Free Money Finance

Owners of Second Homes: Beware of New Tax Laws

The following is a guest post from Marotta Asset Management.

If you own two homes, sell the one you are living in and move into your second home as soon as possible. Tax changes taking effect on January 1 will make owning a second home much less attractive in 2009. As a result, the already depressed market for vacation homes will deflate even more.

Previously, any capital gains on your primary residence were excluded up to $250,000 for singles and $500,000 for couples. A primary residence was defined as any home you had lived in for two of the previous five years. The "prior rule" gave seniors moving to a new residence three years to make the move permanent. During that time they could still sell their original residence and take advantage of the exclusion.

It also allowed seniors who had a vacation home to move there and sell their primary residence. After two years their vacation home qualified as their primary residence. Young grandparents approaching retirement could buy a retirement home as a vacation destination while they were still working. After retirement they had time to sell their original home and in two years gain a full exclusion for their new residence.

With the new rule, primary residence is not something you can qualify for. Rather it is just a percentage of the time you live there.

The new law eliminates the capital gains exclusion, prorated on the amount of time a home was not your primary residence. After January 1, every day you aren't living in a home starts adding to the percentage of capital gains tax you will ultimately be obliged to pay.

Also, capital gains are no longer waived on a primary residence unless it has always been your primary residence. Starting in 2009, the percentage of time a home is not your primary residence will be the same number used to calculate the amount of capital gains that won't be waived. For example, if you own a house for ten years and have only lived in it for five, you will have to pay taxes on half of the capital gains when you sell it.

These are the same capital gains that President-elect Obama promised during his campaign to raise from 15% to 28% on the most productive citizens. Some states (e.g., California) tax capital gains at ordinary income tax rates, adding an additional 9.3%. So people who make significant contributions to society could easily be facing taxes of 37.3% on gains that are mostly inflation.

This isn't just a problem for the wealthy. You can be pushed into the top 1% of income tax payments simply by selling a house in California. Middle-class couples routinely get hit with unexpected taxes selling a home with capital gains well over the $500,000 exclusion. Because it is not a onetime exclusion, couples who have stayed in the same house for 40 years get socked with the tax, whereas couples who move every decade have multiple chances to realize smaller gains that are under the limits. People who move frequently shouldn't be rewarded with a tax break.

Here's another factor to consider: Home appreciation is mostly inflation. Taxing government-created inflation as so-called gains isn't fair. Even according to the official inflation numbers reported by the government, the equivalent of a million-dollar home today was a $179,154 home in 1970. Calling the $820,846 inflation a capital "gain" is ludicrous.

Class envy is equally mindless. Capital gains on real estate affect your finances even if you don't own a second home. The housing market isn't segmented into primary and secondary residences. What depresses the values on second houses depresses the value of all homes.

The second-house class is the very group that could have helped shore up today's slumping housing market. Speculators who would have bought real estate at the current depressed prices will find this option far less attractive in 2009. Instead the new law will encourage them to sell their current residence (taking the full deduction) and move into their second home. Then their second home will become their sole and primary residence, and they won't have to deal with future nonexempt capital gains taxes. Ask your financial advisor about the potential costs of continuing to own two homes. If you delay, you may be holding an unused vacation home until you die just to avoid this new tax burden. And as a result, your heirs will inherit the house with a step-up in cost basis.

Because of the law, thousands of additional homes will be added to the market, softening the demand for housing even further. It is as though a shortage of people are buying real estate and we've passed a one-per-customer tax incentive law. There is no reason to discourage what no one is willing to buy. The new legislation will probably push home values to new lows during 2009.

Why the law was changed is unclear. The old law was difficult to abuse. Those who were rapidly turning over real estate could not take advantage of the law. If someone tried to flip 25 homes, it would take 50 years. The new law doesn't make any sense, but if it did make sense, it probably would not be Congress.

The new law won't bring in much additional revenue either. But it will complicate record keeping and tax returns for anyone selling a home they have not lived in continuously. As a result of these disincentives, buying or selling vacation homes will become less desirable.

This legislation graphically illustrates the deadweight costs of taxation. Rarely is the concept so clear. The law will remove much of the value of vacation homes from the economy without collecting much additional tax revenue. All pain, no gain. It teaches us a sad lesson about the destructive power of taxation.

Vacation homes represent an expense that can easily be let go in challenging economic times. Many families own a vacation home during the season of children or young grandchildren. After that, the travails of maintenance and repairs outweigh their pleasure in the home. Management companies remove much of the headache but make the economics even more problematic.

In times of rising home values, the investment in a home at least kept up with inflation, but with the new laws the government will tax you on that inflation. As a result of these changes, consider simply renting a vacation home and letting someone else pay the capital gains tax.

When It's Good for Couples to File Taxes Separately

The Wall Street Journal says that in most cases it's better for married couples to file joint federal income tax returns. But they do list some situations when it may be better to file separately. A couple examples:

• A two-income couple where one spouse has large medical expenses and the other has little or none. Medical expenses typically are deductible only to the extent they exceed 7.5% of adjusted gross income. Thus, this couple might save taxes by filing separately, because one spouse's big medical expenses might be deductible on a separately filed return but could be reduced, or even eliminated, on a joint return.

• Consider filing separately if your marriage is on the rocks or if you fear your spouse may be cheating on taxes -- such as hiding taxable income or claiming phony deductions. If you file separately, you won't be held liable for your spouse's wrongdoing.

They go on to suggest you crunch the numbers both ways to see which the better option for you is. Or, if you're like me, you have someone crunch the numbers for you. :-)

Six Myths about the Big Three

As part of our on-going conversation about a potentail bailout for the big three automakers, US News offers six myths about these companies. Their list:

• They don't build small cars.
• They don't build any desirable cars.
• The same guys asking for handouts are the ones who caused the problems.
• The CEOs should fly coach.
• It's all the unions' fault.
• They've done nothing to help themselves.

Interesting read.

A Note on the Big Three Bailout from a Michigan Senator

Got this email today from Senator Carl Levin, the second worst senator in the Senate after our other senator (is it any wonder my state is in such a mess with the people we keep electing?) Anyway, here's what Levin has to say about the big three bailout. Thought you all might like to see it since we discussed the topic yesterday.

Immediate support is needed to shore up our automotive manufacturing sector and to preserve the more than 2.5 million jobs directly and indirectly linked to the U.S. auto industry. This morning, I testified in front of the House Financial Services Committee to emphasize the need for Congress to take swift action on behalf of our nation’s automakers. Standing idly by as the financial crisis decimates our domestic manufacturing capabilities and pulls our fragile economy further into recession is unacceptable.

Throughout the world, the dire financial crisis continues to spur governments to provide assistance to their manufacturing industries, which are not able to obtain the credit they so vitally need to continue operations. Both Germany and the European Union are studying the possibility of providing support for their automotive industries. Australia has provided more than $4 billion in funding for its vehicle manufacturers. Automotive manufacturers in China are already voicing their expectation of financial assistance from their government as well. “The Chinese government will undoubtedly support us,” says She Cairong, general manager of JAC Motors, a Chinese automobile manufacturer. This quote appeared in a New York Times article this morning, highlighting China’s consideration of a plan to provide assistance to its domestic automobile companies.

The spotlight is now focused on Congress, which is considering the possibility of rescuing the industry from an economic downturn not of its own making. President-elect Obama has called the U.S. auto industry “the backbone of American manufacturing” and said that the failure of our domestic automakers would be “a disaster” for our economy. President Bush, Speaker Pelosi, and both the Majority and Minority Leaders of the Senate agree that bridge loans for our domestic automakers are necessary at this time. I will continue to work with my colleagues in the Senate and the Congressional Leadership to come up with a plan that would provide auto manufacturers with the bridge loans they need to weather this financial storm.

You can read the transcript of my testimony before the House Financial Services Committee. During these difficult times, I am doing everything within my power to convince the Congress to provide the bridge loans for the domestic auto industry that the President, the President-elect and the leaders from both houses of Congress support.

Your Money: Bailout American Auto Manufacturers?

Lots of talk today about whether or not the government should or shouldn't bail out the big 3 automakers with our tax money. A few articles for consideration:

• Let Detroit Go Bankrupt 

• How Many Jobs Depend on the Big Three?

• How Bankruptcy Would Benefit GM

Here's my solution: the government should take the money it's thinking of using to bail out the big three and buy stock in Toyota or Honda instead. Seems like a better investment. ;-)

Seriously, I haven't decided what I think of an auto bailout other than it's likely to be pouring money down a drain. If anything, maybe we should save one or two of the big three at most?

