people than ever are expected to apply newly discovered tax information to 1040s filed in previous years.

The IRS receives millions of amended returns every year. It expects to process about 5 million corrected 1040s for 2010, says Diane M. Besunder, a spokesman in the New York office of the IRS.

Most mistakes involve overlooked write-offs or income items. But sometimes, returns that are accurate when submitted still need to be redone because Congress or the IRS retroactively revises the rules. Much more on that later.

The Paperwork

The IRS provides a relatively easy way to fix flubs or take advantage of retroactive changes, without the need to completely redo the return or go through any complicated red tape. Just contact the feds for Form 1040X, a simple (in most cases) two-page form known officially as Amended U.S. Individual Income Tax Return. Form 1040X comes with 11 pages of instructions on how to explain the reasons for the changes and how to compute  refunds or balances due.

Enter the refund amount sought on line 21 of the 1040X.  But you needn’t list an exact amount. To leave the door open for a refund in excess of the amount specified, tax pros routinely add this language: "Or such greater amount as is legally refundable, with interest."

Make sure to calculate the tax using the rates for the year of the return that you’re amending. And the tax brackets change every year because of indexing, that is, annual adjustments to reflect inflation.

Use the latest version of Form 1040X (completely redesigned in January of 2010), available at irs.gov. While you’re at the IRS site, download any forms or schedules for the year you’re amending. Also get Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund, which has helpful information not contained in the instructions accompanying Form 1040X. Click on “Forms and Publications;” then click on “Previous Years.”

Amend with Care

Return corrections that change AGI, short for adjusted gross income, may affect a slew of deductions, credits and other breaks authorized by the tax code. Among other things, AGI governs the extent to which Social Security benefits are taxed. Revised computations also may prove necessary for deductions or credits that are tied to AGI or limited by a percentage of AGI, caution the 1040X instructions. These include: Schedule E deductions for losses on rental properties; “above-the-line” write-offs on the front of Form 1040 for higher education expenses, funds put in traditional IRAs, and interest payments on student loans; credits for first-time home buyers or longtime owners who bought another principal residence, adoption expenses, children under 17, child and dependent care, and education; and Schedule A itemized deductions for medical expenses, uninsured casualty or theft losses and  miscellaneous expenses.

Filing Tips for Amended Returns

Be mindful that no matter how meritorious your claim or how sympathetic the IRS may be, the agency will approve a refund only if you satisfy certain procedural requirements and file a claim in a timely manner. More in a moment on time limits. First, though, some IRS admonitions on how to avoid delaying correspondence and to speed up the processing of your refund claim.

• Submit a separate 1040X for each year for which you apply for a refund. The IRS is adamant on that; it makes no difference that your error is identical for more than one year. Filing a claim for, say, 2008 doesn’t put the IRS on notice that you also seek a refund for another year.
• Along with your 1040X, submit any applicable correspondence from the IRS or relevant tax-return schedules and forms—for example, corrected versions of Schedule A (changes in amounts claimed as itemized deductions) or Schedule D (changes in amounts reported as capital gains from sales of homes, shares of stock or other assets). Attach copies of any IRS notices that relate to your refund claim or previously filed return. The instructions specify, “Form 1040X must have the appropriate forms and schedules attached or it will be returned for them.”
• Remember to sign the 1040X. Joint filers both must sign.
• The 1040X is one of the few forms that can’t be filed electronically. You’ll have to send a paper copy to the IRS. Mail each 1040X in a separate envelope to the IRS Service Center responsible for where you live now, even if the return was originally filed with a different Service Center. But if you’re filing a 1040X in response to a notice received from the IRS, mail it to the address shown on the notice.

EXAMPLE: While preparing this year’s return, you discover that 2008’s return failed to claim all of your allowable deductions on: Schedule C for business travel; Form 3903 for moving expenses; and itemized deductions on Schedule A for job-search expenses, charitable travel, medical travel and investment travel. Or maybe you now realize you should have itemized deductions instead of taking the standard deduction or you forgot to take advantage of the child-care credit, which gives you a tax break on money paid to a caregiver for your children. Along with the 1040X, submit corrected 2008 versions of: Form 3903; Form 2441 for child and dependent care expenses; and Schedules A, C and SE (Self-Employment Tax). Why is it important for you to revise Schedule SE? Claiming additional expenses doesn’t just reduce the amount you show as profit on Schedule C, thereby reducing the amount of your income subject to income taxes. It also reduces the amount of your income subject to self-employment taxes, as calculated on Schedule SE. Many individuals get nicked more for self-employment taxes than for income taxes.

Note: The book goes on to list the following as "good reasons to amend your tax return" as follows: the wrong basis (on sold investments), medical deductions for home improvements, standard deduction versus itemizing (take one then find the other was better), change of filing status, and retroactive law changes and tax elections. See the book for details.

Marriage or Divorce as a Tax Shelter

The following is an excerpt from Julian Block's Tax Tips for Marriage and Divorce: Savvy Ways for Couples to Trim Their Taxes.

“Bachelors should be heavily taxed. It is not fair that some men should be happier than others.”—Oscar Wilde

Couples planning their weddings focus on the biggies like ceremonies, rings, flowers and adding to or subtracting from guest lists. And when John and Mary are on the threshold of marriage, they don’t want to think about federal income taxes. But that’s just what many couples ought to do when they are choosing between marriage in December or in January.

Timely Tax Tips for the Soon-to-be-Joined

Taking the plunge before or after the stroke of midnight on New Year's Eve can make a significant difference in the size of their tax bill for 2010 and 2011. The rule—too often overlooked—is that their marital status as of Dec. 31 usually determines their filing status for the entire year. In other words, the Internal Revenue Service ordains that they’re married for all of 2010 even if they should get hitched one minute before New Year’s Eve, or even though they may be living apart, absent a final divorce.

By the same token, the IRS considers them to be single all year—even though their divorce or legal separation takes place as late as Dec. 31. (When one spouse dies during the year, the other can still file a joint return for the year. This is an exception to the standard rule that one’s marital status on Dec. 31 determines whether one is considered married for that year.)

The Dual-Income Drag

Here’s an example of how and why the so-called marriage penalty (or sin subsidy, depending on one’s point of view) applies. Let’s say that prospective mates John and Mary both work and have similar incomes. If they wed before the close of 2010, the marriage penalty may compel them to pay more income taxes on their combined incomes than if they remained two swinging singles who shared bed and board and reported exactly the same incomes. The penalty occurs when a married couple’s combined income pushes them into a higher tax bracket than they would have been in if they filed as single individuals.

John and Mary need not fret about the penalty when each has taxable income under the top end of the 15 percent bracket for singles, which is $34,000 for 2010. Married or unmarried, they stay within the 15 percent bracket. (In IRS lingo, taxable income means what remains after their adjusted gross income, the amount they enter on the last line of the front page of the 1040 form, is offset by dependency exemptions and itemized deductions like charitable contributions and medical expenses on Schedule A of the 1040 form or the standard deduction if they don’t itemize.)

But suppose John and Mary each has taxable income for 2010 of $75,000. As single taxpayers, each stays well below the top end of the 25 percent bracket ($82,400), whereas if they marry and file jointly, more than $12,000 of their combined income of $150,000 would spill over into the 28 percent bracket, which applies to taxable income between $137,300 and $209,250.

The penalty escalates when each one’s taxable income increases to $110,000.  As single filers, each is in the 28 percent bracket; as joint filers, John and Mary move up to the 33 percent bracket. The marriage penalty ceases only when each is in the top bracket of 35 percent—that is, taxable income of more than $373,650, whether they file single or joint returns.

There’s an easy way for John and Mary to sidestep the marriage penalty for 2010. All they need to do is postpone getting hitched until 2011.

Marriage Bonus

Many couples benefit from a bonus. Suppose Mary earns the bulk of the income or considerably more than John. Then getting married by Dec. 31, rather than waiting for a June wedding, could definitely be a smart move. Their taxes as a couple usually will be less than if they remained unmarried.

TIP: What if John has a capital loss carryover from a previous year and Mary has capital gains? Then it might be advisable to wed this year and use the carryover to offset the gains.

Marriage penalties and bonuses are "one of the major reasons the American people have become so dissatisfied with the income tax. When a tax system departs dramatically from the fundamental values of the people it taxes, it cannot sustain public support,” notes Michael Graetz, a Yale law professor and former Treasury Depart­ment official.

Each Year Stands on Its Own

Married couples might be stung by the penalty in some years and enjoy a tax bonus in other years. Consider, for example, the history of the ultimate two-career couple, William Jefferson and Hillary Rodham Clinton. The Clintons were subject to the penalty for the years 1983-1992, when he received an annual salary of $35,000 as governor of Arkansas and she earned much more as a partner in a Little Rock law firm.