What do you think?

The Bailout and You

Here's a guest post from Free Money Finance reader Kevin McCoy.

Think the recently passed bailout legislation didn’t affect you?  Think again.  There are several income tax-related provisions that could save you some money if you know how to prepare.

There are actually three sections to the bailout legislation.  The “Emergency Economic Stabilization Act of 2008” deals with the terms for financial institutions to receive bailout help.  Next, the “Energy Improvement and Extension Act” acts as a one year extension of various energy related provisions.  Finally, the “Alternative Minimum Tax and Extenders Tax Relief Act” has many deduction extensions, AMT relief, etc.  This discussion will deal with the latter 2 acts.

Provisions for Homeowners:

1) IRS-speak - Exclusion of debt relief on qualified principle residence extended through 2012.

In English -  in a nutshell, this is a bailout for homeowners that lose their home via short sale, foreclosure, etc.  Previously, the homeowner would have paid tax on the debt forgiven.

2) IRS-speak - Additional $500 (single)/$1000 (married, filing joint) standard deduction for real estate taxes paid. 

In English - If you don’t itemize deductions, you can still deduct the lesser of $500/$1,000 or actual real estate tax paid along with your regular standard deduction.

Alternative Minimum Tax (AMT) provisions:

The AMT is increasingly hitting middle class taxpayers, in addition to the high income earners it was originally designed to bite.  The most common items that would subject someone to AMT are: a high number of personal exemptions (lots of kids), high state and local income taxes/sales taxes, exercise of incentive stock options, including others.  These provisions add some relief.

1) IRS-speak -  Higher Alternative Minimum Taxable Income (AMTI) exemption amounts - $69,950 for married, filing joint (vs. $45,000 in 2007); $46,200 for single ($33,750) and $34,975 for married, filing single ($22,500).

In English – basically, if your AMTI (adjusted gross income with some adjustments) is lower than these amounts, you won’t be subject to AMT.

2) IRS-speak – Non-refundable credits can now offset AMT

In English – Several “regular tax” credits were previously not allowed to be used against AMT, but now are allowed.  They include the dependent care, elderly & disabled, child, home mortgage interest, Hope & Lifetime Learning, retirement savings, non-business energy, residential energy efficient property, among others.

Other Individual provisions (extended through 2009):

1) IRS-speak – IRA transfers to charities excluded from income

In English – Individuals can donate up to $100,000 using an IRA withdrawal and not be taxed on the withdrawal (however, the deduction cannot be taken on Schedule A).

2) Elective state and local sales tax deduction extended for 2009 – good for those who live in no state income tax states such as Texas, Florida, Washington, etc. or those who buy big ticket items and pay substantial sales tax (cars, boats, etc.)

3) Qualified tuition and fees deduction – up to $4,000 (with limits of course)

4) $250 educator’s expense deduction – teachers can deduct up to $250 of their supplies expense as an adjustment to income (the balance can be taken on Schedule A as a miscellaneous deduction).

Energy related provisions:

1) $500 max residential energy credit reinstated for 2009 and expanded – applies to qualified energy efficiency improvements (windows, doors, insulation, some metal roofs) and residential energy property expenditures (certain HVAC systems and water heaters)

2) Residential alternative energy credit extended through 2016 – applies to solar, wind, geothermal expenditures.  Taxpayers can generally receive a credit for 30% of the expenses up to $2,000.  For 2009, there is no $2,000 cap on the solar portion.

Note:  There are several other energy related tax credits geared more towards businesses that probably don’t apply to most people. 

In summary, the above represent the most common tax provisions of the new bailout legislation.  There are many, many other provisions that could affect you, so please consult your tax advisor or read up on the full bills here:

• The Energy Improvement and Extension Act of 2008 (pdf)

• The Alternative Minimum Tax and Extenders Tax Relief Act of 2008 (pdf)

Please feel free to pose questions in the comments and I’ll do my best to check back and answer.

Three Tax Tips from TurboTax

Just received the following via email today.

Given the current state of the economy it is even more important for taxpayers to do everything they can to slash their tax bill.  Bob Meighan, CPA and vice president at TurboTax says there’s still time for taxpayers to take advantage of some easy, year-end tax tips: 

• Sell losing investments – Taking a loss this year may help taxpayers offset tax from other gains or income, but that loss is limited to $3,000. Any amount in excess of that must be carried over to their 2009 tax return.

• Donate to Charity – Donating clothes, toys, household goods and other items to charity before Dec. 31 may help taxpayers who itemize claim bigger refunds while helping someone else.  Using software like TurboTax helps taxpayers accurately value donations in accordance with IRS guidelines so there’s no need to guess at an item’s fair market value.

• Prepay some bills: Taxpayers can prepay a few of their 2009 bills in 2008, and get to write them off on this year’s tax return. This includes mortgage payments and predictable medical expenses, like braces for the kids.

One other thing to remember: taxpayers that did not qualify for an economic stimulus payment in 2007 are getting a second chance. People who had financial or other life changes in 2008, like a lost job or a new baby, and now meet the requirements may be eligible to receive a rebate in 2009.

Can Obama Save Michigan?

I am praying like mad that Obama saves the state of Michigan by ridding us of our governor. Maybe he can give her some sort of hard-to-do-damage-from political post (maybe Ambassador to Nowhere?) At least then our state would have the chance of recovery.

Then again, I've heard the Lt. Governor is worse than JG -- which is hard to believe.

Anyway, there's so much wrong in my state now (high taxes, foreclosures, businesses failing, etc.) that people are feeling a big, big financial pinch.

How about where you are living? Are you/those you know starting to be impacted by the economy? In what ways?

Ten Ways to Prepare for Higher Taxes

Here's a list of ten ways to prepare for higher taxes from the Wall Street Journal. Whether you'll have higher taxes simply because taxes go up or because you start earning more (good for you!), this is a useful list:

1. Invest in municipal bonds.
2. Sell your Apple stock now (and then buy it back straight away).
3. Get ready to maximize contributions to your 401(k), up to the $15,500 annual limit.
4. Don't overlook the other tax shelters your employer may offer including Health Savings Accounts and Flexible Spending Accounts.
5. Open a low-cost variable annuity, like the ones offered by Fidelity, Vanguard or Schwab.
6. Invest in your home.
7. Borrow against your home!
8. Open up 529 plans for any children, or grandchildren, who are hoping to go to college.
9. If you are self-employed, or you have self-employed income, set up a solo 401(k) or SEP-IRA.
10. Don't forget to harvest your tax losses this year.

I'm always looking for ways to lower my taxes, and I've done many of these already. Here's where I stand on each of them:

1. Not yet, but I do have some tax-exempt bonds in a Vanguard mutual fund.

2. Don't have Apple or any other stock at this point (my money is in index funds.)

3. I've maxed out 401k donations for years now.

4. We have a HSA and I put the max amount in it.

5. A potentially costly option, but if costs are low enough (through Vanguard, for example) and the tax savings high enough, it may be a good option. I'm in the process of investigating options.

6. Looking at this (some enhancements), but I won't borrow to do it.

7. No!

8. I have 529s and Coverdells for both kids.

9. I do contribute annually to a SEP.

10. Unfortunately, I'll have losses to claim for years to come. :-(

Jane Bryant Quinn Hates Gold Investing

Here's an interesting piece on investing in gold where the author (famed personal finance writer Jane Bryant Quinn) says there's no reason to invest in physical gold (coins, bars, etc.). A summary:

Owning 20 or 30 coins is nice but won't protect your standard of living in a world where dollars are dust. Gold isn't even a reliable hedge against inflation. It reached $850 an ounce in January 1980, a price not seen again until January 2008. During those intervening 28 years, gold plunged and reared but lost more than half of its purchasing power. For a 1980 investor to break even after inflation, gold would have to reach $2,200. It might, but how long did you plan to wait?

Ok, so you can't buy enough of it to protect you in case of a collapse and it doesn't outpace inflation -- so what's the use of buying physical coins? Her point exactly!

Now she does offer some alternatives to buying physical gold including the following:

A cheaper way of buying gold is through an exchange traded fund. The most widely traded fund, SPDR Gold Shares, costs 0.4 percent a year in fees, plus your brokerage commission. You don't own the gold directly. A trust holds large gold bars (warehoused principally in London) and sells shares against them, which are traded on the open market.

It costs even less to buy bullion in a pool account, such as the ones offered by Kitco. Like an ETF, a pool account sells shares in a large bar of warehoused gold. You pay just a hair over the spot gold price, and sell it back to Kitco for just a hair under. There are no annual expenses. For a fee, you can redeem in gold itself. As with ETFs, you depend on the pool's trustee to support its guarantee.