They reaped a bonus for the years 1993-2000, when he received an annual salary of $200,000 as president of the United States and was the sole earner in the family unit until she entered the Senate in January, 2001.

Timely Tax Tips for the Soon-to-be-Parted

Comparable rules apply to couples contemplating divorce or legal separation. Estranged spouses who sever their ties at any time before midnight on Dec. 31 forfeit the benefits of joint filing for the entire year. Only couples who are able to grin and bear it through Dec. 31 can save taxes for 2010.  What if being single provides an advantage? Then they must undo their marriage by Dec. 31.

Profiting from a Year-End Divorce

These tax quirks have not gone unnoticed by some dual income couples. To the surprise of no one but the IRS, an increasing number of these couples have journeyed to Haiti or some other equally obliging place to get a divorce in December, only to remarry in January.

Some affluent couples announced on “60 Minutes” and other national television programs—what were they thinking?!—that they slip into and out of marriage with annual quickie divorces, just so they can file as two unmarried persons and save on taxes. Even if their savings were largely offset by the divorce fees, their outlays also allowed them to frolic for a week or so in the Caribbean sun and to buy some extra nice Christ­mas presents for the folks back home—all courtesy of those obliging souls at the IRS.

The party poopers at the IRS issued a prim warning: Revenue Ruling 76-253 specifies that the agency will disregard a divorce obtained solely to save taxes and will require the couple to recalculate their taxes as if they had stayed married for the entire year, making the couple liable not only for additional taxes, but also for interest and possible penalties.

TIP: A beleaguered IRS concedes that there’s nothing to stop couples from filing as single persons as long as they get a regular divorce and simply live together out of wedlock. This arrangement has become a socially acceptable way of life for the more than five million couples who fit the Census Bureau definition of “POSSLQ,” meaning “persons of the opposite sex sharing living quarters.“

Figuring Taxes on Social Security Benefits

The following is an excerpt from Julian Block's Tax Tips for Marriage and Divorce: Savvy Ways for Couples to Trim Their Taxes.

Americans often dream about a simplification of the Byzantine Internal Revenue Code, only to awaken and find the tax laws becoming more complicated. The rules for Social Security benefits are especially convoluted and confusing. Although most Social Security recipients escape income taxes completely on all of their benefits, middle- and upper-income level retirees have to count up to 85 percent of their benefits as reportable income.

Gift of the Magi

Taxes are triggered for Social Security recipients when their MAGI exceeds specified amounts. MAGI is an acronym for modified adjusted gross income, which, in most instances, is essentially the same amount as adjusted gross income, and not the term for the three wise men from the East who bore gifts to the infant Jesus.

To calculate whether MAGI surpasses the tax-triggering thresholds, retirees must consider income from various sources such as: salaries, pensions, dividends, capital gains, rents, Roth conversions (money moved out of traditional IRAs and into Roth accounts), and required minimum distributions (RMDs) starting at age 70 1/2 from traditional IRAs, 401(k)s, and other retirement plans.

Add to the wide-ranging MAGI tally for Social Security benefits whatever retirees receive as tax-exempt interest from municipal bonds (obligations issued by state and local governments) or from muni bond funds, as well as 50 percent of Social Security benefits.

Take, for example, a married couple that has an adjusted gross income of $31,000, tax-exempt interest of  $5,000 and Social Security benefits of $28,000, for a total of $64,000. Their MAGI is $50,000 ($31,000 + $5,000 + $14,000 [50 percent of $28,000]).

The Internal Revenue Service uses a three-tiered threshold to determine the size of its bite on benefits. If MAGI is less than $25,000 for single taxpayers ($32,000 for married couples filing jointly), then benefits are not counted. If MAGI is between $25,000 and $34,000 for singles (between $32,000 and $44,000 for couples), up to 50 percent of Social Security benefits are taxed. And if MAGI tops $34,000 for singles and $44,000 for joint filers, up to 85 percent of benefits are taxed. Special rules apply to married couples who file separate returns. More on that later.

The MAGI numbers are significant for those receiving Social Security benefits because the greater the incomes they derive from sources other than Social Security, the greater the portions of their benefits that become taxable. Once beyond the top threshold, each additional $100 of income from pensions or investments can cause an additional $85 of benefits to be taxed.

Suppose Patrick and Nadine Vennebush fall into a 15 percent federal tax bracket (for couples in 2010, taxable income between $16,750 and $68,000), and they need additional funds to cover unanticipated expenses. Without considering the tax consequences beforehand, Patrick and Nadine opt to take $3,000 from a traditional IRA, a withdrawal that is in addition to any RMD. The $3,000 pushes their total income into the highest MAGI tier, thereby bumping another $2,550 (85 percent of $3,000) of benefits into taxable terrain.

That means the $3,000 withdrawal increases their income taxes by $833: the sum of $450 (15 percent of the $3,000 IRA withdrawal), plus $383 (15 percent of the $2,550 worth of Social Security benefits). Consequently, their effective tax rate on the withdrawal nearly doubles to 27.8 percent. Worse still, the federal tab is before any applicable state income taxes.

Most of the time, I encourage clients like the Vennebushes to defer taking distributions from their retirement  plans for as long as possible, using only the RMD, whenever feasible, as a way of delaying the inevitable tax bite. This tactic becomes even more advantageous when there’s the potential for higher taxes on a portion of Social Security benefits.

A savvier strategy that leaves MAGI unchanged would be for the Vennebushes to take a nontaxable $3,000 from a place like a savings account and then repay the “loan.”

Alternatively, the couple could realize paper losses on investments in individual stocks, bonds or mutual fund shares to offset capital gains. They can’t offset capital losses against “qualifying dividends,” which is IRS lingo for dividends that are taxed at rates of 15 percent or zero percent; it makes no difference that those rates are the same as those for capital gains.

What if the Vennebushes have no gains to offset or losses exceed gains? They can use their losses to offset as much as $3,000 of ordinary income, such as salaries, business profits, pensions, and interest, thereby reducing MAGI. What if losses aggregate more than $3,000? Not to worry. They can carry forward unused losses indefinitely to offset future income, should that prove necessary. But the couple’s planning can come undone if they ignore or are unaware of what the IRS characterizes as the wash-sale rules.

They forfeit a current deduction for their loss if they step back into the same or “substantially identical” investment within a period that spans from 30 days before to 30 days after the sale.

Taxes on Social Security When Couples File Separately

Yet another complication is a much-misunderstood restriction for couples who opt to file separate returns. The general rule is that their threshold for exemption from taxes drops from $32,000 to zero. To qualify for relief from the general rule, the spouses must not reside together at any time during the taxable year. Stated another way, a couple who live together, even for just a day, and file separately are not allowed a base amount of $25,000 each. All of their benefits count as reportable income.

This trap snared Thomas W. McAdams, a retired Army colonel. Tom and his wife Norma stayed married but lived apart, she in the home they owned in Boise, Idaho, while for many years he lived most of the time in Ninilchik, Alaska, and other locales far from Boise. The estranged spouses listed themselves on their 1040s as “married filing separately.”

The IRS computers bounced Tom’s return. During the audit, Tom inadvertently divulged that he stayed in Norma’s dwelling for more than 30 days during the year in issue, though he always slept in a separate bedroom. That admission convinced the United States Tax Court to agree with the IRS that Tom didn’t, as the law specifies, “live apart” from his wife “at all times during the taxable year.” The 2002 decision deconstructed living apart to mean only living in separate residences, not separate areas of the same residence. It held that his visits disqualified him for the $25,000 exemption. Hence, his Social Security benefits didn’t sidestep taxes.

The 2002 decision deconstructed living apart to mean only living in separate residences, not separate areas of the same residence. It held that his visits disqualified him for the $25,000 exemption. Hence, his Social Security benefits did not sidestep taxes.

CompleteTax Review #1

In January I selected several readers to receive free copies of various income tax software programs. In exchange, they agreed to use the software to do their taxes and write an unbiased review. The summary below was written by FMF reader RA and contains her thoughts about CompleteTax’s Premium MVP product.

By day, I am a Web Developer at a small company (fewer than 15 employees). After work, I occasionally take time away from my hobbies to freelance more Web design, development and content writing, generating a couple thousand extra dollars to support those hobbies. Between the freelance income (self-employed tax payments required), student loan interest and investments, free 1040-EZ filing doesn’t work for me, so I jumped at the chance to try out a new preparation software this year.

CompleteTax Premium looked promising: after signing up, the program told me that if I imported a .pdf of last year’s return from a major preparer, they would waive the federal fee for the premium program. The import was of little use; it only imported my name, address and SSN—and confused a couple of those fields (my SSN ended up in place of my first name).