Then again, she doesn't detail why buying these are or aren't a good investment -- she just tells us about them. This leads me to believe she's not a big fan of investing in gold no matter where or how you buy it.

Finally, she lists a couple tax-related issues associated with gold that I found interesting:

• Dealers have to report to the Internal Revenue Service if you sell 25 or more Maples or Krugerrands. They're not required to report your sales of American Eagles and some other coins, although some may do so.

• Gold, by the way, is taxed as a collectible -- whether you buy it in the form of coins, ETF shares or an interest in a pool account. Your tax rate on long-term capital gains would be 28 percent, compared with 15 percent on other assets. Only a significant price gain (or currency collapse) redeems your bet.

Yikes! That last one is a killer!

Anyone out there have any sizeable amounts of gold? How are you holding it (physical, ETF, pool account)? Why?

Deducting Investment Losses Off Your Taxes

This topic seems well-timed. It's on when and how much you can deduct from investment losses on your taxes. The summary:

First, you can use your capital losses to soak up your capital gains, with no dollar limit. For example, suppose you sold a stock earlier this year for a $25,000 gain. Now you sell another stock for a $25,000 loss. Put those two together, and your loss erases your entire gain. Thus, you don't owe any capital-gains tax on that $25,000 gain.

Now suppose your capital losses are bigger than your gains, or that you have no gains at all. In that case, you can deduct as much as $3,000 of net capital losses (or as much as $1,500 if you're married and filing separately from your spouse) each year from your wages and other ordinary income. Additional amounts get carried over into future years.

I think I'll have amounts to carry over for a few years (if you need details on what I'm talking about, see my Wednesday post on selling my mutual funds.)

Do You Write off Your Charitable Contributions on Your Taxes?

I recently received this comment while discussing what politicians give to charitable organizations (as seen on the public tax forms they have to release):

Lots of people I know don't list their tithe for taxes, since they don't want to receive an earthly reward for their giving. Paul made it pretty clear that we shouldn't be giving our money to the church for earthly status - something that a politician can't do if they are reporting their giving. It’s also something people should keep in mind when examining the records public officials.

I've heard this argument before, especially from Christians. They say they don't deduct their giving from their taxes because "they want a heavenly reward, not an earthly one." My response has always been to suggest that if they feel that way and they want to be the best stewards possible, why don't they claim the deductions on their taxes, get some money back, and give that money away too? Seems like a good way to maximize their giving, doesn't it?

Politicians have a different issue -- they may want to hide the fact that they're giving to a specific organization. So maybe they just don't claim it on their taxes. If it's not on their taxes, then no one knows, right?

As for me, I write off everything that's permitted to be written off. My thoughts are that I'm playing by the rules of the US government, and if they allow us to get credit for certain actions, then I'm going to get credit for them. Then again, no one is looking at my records either.

How about you? Anyone out there not deduct their giving on their taxes for one reason or another (other than you don’t give enough to claim)?

Why I Sold My Mutual Funds

In my post titled Six Investment Pitfalls I commented:

Yep, I've done all of these in my lifetime. Early on in my investing career, when I knew little about the subject and thought I could pick killer stocks better than anyone on the planet, I did all of these -- several times. Then, when I learned a bit more, I became somewhat smarter, but didn't quite get all the facts right again. Now I have some mutual funds that I should have never been in (and want to get out of) but yet have huge capital gains tax implications if I sell them. Making bad decisions early on can certainly have long-term consequences. Hopefully, someone can learn from my mistakes.

Let me add a bit more detail to this.

After I figured out that I wasn't a stock-picking pro (10 to 15 years ago), I decided that I'd invest in mutual funds instead. But I 1) didn't have a strategy and 2) didn't know how important it was to control investing costs. So I picked a NUMBER of funds here and there in various accounts -- taxable accounts, IRA for my wife, and an IRA for me (rolled over from a 401k). In fact, I never met a mutual fund I didn't like. I ended up with somewhere around 40 different funds in three accounts.

I eventually realized that this was foolhardy (investing without a strategy) and I studied the topic a bit more. That's when I decided index funds were for me and I developed a strategy around investing in them. That was several years ago and since that time index funds have become the mainstay of my portfolio.

But I still had the other 40 funds. When I moved over to index fund investing, I simply started new funds -- I didn't sell the old ones. So I ended up with money in a wide number of funds I didn't really want. So I could have simply sold them, right? Not unless I wanted a big capital gains tax hit. After all those years, the funds had made some decent gains, so if I sold them all at once, I'd have a hefty tax bill.

Of course I could have sold them when I sold loser funds/stocks (then the gains would be offset by other investment losses), but I didn't have any losers because I was never selling. So I ended up with a huge number of funds that were difficult to track and manage.

That's when a reader suggested that I give away my appreciated mutual funds. If I gave them directly to a charitable organization, I could avoid the capital gains tax altogether (for more info on this, see How Shrewd Investors Save on Taxes.) So this is what I did in 2007 and the first half of 2008. I gave mutual fund shares directly to my favorite charities. I then took the amount I would have given in cash during normal times and invested that in index funds. This got rid of several funds in a couple years, but I still had a long road to go (BTW, in case you're interested, I gave a boatload away in early 2008 -- enough to cover my giving for the whole year -- so I got a good amount of value from some of these funds before the market tanked.)

Then the market crashed big-time. In the span of a few weeks, my capital gains were eroded and I had losses. Now I didn't need to wait to sell all the funds I owned, so I sold them all and invested the proceeds into the following index funds:

• Vanguard Total Stock Market Index (VTSMX)
• Vanguard Total Bond Market Index (VBMFX)
• Vanguard Total International Stock Index (VGTSX)

Of course I would have preferred that the market stayed high and I would have gotten myself out of the funds as originally planned, but I'm trying to make lemonade out of lemons here. At least my investments will be much simpler to manage in the future and will reflect the strategy I want them too. Then again, they'll be easier to manage because they're a lot lower in value too. :-(

For additional perspective, check out this piece from the Wall Street Journal on getting a portfolio do-over.

Our Tax Dollars Hard at Work

From MSNBC:

The government sent out more than $1 billion in fraudulent refunds last year and offered this explanation Thursday for the bad checks in the mail: The Internal Revenue Service has too few resources to pursue every tax fraud case.

IRS investigators never even looked at an estimated $742 million in fraudulent refunds, according to a report by the Treasury Department office that monitors the agency. When they did identify an additional $264 million in bad refunds, it was too late to stop them from being issued.

Yep. A billion here, a billion there. After awhile, it adds up to real money.

Privatization Could Fix Social Security

The following is a guest post from Marotta Asset Management. The combination of a controversial topic and the "popularity" of the Marotta articles made me think twice about running this piece. But if the numbers on the returns offered by Social Security are even close to being true, then I think the article makes some very compelling arguments that deserve consideration and debate.

Between 2037 and 2075, the Social Security program is projected to run deficits totaling $30 trillion. And annual shortfalls could be a problem as soon as 2017.

Privatizing the system could break the political deadlock between cutting future benefits and raising payroll taxes. We can have both our benefits and lower taxes if we finally admit that socializing retirement was a mistake and once again trust in the power of free markets.

For some people, the current volatility and decline in the stock market makes the best case against privatizing Social Security. Why would we want to inflict market shocks on every American's retirement? Isn't Social Security at least secure? Unfortunately, it is not.

Computing a return on Social Security as though it were an investment is difficult but not impossible. For example, my average annual return is about negative 7%. It is so poor for three reasons. First, average lifetime annual incomes above $60,000 produce miserable returns. Second, because I fall at the end of the baby boomers, my Social Security withholdings are at the current high rate of 12.4% rather than the lower rates that might have produced a better return. Finally, for those born my year (1960) or later, the age to receive full Social Security retirement benefits was raised from 65 to 67, further lowering returns.

A negative 7% return is huge. That's like investing $100 and 30 years later getting back $11, or investing $100 a year over 30 years and getting back $1,177 of your $3,000 investment. If recent shocks in the stock market seem difficult, imagine losing 60% of value over 30 years of investing!

Not everyone's return on Social Security will be as bad as mine. On average, Social Security provides a return of about 1.2%. If you don't work and therefore haven't paid into the system, your return is a complete gift.