Each page has a checkbox labeled “Check if page is complete,” but there was no error when I tried to proceed without adding a first name (after deleting my SSN from that field). In a quick online chat with a friendly, knowledgeable representative, I learned that the checkbox is purely for my own notes, not an option to have CompleteTax double-check my fields. Novel, but not all that useful.

The address page, which was partly filled from the import, asked for daytime and evening phone numbers. I typed in the format 555-867-5309 and pressed Continue to move on to the next page. At that point, I received an error pop-up stating that I must enter at least one phone number; there was no tip that I needed to enter the number in any specific format. By trial and error, I learned that (555) 867-5309 is the magic formatting. I couldn’t proceed until I solved that. This was very confusing, because I was told exactly how to format other fields.

The income section provides a way to import your W2s from a federal database by using your employer’s FEIN. My employer couldn’t be found, so I entered it manually, and the rest of the income section was straightforward. Adding my freelance income was simple, and the help sections on how to claim a new computer purchase as a depreciable asset were thorough.

The investments section was easy to complete by answering a few yes/no questions and including info for each account. However, the program only handles the business-side of SIMPLE IRAs in this section. Employee contributions to SIMPLE IRAs are already factored out of your income on your W-2, but there was no note of that. I had to research elsewhere to be sure I was completing the section correctly with my combination of SIMPLE and Roth IRAs.

A miscellaneous category combines most other deductions. I took the standard single deduction, and claimed student loan interest paid and HSA contributions. The program stepped me through both after answering more yes/no questions. Entering the 1098-E data for my student loan was painless. The HSA section was confusing because of how they word things. For instance, my contributions are Section 125 (pre-tax), so they’re included in the W-2 info. There is no notice in the HSA section that I’d already claimed that money. This is also the section where I would claim any estimated tax payments for my freelancing. I prefer to claim one fewer allowance on my full-time job’s W-4. It covers my tax liability without having to deal with estimated taxes or underpayment penalties.

Filing for NY was a breeze, because I don’t qualify for any special deductions and do not live in New York City. I had to answer no to a lot of questions about deduction qualifications, and that was that—it’d already imported my income (all earned in NY) and included the freelance income and expenses from the Federal section.

E-filing was simple, allowing me to choose direct deposit to receive my return. Had I owed, I could have paid by authorizing a debit from my checking account. The program did check the return at this point and offered a few suggestions before I authorized the e-file submission. It caught an issue with the 2009 import that I’d overlooked—the program imported my state abbreviation into the city field.

Because I make a living developing online forms and applications, I know what it takes to create a good user experience. When you expect your users to pay to use your product, you need to put much effort into making it as user-friendly as possible. Overall, CompleteTax falls short of what I would consider a completed commercial product when it comes to user interaction. It ultimately comes down to trust—if a company doesn’t tell me that it requires me to input data in a specific way and fails to give valuable feedback for missing or incorrect fields along the way, do I trust them to tell me if I made a major mistake on my taxes? No. The errors presented at the very end did help with some of the anxiety caused by the lack of feedback throughout the process, but I won’t use CompleteTax in the future.

That said, the guidance on most issues does give CompleteTax an advantage over filling out the forms and worksheets by hand. I’d just be hard pressed to say it is an advantage worth paying for.

What Should You do if You Get an IRS Audit Letter in the Mail?

The following is a guest post from H&R Block’s Leigh Mutert, CPA and hrblock.com Community Manager.

Tax filing is on the minds of most Americans right now. Now is also the time taxpayers begin to wonder if they are filing correctly. From valuable tax deductions to new tax credits, it can be disconcerting to consider the possibility of an IRS audit. H&R Block has some tips to keep in mind as you prepare your tax return this year – as well as some advice if you find yourself being audited.

So, what should taxpayers do if they find themselves being audited?

In 2009, the IRS conducted 1.1 million tax audits by mail and more than 326,000 in-person audits. As the IRS tries to collect approximately $290 billion in unpaid and underpaid taxes, more taxpayers and tax evaders may be audited.

What happens if I get a tax audit letter?

Ignoring an IRS audit notice will not make it “go away.” The clock starts ticking as soon as the IRS sends the notice, meaning interest and penalties are added to any additional tax owed – whether or not the taxpayer has read the audit letter.