As a comparison, the S&P 500 closed at a low on October 10, 2008, at 899.22. It closed exactly 30 years earlier on October 10, 1978, at 104.46. Even with the recent losses, investments in the S&P 500 have gone up 8.61 times, reflecting an average annualized return of 7.44%. Bond investments show a similar return with much less volatility. In fact, nearly any kind of investing has done better than the return within Social Security.

Proponents of the system view the redistribution of wealth from workers to retirees as positive. They believe we should pay whatever it takes to preserve the program in its current form. That the system destroys wealth and property rights is ignored because the system impoverishes the elderly more equally.

The proposal for privatizing Social Security is simple but elegant. Allow younger workers to deposit part of their Social Security taxes into a private account. If it produces a better retirement than Social Security, they can refuse Social Security and keep the private account. Otherwise they can take Social Security. Given my expected rates of return, putting just a tiny fraction of my withholding into a private account will do better than getting a negative rate of return in Social Security, even using the poor rate of return to where the market bottomed.

For more typical people who might receive the equivalent of a 1.2% return on their Social Security, they would get just as much benefit earning 7.44% on a third of the contributions. Thus 4.1% invested privately could do the job that 12.4% in Social Security can't seem to do without massive deficits. The proposals for privatization suggest allowing younger workers to invest 5% on their own. The other 7.4% would continue to be confiscated to pay aging early baby boomers the normal Social Security entitlement. A few years of deficit spending will be necessary before private accounts begin to relieve the deficit. But ultimately, private accounts will yield a greater benefit than Social Security ever provided. And when the baby boomers are off the Social Security dole, tax rates could be reduced to 5%.

Rather than relieving the problem, raising taxes exacerbates the inequities of Social Security and sends the average returns negative. Additionally, no matter where they are found, the higher taxes required to bail out Social Security would stifle economic growth. Most of the solutions that propose raising taxes result in top margin rate increases of over 15%. This level of curtailing freedom would kill economic growth and innovation.

Of course, cutting benefits is hardly a more attractive option.

Interestingly, either increasing taxes or reducing benefits sets the bar lower for private accounts to beat by any comparison. Privatization simply eliminates benefits for all the workers who can do better with 5% of their payroll taxes than the government does with the entire 12.4%.

Some people like the idea of using the growth engine of private accounts. But they suggest the government maintain control of the money. They would allow the government to invest retirement accounts directly in the private markets. So the government supposedly would protect citizens from their own ineptitude.

Others suggest that governmental involvement and oversight in the financial markets would bring a welcome measure of accountability to corporate America. They favor the so-called good intentions of politicians over the greedy motivations of the financial world.

Although tempting, this idea would be disastrous for freedom and for free markets. Even Alan Greenspan, former chair of the Federal Reserve, warned that governmental investing would "have very far reaching potential dangers for a free American economy and a free American society."

With private Social Security accounts, millions of workers would make independent investment decisions. But if the government took it on, the impact would be unified and rigid. And concentrating that power in a single government entity would magnify its effect. Having a Social Security trust buying and selling in the markets would be like turning on every electrical appliance in your house at the same time. The government retirement monopoly would short-circuit the free markets.

Overnight the government would have a controlling interest in virtually every major company in America. We should have learned from the scandal of political appointments to Fannie Mae and Freddie Mac that political power breeds political corruption.

The federal system would become swamped with feel-good laws requiring investments designed to stimulate the economy, create jobs or develop alternative energy sources. Federal advisors would shun investments that did not pass the litmus test of political correctness.

Some have suggested limiting the government's investments to passive index funds. But that leaves unanswered the question of which indexes will be used and in what percentages. Would all the investments be in U.S. stocks and bonds? If so, the resulting asset allocation would only use two of the six asset categories we recommend.

Ironically, the goals of collectivism are best achieved by respecting individual liberties. When well-intentioned bureaucrats force choices on workers, the incentive for innovation and risk vanishes. As a result, society hardens into a rigid structure that cannot easily align itself with changing market conditions.

Collectivism starts with the premise that the common people cannot be trusted to make their own choices. Once you have accepted that premise, you will take whatever you need and give whatever you want without regard for individuals who would have done otherwise.

Acting on behalf of a collective often justifies imposing our priorities on individuals. For example, if the few in charge believe that foreign investing costs American jobs, they will not allow us to invest overseas. Or if they believe that companies who develop alternative energy sources are a good investment, they will force us to invest in them.

We certainly know by now that not even smart people can force the markets to behave in a certain way. You might as well pass laws outlawing hurricanes.

These are some of the socialistic assumptions that caused the current Social Security system to fail. Privatized accounts could turn that around. It would be a shame to make the same mistake a second time and destroy the engine of capitalism in the process.

Privatization uses the strength of America's capitalist engine to solve the weakness of socialized retirement. Do your part by asking your senators and representative to support privatizing a portion of Social Security. And then assure your own retirement by saving 15% of your take-home pay regardless of what happens in Washington, D.C.

Amazing Financial Facts

This piece from MSN Money has a ton of interesting money-related facts about who earns what in the US and who pays taxes. Here is the information along with some of my comments:

The highest-earning 1% of taxpayers in America make 22.06% of all income reported to the government. That's almost twice the 12.51% of total income earned collectively by the lowest-earning 50% of workers. Yes, 1.4 million taxpayers claim 22% of income earned while 68 million share just 12.5%.

Ok, no surprise here -- the cream of the crop earns a boatload of money. Not a shock at all.

When it comes to taxes paid, an even wider discrepancy shows itself, in reverse. Those earners in the top 1% pay 39.89% of all federal individual income taxes. The bottom 50% of earners pay just 2.99% of those taxes.

To note, these are only federal income taxes, but still the bottom 50% number is amazing to me. Half the working population pays only 3% of income taxes? That's almost unbelievable. No wonder so many in our country want the government to take over more and more services (like healthcare). If I was paying a sliver and getting full benefits, I'd probably want the same.

In 1986, the top 1% of earners reported 11% of all income and paid 26% of the income taxes; the lower-earning 50% made 17% of the income and paid 6% of the nation's individual income-tax bill.

The rich are getting richer and paying more of the bill. The poor/middle class are making less relatively and paying less in taxes.

An income of $31,988 or more puts you in the top half of taxpayers. Earning a bit more than twice that much -- $64,703 -- places you among the top 25% of all wage earners. You crack the elite top 10% if you earn $108,905 or more. And $388,807 buys top bragging rights: Earn that much or more, and you're among the top 1% of all American earners.

Really? Really? $32k per year puts you in the top half of all taxpayers? Holy cow, I would have guessed it was more like $50k. Now wonder the lower half pays so little in taxes -- they barely make anything. Then again, they get just as many benefits from the government, don't they? So shouldn't they pay the same? It's a difficult set of ideas to balance for sure.

I guess this is the debate we see playing out in front of us in the presidential election -- and why both candidates have a different view of what "middle class" means. The most interesting point to me is that 50% of the people basically pay nothing in federal income taxes, yet they have enough size to elect whoever they like and end up paying even less! That's a scary place to be for any country IMO.

Are "Taxes" and "Giving" the Same Thing?

On my post titled What Politicians Give, one reader left a particularly interesting comment. Here's the part of it I'd like to focus on:

The top 5% of wage earners pay 57% of taxes. (IRS 2004) Old info, but I'm running with it. I use this information because I feel that those mentioned in your post are in or close to the top 5%, if not, then they're probably in the top 10% and paid 68% of taxes.

Now, the last time I checked there are numerous organizations that receive this money with the sole purpose of giving and taking care of those that are less fortunate. There are food stamps, education funding, money to fight world poverty through the U.N., AIDS, environmental crisis, employment help, Medicare, Medicaid, just to name a few. There are additional grants for non-profit organizations that help more focused groups of people. By this information, doesn't paying taxes make you a charitable giver? Not to mention more so for the high earners you mention since they pay more taxes than the rest. Why should they have to give another 10% of their income to be considered a "good person.”

The issue I'd like us to discuss is whether or not paying taxes is the same as giving. I've had several people comment along the lines of "I pay X% in taxes to help out others -- that's my giving."

In part, I can see their point. If a huge chunk of their income is taken away to help others, why should they add more to it? Don't they already give by default?

Here's my take on the situation:

1. Personally it doesn't matter to me whether you give or not. I do think it's our responsibility to help others, I do advocate giving both time and money, and I do so personally. That said, I don't think you're a "bad" person for not giving.

2. Paying taxes and giving are not the same thing. The key difference -- one is voluntary and the other isn't. Dictionary.com defines "giving" as follows: to present voluntarily and without expecting compensation. When was the last time taxes were voluntary?