If the taxpayer asks for more time to respond, the IRS typically will grant an extra 30 days.

What should I do if I receive an IRS audit notice?

Taxpayers should meet with their certified tax professional to discuss what the notice means, what information is being requested and what records they need. If H&R Block prepared your return, or if it was completed at home or online using H&R Block tax preparation software, H&R Block will support you in the rare event of an IRS audit.

“While most people only think about taxes during the first four months of the year, the IRS actually communicates with taxpayers year-round," said H&R Block Master Tax Advisor, Elaine Smith. "A timely response to an audit notice can save you money and the guidance of a tax professional can make you feel more secure about competently responding to the inquiry.”

If I’m audited, does it mean I owe the IRS more money?

Getting an IRS audit notice does not necessarily mean you will have to pay more taxes. It does mean the IRS wants to verify the information reported on tax forms is correct by reviewing supporting documentation and financial information.

In some situations, the IRS will work out payment arrangements, which may mean some additional paperwork for the taxpayer. A tax professional can ensure all requested documents are filed correctly.

These notices could be common for senior taxpayers when it comes to making sure they claim all of their income. Often, taxpayers misplace or genuinely forget to claim certain income from stocks, other investments. It’s important to remember that the IRS gets the same paperwork you should from your investment providers.

FMF note: My wife was audited the first year after we were married. She actually got more money back AFTER the audit.

What if I disagree with what the IRS is claiming?

Taxpayers can provide additional information to support their tax returns and partially agree or disagree with the IRS audit notice. If the IRS initially did not have all the information needed to assess a return, a taxpayer may be able to prove less is owed in taxes.

How are taxpayers selected for audits?

There are three ways tax returns are selected for audits:

• Random selection and computer screening based on statistical data
• Document matching that compares the information on forms like 1099s and W-2s with what individuals report on their actual tax returns
• Related examinations, which may occur when the accuracy of one taxpayer’s return is questioned. This may mean that individuals with close financial ties to the taxpayer also receive audit notices.

I hear tax audits are on the rise. Is that true?

The IRS initiated 150,000 audits specific to the new Homebuyer Credit. For this coming year, more audits are checking into the Adoption Credit.

What are some myths about audits?

Audits are just for the rich and famous. - That’s a myth. The IRS doesn’t discriminate based on income. In fact, more than half of audits are for taxpayers with less than $50,000 in income, and nearly 1/3 of all audits are centered on those claiming the Earned Income Tax Credit.

Owning a small business will trigger a tax audit. - This myth is popular because some Schedule C filers may claim income that isn’t necessarily reported by another party to the IRS. Certain self-employed taxpayers just need to be more diligent with tracking all expenses.

Making a large donation or claiming a new credit that they didn’t last year will trigger a tax audit. - That is just not true. Some taxpayers even forgo claiming all of their charitable donations, for example, thinking they must keep it below a certain dollar value to avoid an IRS audit. In fact, taxpayers should claim all credits and deductions they are entitled.

H&R Block's tax tips for someone who gets audited:

First, don’t panic. Most of the time the IRS is simply requesting information. A tax professional at an H&R Block office near you can assist you with responding if needed. And because H&R Block is open year round, they even help clients who didn’t originally file with them through the audit process.

Second, don’t ignore the IRS audit notice. That could add up to be a costly delay.

Finally, if you feel you need representation, an Enrolled Agent, who is authorized to represent taxpayers with the IRS, can assist you. That’s why it’s important to find a certified tax professional who is available year round. Taxes aren’t just a one-day, annual event.

Seven Tax Dodgers Who Prove It Pays to Pay

The following is a guest post from All Over Tech.

Unless you enjoy running from the law, there’s not much point in evading payment of your fair share of taxes. While some people do try their hand at proving that they can avoid one half of the inescapable combo of ‘death and taxes,’ it’s usually not too long before the IRS comes knocking on your door to wring those dollars free of your grasp.

Many people have already helped the IRS to demonstrate its sleuthing powers. Here are seven whom history showed to have tried to cheat their way beyond payment.

1. Possibly more famous now, decades later, for his tax evasion than for his murderous deeds associated with the St. Valentine’s Day Massacre, Al Capone was a mobster brought down by his failure to file taxes. Of course, one could argue that if Al had filed taxes associated with his activities, such as bootlegging then-illegal whisky, he’d have been imprisoned even sooner!

2. Heidi Fleiss, who managed a prostitution ring that catered to the Hollywood crowd, was in roughly the same position as Mr. Capone – her business was illegal, so reporting income derived from it would have illuminated that fact. Regardless, not paying taxes helped to bring the law into her life.

3. Former Senator Tom Daschle mishandled his taxes to the tune of being $128,000 dollars short on payment as April 15th rolled around. This oversight cost him his nomination for an advanced political position.

4. Perhaps an honest man – it’s always hard to tell when taxes are involved – Willie Nelson famously owed nearly $17 million in back taxes in the early 1990’s. However, with a bit more valid of a reason than some other tax cheats, Willie claimed that his tax firm, then known as Price Waterhouse, had given him bad advice on tax shelters. He sued, the firm settled with him for an undisclosed amount, and Nelson went on to raise money with an album which made light of the entire tax situation. He even starred in some ads on TV which poked fun at the mess, although he stopped short of hawking H&R Block coupons as a method of reducing one’s total tax preparation bill.

5. The Artist Formerly Known as Prince, who is once again known as Prince, was accused of owing over $500 million in property taxes in Minneapolis, Minnesota. With a short history of previous tax non-payments, Prince may make good on the claims to avoid further troubles, but his repeated non-payments make a statement that he’d really rather not be bothered with paying taxes.

6. Wesley Snipes single handedly proved that trying to make a moral or legal objection to the law requiring that taxes be paid is no more effective than simply not declaring income in the first place. His mistake has landed him jail time.

7. Bernie Madoff. Well known for having defrauded investors out of their money, Bernie also didn’t pay taxes on the full sum of his exorbitant illegal profits, either.

There you have it; seven examples from various industries whose antics of tax evasion landed them in hot water. Some will never be free again due to their activities. None will be forgotten.

The Return on Your Social Security Taxes

Here's an interesting piece from Money Watch that discusses the return on your Social Security taxes that addresses the issue of whether or not contributors (on average) get the money they put into Social Security and Medicare (through taxes) back in benefits. Here's their summary:

The question remains, though: Is it worth it? Will the benefits you’d receive under current law compensate you for the career’s worth of taxes you’ll have paid into the system? The latest answer, generated by a new Urban Institute Social Security study, is: yes. (Surprised?) As far as it’s possible to project, Social Security and Medicare give you a positive return on your tax “investment” even after inflation.

And here are some specifics:

How’s it shake out? If you retired last year as an average wage-earning man, for example, you could expect a lifetime benefit worth $417,000 in today’s dollars on $345,000 in taxes. If you were a woman with the same work history, you could expect to collect $464,000 on the same taxes.

A couple things to note:

1. Their last example shows a couple earning around $85k -- what they put in and what they get out. These people are close to the breakeven point. Thus, though they don't show it, I'm assuming that the more you make, the worse the deal gets (that you pay more in taxes than you take out in benefits.) Wow, that's inspiring.

2. Since when was "getting your money back" a criteria for a "good deal"? (Not that they are saying that, but they imply that it's a good deal.) Wouldn't getting a "good return" (8% to 10%) on a few hundred thousand you "invest" (pay in taxes in this case) over a working lifetime be a better measure of a "good deal"?

So it's a decent (at least breakeven) deal for most people. Personally, I'll just be happy to get SOMETHING back. Hopefully the age to get Social Security won't be 95 by the time I retire. ;-)

What Will You Be Doing with Your Extra Money?

As I'm sure most of you know already, the tax legislation passed at the end of 2010 included a drop in Social Security payroll taxes. The details:

One of the major elements of the tax package is a one-year reduction in the payroll tax that funds Social Security. FICA taxes will drop from 6.2% to 4.2% for most workers. Since the tax applies to up to $106,800 in 2011, the tax cut is worth as much as $2,136 for a worker or $4,272 for a working couple. (The self-employed will pay 10.4% on income up to the cap, down from 12.4% in 2010.) The 1.45% portion of payroll taxes that funds Medicare will continue to apply to all earnings with no cap.

From what I understand, the thought from D.C. is that since people will be getting a bit more money with every paycheck instead of in one big lump sum, they will be more likely to spend it. And as they spend it, they will help pull the economy out of the economic doldrums.

This isn't going to work for me. I plan on saving all of the money I get to keep (which is a very nice amount over the course of the year.) Getting extra won't cause me to spend more since I don't really see it as a "windfall."

How about you? What do you plan to do with your extra Social Security tax money?