3. Now, combining thoughts #1 and #2, while I don't think the non-giver is "bad", I do think they are not generous. Trying to hide behind the "I'm a generous person because I 'give' taxes" is a huge cop-out to me. Why not just say "I don't want to give?" That's the truth, isn't it? Why try to pretend to be generous when you're giving nothing? (again, taxes are taken/paid, not given)

So, what's your take on the issue? Is paying taxes a substitute for giving or is there a difference? I'm interested in hearing your thoughts.

Why You Need to Know About Taxes Even If Someone Else Does Your Taxes

From the Wall Street Journal:

In a limited study of tax returns completed by unlicensed paid preparers, 17 out of 28 -- or 61% -- were prepared incorrectly, including one that showed the taxpayer owing $4,903 more than he really did, according to a study by the Treasury Inspector General for Tax Administration (TIGTA), which provides independent oversight of IRS activities.

While most of the mistakes resulted in an underpayment of taxes or a too-big refund, sometimes it was the taxpayer, not the government, who would have paid for the mistake, according to the study in which TIGTA auditors posed as regular taxpayers and visited tax preparation offices in a single metropolitan area.

Given the study's small sample size, the findings cannot be generalized to all paid preparers.

Ok, so it's not scientific, but this piece does illustrate a key point: you need to know about taxes even if you have someone prepare your taxes for you. Why? Because preparers make mistakes. Or (more common) you don't give them all the facts they need to lower your taxes like they can. Why would you not give them needed facts? Many fail to provide adequate information because they simply don't know it's needed/valuable information.

I use a CPA to do my taxes, but I still keep on top of the tax laws so I know what information to give her, how to check her work once she's done, etc. This paid off for me big-time this year when I caught a mistake my CPA made (which was eventually resolved.) Because I was educated on the issues, I didn't over-pay my taxes. If I had looked the return over and didn't see the mistake because I didn't understand the issues, I would have lost a good amount of money.

One other tip if you use a preparer: get one that asks some questions upfront. My CPA sends me a three-page questionnaire each year that helps me identify tax issues I'm not aware of. This in itself is a great educational tool that helps me keep on top of the latest tax changes.

So even if you use a planner you still need to be up-to-date on current tax laws. You also need to keep good records, but that's for a different post. ;-)

For those of you looking for more information on this topic, see these posts:

• When to Hire a Tax Professional

• How to Hire a Good Tax Professional

• How to Get More Out of Your Accountant

Maybe Social Security Isn't the Issue

After sharing my thoughts on Wednesday about how I think we need to fix Social Security, it turns out that maybe SS isn't the issue we need to address. Instead, maybe it's healthcare (what a shocker, huh?) A summary from CNN Money:

Social Security is actually a relatively small and fixable piece of the entitlement puzzle. Medicare for the old and Medicaid for the poor are the programs that really threaten to swallow up the budget.

The federal deficit, not counting interest payments, could eat up 9% of GDP by 2050 if business continues as usual. According to Brookings Institution economist Henry Aaron, the two big federal health programs account for nearly all of the gap.

The main problem is not the demographic bulge of baby boomers, says Aaron. It's that health-care costs overall, for private payers as well as in Medicare, are growing about 2.5 percentage points faster than the economy every year. New drugs, procedures and technologies keep upping the ante, even when we aren't sure if they work better than what came before.

If we could get a grip on runaway cost growth throughout the system - not just for old folks - we'd solve much of the budget problem. And we could even afford to cover everybody. As a practical matter, Aaron argues, the two reforms must go together.

The piece goes on to say that both Obama and McCain don't really have a workable solution at this point. I wonder if we'll ever get a workable solution. After all, it's a huge issue with trillions of dollars at stake and many special interests involved. To get a good solution, we'd need our politicians to make tough choices in the best interest of the country (not their own best interests) -- something that's virtually impossible to do. If they ever do address the issue (which will likely occur only when it gets so bad that there's no other choice), we're likely to end up with an everybody-gets-his-own-special-interest-into-the-program sort of plan that makes the cure worse than the disease.

As you can tell, I'm not optimistic.

Looks like I'm going to be right about healthcare and retirement.

Social Security Age Inflation

As many of you know, I'm not the biggest fan of how the government spends our money. It's been shown to be wasteful in many different ways and I don't think it's the best money manager out there. And while this post isn't about waste per se, it is about how the government uses a ton of our money through Social Security.

In Politics and Your Money, I said I favored the following as a way of adjusting the Social Security system to make it more financially solid:

Raise the age at which benefits are received. It's in alignment with the original intent of the program, but politically I don't think it will happen.

At that point, I didn't have specifics, but now I do. Consumer Reports has listed the eligibility ages for various Social Security benefits if they had been adjusted since these programs began. The details:

• Social Security early retirement age (currently 62) would have been 65.6 to 67
• Social Security normal retirement age (currently 66 to 67): 73 to 81.8
• Social Security delayed retirement age (currently maxes out at 72): 76 to 78.6
• Medicare eligibility (currently 65): 70 to 72
• Penalty-free IRA withdrawals (currently 59.5): 63.8 to 66

These look like good/fair numbers to me (though I would like to get my own IRA money sooner) -- after all, the average lifespan has risen dramatically since the inception of the program, so why hasn't the age that benefits are available risen? Sure, there needs to be some sort of phase-in process to make this happen, but I certainly prefer this option to increased Social Security taxes. Why? Because I think the government is a poor manager of our money and I'd rather put the responsibility for my retirement in my own hands rather than those of the Congress.

That said, I'm not counting on anything from Social Security as part of my retirement number. Who knows where the program will be by the time I retire -- or if it will even be around. So I'm counting on it as "gravy" over and above what I plan to save for myself. This is another reason I'm not too excited about putting money into the system -- who knows what I'll get back (if anything.)

Obama versus McCain on Taxes

For those of you interested, here's some good information on Obama's tax proposal versus McCain's. Don't put too much stock in this though -- I'm sure things will change a LOT no matter who's elected (as they always do.) That said, at least this lets you know what each candidate is thinking.

My Kids Tell Me Why We Pay Taxes

Since we live in Michigan, an important presidential battleground state, we see a commercial for McCain or Obama about every ten minutes. I was watching TV with my kids a week ago (can't remember if it was the Olympics or some other show) when an ad for one of the candidates came on and started telling how great the (assumed) party nominee was.

My son said over the commercial:

"He's not that great. All he wants to do is raise taxes."

I was surprised at this comment since we haven't discussed what one candidate thinks versus the other when it comes to taxes. I was even more surprised since I didn't think my son knew what taxes were (we've taught our kids how to earn, save, and give, but nothing as "high level" as taxes yet.)

So I asked him:

"What are taxes?"

He responded without a blink:

"Taxes are money we pay to the government so they can buy the president a big screen TV. Then at lunch they watch popular movies."

Obviously, there was a problem with this interpretation -- and my daughter chimed in immediately:

"That's not right. Taxes are money we pay to the government -- half goes to stuff like roads and libraries and they keep the other half for themselves."

I didn't know whether to correct her or congratulate her on a relatively accurate assessment of the situation. ;-)

My Issue with How Tax Money is Spent

Here's a comment left on my post titled The Other America that struck a note with me. Recall that the post was about a CBS video series on people who are barely making it (if making it at all) due to the high food prices and "lack" of government assistance. One reader said the following:

I watched the segment. I saw meat, meat, meat, fruit loops, frozen waffles. A local newspaper article here said a family of 4 gets $550 in SUPPLEMENTAL (i.e. add your own money to it) food stamps. I could feed my family of 4 on that and not need to supplement! It also said people on food stamps overbuy on convenience and prepackaged foods. How about oatmeal, dried beans, rice, peanut butter, using coupons??? I didn't see one coupon being handed over. Also everyone was well dressed and overweight. It's easier to complain about food stamps not being enough than to be frugal and put more effort into the grocery shopping.

This point illustrates several of my beefs with how our tax money is spent. Specifically, I take issue with the size of the "assistance" (my family too could easily feed ourselves for less than $550 per month), the lack of "helping yourself" effort that many of these people seem to show (for example, not really "shopping" for the best deals like the rest of us do) and the fact that many of these people are better dressed/have luxuries that people who aren't on assistance can't afford. It just seems so wasteful on so many fronts.

As I've said before, I'm all for helping the poor (that's why I give to charitable causes) and would even be willing to pay MORE in taxes if I thought the government wasn't wasting or mis-allocating a good portion of it. But I find it hard to support a system that's so out of whack that examples like the one above seem more like the rule than the exception. It frustrates me to no end.

Am I reading this the wrong way? Maybe there's a point of view I haven't considered? Thoughts?

When to Hire a Tax Professional

Here's a piece I originally wrote for a national magazine.

Believe it or not, there once was a time when preparing and filing your own tax return wasn’t that difficult. But over time, the tax law has grown and become more complicated, leading many Americans to seek help on tax matters. Here are some instances when you might benefit from hiring a tax professional:

• You’re not familiar with tax law. According to the U.S. Treasury Inspector General for Tax Administration, in 2007 Americans forfeited some $4 billion in phone tax refunds, in part because they didn’t know the refund existed. Tax professionals are up to date on current laws, and often find deductions that can offset the cost of paying to have your taxes prepared.

• Your taxes are complicated. Have you moved out of state recently? Do you own your own business? Buy and sell investments? The more complex your taxes, the more paperwork that’s required, and the more likely it is that a tax professional would be a worthwhile investment.

• You have better things to do. The IRS estimates it takes an average taxpayer 13 hours to complete a tax return. If your time is worth $10 an hour, that $130 could help pay for someone else to do your taxes.

• You want help in an audit. If you’re audited, most tax preparers will represent you if they prepared your return.

• You want a quick return. Tax professionals usually file returns electronically rather than by mail; that means if you’re due a refund, it will arrive sooner and can be deposited directly into your bank account.

If your taxes are relatively simple, or if you enjoy preparing your own return and feel capable of completing it, then go for it. But the more of these categories that apply to you, the more you’ll want to consider hiring a professional.

For more thoughts on taxes, see these posts:

• How to Hire a Good Tax Professional

• How to Get More Out of Your Accountant

Determining the Proper Withholding

I've noted previously that none of us should be giving the government an interest-free loan by having too much tax withheld from our paychecks. Instead, we should adjust our withholding so that we pay a bit more than we expect to owe (maybe $100 or so), bit not much more.

This begs the question: how do we set our withholding to get to this amount? Well, Bankrate has some good thoughts on this subject:

One withholding allowance is generally equivalent to a personal exemption. In 2008, a withholding allowance is equivalent to $3,500. An individual can estimate the total amount of their tax deductions, such as interest on a large mortgage for a small New York apartment, and translate the deductions into equivalent withholding allowances. For example, $35,000 in mortgage interest would be equivalent to 10 withholding allowances.

But if this isn't clear enough, you can also visit the Federal Withholding Tax Calculator for a bit more direction.

I basically fill out a pro-forma tax return to see where I think I'll end up for the year, then set my withholding accordingly. Anyone else do it differently?

How to Hire a Good Tax Professional

Here's a reminder that if you hire a poor tax return preparer, it's not him/her who's on the hook if the return is wrong -- it's you:

Unfortunately, [the preparer] is not the one on the hook should the IRS examine her tax return. In fact, she'll be left owing the IRS the back taxes, interest and possibly penalties if her return is selected for examination.

This is why it's important to be sure and get a tax preparer you can trust.

I use a CPA and have for several years. Here's the advice I can offer you for finding a good one and making sure your return is done correctly:

• Ask people you know, trust, and respect for references -- ask them who does their taxes, how long he's done them, etc. I got my referral from the CFO at my former company. he was a very successful and frugal businessman and I knew he'd point me in the right direction.

• Once you have a recommendation, interview the potential advisor. You can do this over the phone, but I prefer a face-to-face meeting. I had mine in the CPA's office (so I could check out the set-up as well as talk to the guy directly.)

• Ask for references from current clients. Call them up and ask what sort of service they've received, what they like and dislike about the preparer, etc.

• Once the preparer is hired, be sure you do your part. Give him the right information, summarized appropriately, and in a timely manner. Also be sure to communicate the events in your life that may impact your tax return.

• Be sure you know the tax law yourself (at least at a basic level) and review every page of your return. Yes, the preparer is a professional, but even they make mistakes. Looking over my return with a fine-tooth comb saved me a ton of money this year.

Anything I missed?

More on Economics and Taxes from the Candidates

As a follow-up to my post Politics and Your Money, here's a Yahoo piece on each of the presidential candidates and what they'll likely do once elected. The summary:

Obama, the Democrat, seemingly has a traditional liberal outlook of taxing the rich more while having the government help people of more modest means through tax breaks. McCain, the Republican, advocates a classic conservative vision of cutting taxes — many geared toward businesses — to promote competition within a free-market system.

Neither plan is cheap.

All I can say is "heaven help us." Where's the low taxes, low spending, pay off the debt candidate?

Taxes Killing Michigan

Not sure how I missed this, but if you live in (like I do) or near Michigan this should interest you. The Wall Street Journal tells how higher taxes are killing the state:

Officials in Lansing reported this month that the state faces a revenue shortfall between $350 million and $550 million next budget year. This is a major embarrassment for Governor Jennifer Granholm, the second-term Democrat who shut down the state government last year until the Legislature approved Michigan's biggest tax hike in a generation. Her tax plan raised the state income tax rate to 4.35% from 3.9%, and increased the state's tax on gross business receipts by 22%. Ms. Granholm argued that these new taxes would raise some $1.3 billion in new revenue that could be "invested" in social spending and new businesses and lead to a Michigan renaissance.

Not quite. Six months later one-third of the expected revenues have vanished as the state's economy continues to struggle. Income tax collections are falling behind estimates, as are property tax receipts and those from the state's transaction tax on home sales.

Michigan is now in the 18th month of a state-wide recession, and the unemployment rate of 6.9% remains far above the national rate of 5%. Ms. Granholm blames the nationwide mortgage meltdown and higher energy prices for the job losses and disappearing revenues, but this Great Lakes state is in its own unique hole. Nearby Illinois (5.4% jobless rate) and even Ohio (5.6%) are doing better.

Needless to say, Jenny wasn't too thrilled with the assessment of the WSJ. Her thoughts and the WSJ rebuttal can be found here. The highlights:

Ms. Granholm was not pleased, going so far as to denounce the op-ed as "treasonous for the state of Michigan." The authors' high crime? Exposing Michigan as a high tax state and criticizing Ms. Granholm for wanting to raise taxes. Her choice of words was no inadvertent slip of the tongue, by the way--a Howard Dean-like temporary loss of sanity. The Governor has used the "t" word repeatedly and has even suggested that Mr. Baxter "should be removed from office."

Ha! Hard to face the facts, huh, Jenny?

But the WSJ isn't moved:

Sorry to say, the facts laid out in Messrs. Baxter and Wolfram's column and in our previous editorial are well-established. When it comes to high taxes, the Wolverine State ranks fifth both in per-capita terms and as a share of personal income. Michigan also has the nation's highest unemployment rate. There is no shortage of studies that have linked these two phenomena.

More troubling about Ms. Granholm's recent combustion is that she seems to believe that the problem is that the rest of the world will find out about Michigan's high taxes, not the high taxes themselves. But Michigan's inhospitable tax climate is hardly a state secret, especially to the state residents and businesses who have to endure it.

It certainly isn't a secret to me. 100 inches of snow this year.

But really, I told you she was taking the state down.

Politics and Your Money

I plan to remain neutral on this blog during the upcoming election because I think most of you don't care who I'm voting for. That said, I need to qualify my neutrality -- I'm going to be neutral on the candidates, but NOT neutral on the issues. Why? Because several issues impacting our personal finances are up for debate this election year. The two I'll talk about the most: the economy (which impacts your biggest financial asset) and taxes (including how your money is both paid to the government as well as spent by them -- it's probably the biggest expense most of us have.) I'll let you know where I stand on the issues and you can then either agree or disagree. Should be fun, huh? ;-)

For starters, here's a piece from CNN that outlines both McCain's and Obama's (I'm listing them in alphabetical order, BTW) positions on the key issues. It's a starting point as far as I'm concerned. I expect both of them to "fine tune" their plans over the next several months. Furthermore, I expect what they actually do once one of them is president to be very different than any of the things said here because being president is very different from being a candidate for president -- what a person promises very rarely happens exactly as they've predicted. I think history has shown us that. I especially like this quote at the end of the CNN piece:

Despite the candidates' promises, experts are skeptical that either candidates' economic proposals when taken as a whole could be fiscally sound.

;-)

For now, here's a very brief summary of my positions on the various economic topics the candidates are addressing:

• Taxes -- I'd like to keep taxes as low as possible. I think doing so helps both individuals and the economy as a whole. And given that the government is about the least efficient entity in the world, I don't relish the idea of paying more money only to have a huge part of it spent on administration, waste, and various programs of dubious impact.

• Spending -- I think as a nation we can cut a good amount of spending simply by eliminating unneeded programs and by being more efficient. One idea: turn the post office over to a private business and I'd bet they'd find a way to make it profitable.

• Debt -- The above said, I would be willing to pay more in taxes if the incremental portion went to debt retirement. I think we're walking a fine line in our borrowing.

• Social Security -- Raise the age at which benefits are received. It's in alignment with the original intent of the program, but politically I don't think it will happen.

• Healthcare -- I shudder at thinking of the government running our healthcare system. That said, I do think they should guide/encourage/enact laws to get the private sector moving towards decreasing healthcare costs. We need to get costs under control asap!

• Homeowners -- I wouldn't give them any help. Let the free market work, even if it's painful.

• Energy -- Need to do something here -- encourage development of alternatives to oil. Give the private sector a financial incentive to do this and companies will jump on it. Let's not let this issue pass us by as we did in the 1970's.

So, that's where I am currently. Of course, it's subject to change if someone comes up with a new idea I like.

What about you? What's your take on the various economic issues our country faces?

Obama is a Tax-Cutting Machine

I found this piece interesting. It starts with Democratic presidential candidate Barak Obama calling for another round of economic stimulus checks. Then it goes on and details how he plans to cut taxes in general:

Obama in his speech criticized his Republican rival, John McCain, for proposing to extend all of President Bush's 2001 and 2003 tax cuts.

But Obama himself has taken a page from Bush's playbook on taxes.

Obama has pledged to keep the tax cuts in place for everyone except those making roughly $250,000 and up. He has also made proposals to cut taxes further for the middle class, some of which he reiterated in his speech: exempt seniors making less than $50,000 from having to pay income tax; give a tax credit worth up to $500 per working person ($1,000 per family) to offset the Social Security tax on the first $8,100 of earnings; and expand the earned income tax credit.

To boost retirement savings, he has also proposed a 50% federal match on the first $1,000 of savings for families that earn under $75,000.

Hmmm. I thought Obama was going to be a tax-and-spend guy. Now he's a cut taxes and spend guy...sounds like someone we've all been dealing with for the past eight years. ;-)

Seriously, I'm all for lower taxes and applaud any effort to cut them, but I'm not liking the Robin Hood "tax the rich and give to the poor" methodology. At some point, the weight of the extra tax burden will offer a big dis-incentive for higher earners to earn more (it literally won't be worth their time.) and since these people often control/run businesses, the implications could be that they'll hire fewer people -- not something that benefits our country's economy.

I'm sure many of you have a different take on the situation. I'd be glad to hear it.

BTW, I have a post coming up on my recommended suggestions for our nation's economic issues and how they relate to what Obama and McCain say they'd like to do (though this is a bit like hitting a moving target -- they seem to add details/change recommendations regularly). Should be interesting discussion.

Related:

• McCains: His-and-mostly-her money

• How tax-friendly Obama cuts his own

Myth of the Marriage Penalty

In tax discussions you may often hear of the "marriage penalty" -- the "fact" that married couples pay more in taxes than they would if they were single. MSN Money says this simply isn't accurate:

51% of married couples paid less tax jointly than if they had not been married, according to a 1996 Congressional Budget Office analysis. The average amount these couples saved: $1,300.

42% of married taxpayers paid more by filing jointly than they would have if they'd remained single, the office said. The average penalty: $1,380.

And a bit more detail for perspective:

The people who got tax breaks by marrying were those with disparate incomes, where one spouse earned more than the other. The wider the gap between the paychecks of the husband and wife, the bigger the bonus. The people who tended to face a marriage penalty were those with similar incomes. Typically, the more they made, the bigger the penalty they paid.

I think it's the latter group that people refer to when they talk about a "marriage penalty." But isn't part of the issue that these people are probably making more money too (with both spouses working)? And in this country, the more you make, the more you pay.

The piece also lists advantages of being married including:

• Workplace health and pension benefits coverage.
• Social Security retirement and survivor benefits.
• Lower insurance rates.
• Automatic inheritance rights.
• Preferential estate-tax treatment.

All these benefits PLUS married people are wealthier and live longer.

That Rebate Check Could Ruin Your Retirement Part 2

Here's a gust post from Marotta Asset Management.

Last week's article explained the wrong-headed decisions behind the current tax-stimulus package, its deleterious effects on an already fragile economy, and how consumers delude themselves in the ways they spend the money. This week I explain the effects of the rebate checks on the savings for retirement. Anyone who spends more than 4% of their rebate will actually lose ground saving toward their retirement.

Retirement is the ability to continue your current standard of living solely through the growth of your investment assets. Raising your standard of living is the fastest way to fall behind your retirement goals. Every time you increase your spending by $1, you need $23 more in your investments when you retire.

So if you spend even half of your $1,800 rebate check and put the other half in savings, you fall $19,800 further behind in your retirement. Spending the extra $900 means you are expecting to continue living a lifestyle $900 greater than the lifestyle you have been living. To support that lifestyle, you will need 23 times that amount, or $20,700 more, in the bank at your retirement. But because you are only putting $900 more in your retirement, you fall $19,800 behind.

The problem worsens with every dollar of rebate you spend. Spend the entire $1,800 and you fall $41,400 behind on your retirement savings. Get tricked by the windfall effect I discussed last week, and you will increase several smaller purchases and spend 2.5 times your rebate check. Spending $4,500 more means you have fallen $103,500 behind in saving for your retirement.

Even back at only spending half of your check, you've spent $900 and only saved enough to do that again next year. You've saved like there's only one tomorrow. To support a constant lifestyle increase and not simply a two-year binge, you can only spend about 4% of the $1,800, or $72.

At this point, I can hear your objections: "But I'd just be spending the $900 this year. I'm not really increasing my lifestyle."

Unfortunately, lifestyle is tricky to calculate. It is easy to ratchet up but nearly impossible to trim down. Just try cutting your spending by $900 this month and adding that amount to your investments if you think it's easy to economize. Whatever your standard of living, there are people living $900 below you who are considering using their rebate check to add the one thing they believe they are missing from your lifestyle.

You can't spend money apart from your lifestyle because that's the definition of lifestyle. If you add an additional $900 to your lifestyle, you will have to cut back by the same amount next year just to get back on track toward your retirement.

Most people spend money they will only receive once and are more cautious about spending additional salary. However, the exact opposite should be true. Money you are given once cannot support an increase in your lifestyle. You have to amortize the money over your entire lifetime and spend only about 4% in any one year. But additional salary can be counted on every year. Therefore you can spend between 70% and 80% of salary increases and still stay on track by always saving between 15% and 30% of your income each year.

A much better idea is to think of the rebate check is as a matching contribution. Imagine the government is making you the following deal: "We will give you a check only if you put it in savings and match it with your own money, cutting your lifestyle this year by that amount."

If you take the government's deal and cut your lifestyle by $1,800 and add that plus the rebate check to your retirement savings, then you really grow rich. First, you have added $3,600 more toward your retirement. But more importantly, by cutting your lifestyle by $1,800, you now need $41,400 less to make retirement a possibility! With one small matching funds incentive by the government, you are a total of $45,000 closer to financial independence.

Staying on course toward retirement is as much about moderating your lifestyle as it is about saving and investing. If you need 23 times your standard of living at age 65, you need about 10 times at age 50, 5 times at age 40, and 1.7 times at age 30. Investments can double quickly, but you must have something saved while you are young to get the process started. Delay saving for several years and you will cut in half your lifestyle in retirement.

Compare what you spend with what you have saved to see if you are on the money toward meeting your retirement goals. And consider that tax rebate gimmick for what it is: another cheap attempt at stopping you from achieving financial independence.

Here's a program I could support as president: Offer to pay people matching funds toward their retirement in accounts they would own and control. We wouldn't even have to call it "privatized Social Security."

How to Get More Out of Your Accountant

Here are three suggestions from the Street for getting more out of your accountant:

1. Choose a professional who returns your calls promptly.

2. To really maximize your use of (and relationship with) your tax professional, make sure you are as educated as a non-pro can be on topics relating to your specific situation.

3. Make sure you keep them informed every year about life changes that may impact your finances. (the birth of a child, divorce, inheritance, home purchase, or starting a business)

My take on these:

1. I prefer email to the phone, but I know what they mean and I agree -- you want someone who will communicate with you. My CPA does a great job at this.

2. I agree 100% -- you have to know the basics of whatever you're asking the accountant to do or you'll be at a severe disadvantage. Knowing the tax laws saved me $1,200 this past year when my CPA made a mistake.

3. I see this as part of #2. If you're knowledgeable of the issues (in my case, tax issues), then you'll know what information your accountant will need to do the best job possible for you. Major life changes are obviously factors you'll want to consider and let your accountant know about when he/she needs to. To help this process along, my CPA sends me a questionnaire each year that asks 75 questions or so -- to try and identify any needed information that I may forget to convey.

Tax Rebates Are a Losing Proposition Part 1

The following commentary is from Marotta Asset Management and expresses their views on the current economic stimulus package being given to many taxpayers. I'm sure you all will love it. ;-)

Beginning this month until July, the government will issue over $100 billion in tax-stimulus checks, the equivalent of about 1% of annual consumer spending and some 70% of the country's $14 trillion gross domestic product (GDP). The assumption is that we can spend our way out of a recession by boosting third-quarter GDP growth over 4%.

More than 130 million households will receive $600 per adult plus $300 per child with a family of four receiving $1,800. But for taxpayers with an adjusted gross income of $75,000 ($150,000 filing jointly), who paid more than 60% of all taxes, these amounts are either reduced or eliminated. In contrast, many people who never file a tax return or pay any taxes will receive the full amount. The government has created special forms and public relations campaigns specifically to reach this group and encourage them to file and enjoy a rebate of taxes they never paid.

If I am elected president, I won't insult the public like this. Tax rebate stimulus checks are a cheap and inefficient gimmick that will increase the fragility of our economy and impoverish those who receive such checks.

You can't spend your way out of economic trouble as a country any more than you can lift yourself personally by pulling on your shoestrings. Increased spending is an indicator of economic health only when it is preceded by increased production and earnings. Rich people generally spend more, but it certainly is not what makes them rich.

It would be much better if we as a country tried to save and invest our way out of a recession. Imagine if everyone invested their rebate by creating new businesses or building factories. Then we as a nation would produce more. Increased annual production could be sold, which would increase our GDP.

Consuming more goods doesn't really help our economy when half the stuff we buy comes from China anyway. In fact, deferred consumption is the definition of capital and would allow us to use that capital to build more productive companies. It would lower unemployment and reduce inflation.

The tax rebate gimmick is extremely inefficient. The legislation itself added hundreds of pages to this year's tax code. The IRS launched a tax rebate information center offering check amount scenarios, along with information especially directed toward Social Security recipients and veterans. The agency was taking more than 50,000 calls per day over their normal tax-season load. Their automated-response phones handled 1.2 million calls specifically about the rebates, and the IRS reassigned 1,500+ employees just to deal with the inquiries.

To be eligible for the $300 rebate, parents had to apply for a Social Security number for their children. People not normally required to file a tax return had to do so to receive their rebate checks. The IRS Free File Alliance was created to provide free services to people who were filing solely to receive their economic stimulus payment.

None of these compliance costs are free. Someone has to be paying for them. Estimates suggest that compliance costs add an additional 50% to the expense of taxation. Because of the added burden of a unique program such as this, the costs are probably higher.

That means those $1,800 checks will probably cost taxpayers about $3,000 each.

The tax rebate gimmick impacts negatively on our economy. Economic systems change gradually and operate best in stable conditions. Only when goods and services are free to be used wherever they are deemed most valuable does economic growth have the best chance.

But rather than trust in the free markets, President Bush and Congress have tried to boost consumer spending artificially without any reduction of federal spending, thus increasing the money supply and fueling inflation. More dollars chasing static production is the definition of inflation. Many families earning $36,000 a year will receive a $1,800 rebate check representing an additional 5% bonus, only to find that prices on their purchases are 5% higher. Thinking they are better off, they will actually be poorer if receiving the check increases their spending habits by even a penny.

Every time the government bureaucracy engages in centralized spending plans, the economy is weakened. Free markets are the best method of self-rationing scarce resources to where they will do the most good. Every time the government tries to solve an economic problem via fiat, they can only do worse than the efficiencies of the market itself. By trying to strengthen or bail out one section of the economy, they slightly weaken and destabilize all the others.

Finally, the tax rebate gimmick will impoverish those who receive such checks. In polls, most Americans claim they will put the rebate in savings or use it to pay down debt, but behavioral finance research suggests otherwise.

Studies have shown that even the most rational of consumers who receive money spend more as a result. Surprisingly, when they receive relatively small amounts, they justify additional spending by more than 2.5 times the size of the original check. The psychology behind this thinking is so strong, it is safe to assume we are all influenced by it.

We see evidence that the effect is universal when we hear people say they will save the rebate or use it to pay down debt. The fact that they are thinking of the money from the rebate as though it were different from the rest of their budget means they are already engaging in the two-pocket fallacy of money, thinking of money differently simply because of the source.

Perhaps they will pay off some of their debt, but they did that the month before they got the check. Perhaps they will put money into their 401(k), but that happens automatically. Because these rebate checks will continue to be featured in the media for months as they dribble out, they will continue to be in the forefront of our minds. Someone will complain about a delayed check while other coworkers share what they've already purchased. And most Americans will use the idea they have some extra money to justify a purchase they would not otherwise have made, probably more than once.

In fact, studies suggest that average consumers will spend an additional $4,500 in relatively small purchases simply because they received a $1,800 check: an extra $45 eating out, a $90 electronic toy, and a $650 appliance. Children will be given their $300 as though it somehow belongs to them, and husbands and wives will use the money as an excuse to make that purchase their partner considers frivolous. Without even realizing it, past studies suggest consumers will spend 250% of their rebate check.

In polls, American claim they will spend only 18% to 40% of the rebate. But in reality, anyone who spends more than 4% will actually lose ground in saving toward their retirement. Next week's article will explain the realities of this scenario. Until then, don't spend a penny of those rebate checks.

Control the Federal Government Budget

A reader sent me this the other day. Interesting concept. You can develop your own goals for the federal government, assign spending, and so on. Anyone care to be KIng of the U.S. and set spending the way they'd like to see it? ;-)

Where's My Stimulus Check?

If you're wondering where your stimulus check from the IRS is, here's something you might be interested in from TurboTax:

Recently, you may have received a letter from the IRS advising you when to expect your Economic Stimulus Payment (rebate). That IRS letter may have inadvertently left off some important information. Taxpayers who chose to have their tax preparation fees deducted from their federal tax refund will receive their tax rebate in the mail, not via direct deposit.

Maybe this answers some questions for a few of you out there.

Thanks, Ellen, for passing on the info!

More Government Bashing

More government bashing -- this time not from me. It's not over waste, but about Social Security. Click the link and check it out for yourself.

I've had some people comment about my on-going issue with government waste and spending. Just in case you're interested, here's why I'm talking about it:

1. It's my money. Notice I file these posts under the "taxes" category. I pay a good amount of taxes and would like to get a decent return for them. Generally, I do get a fair return, but just like I'd scream if Vanguard wasted some of my investments or if my wife bought something I thought was useless, I'm going to take note when the government takes my money and uses it in ways I don't like.

2. It's your money too. This blog is about growing your net worth. Expenses are a hinderance to growing your net worth. What's one of your biggest expenses? Yep, taxes. The least I can do is notice when your money is wasted.

3. It's an election year. Folks, we all better start thinking now about how the next president will impact our finances, taxes, spending, and so on. Remember, "It's the economy, stupid." Unfortunately, you never know what you're getting in a politician until after they are elected. Some are better than expected and some are worse. But there seems to be something about finally holding an office that brings out people's true colors.

4. DIY. I'm a do-it-yourselfer in all other areas and I'd prefer to be one when it comes to Social Security. But I don't get that choice.

5. I hate waste. I'd be a lot happier paying my taxes (and paying even more possibly) if I thought a good percentage of them weren't being wasted or spent on bureaucracy. Just like I wouldn't give to a charity with a record of high administrative expenses, why should I have to give to a government with one?

6. Waste, part 2. I work to control financial waste in my own life and I'm holding my government to the same standard.

Really, I'm not a government-hater. But I do get irked when I see my tax dollars wasted, spent on pork-barrel projects, and allocated to mandatory programs that I'd rather manage myself.

Ok, I'll get off the subject for now and simply wish you all a great weekend.

More Government Waste

Continuing our conversation from yesterday on government waste: now 1,500 stimulus checks have been sent to the wrong accounts. Yes, it's a small amount of the total checks sent out, but still -- this is only one example of waste (there are many more as people noted yesterday) -- and this stuff can really add up!!!!

Why I Don't Trust the Government to Spend Our Money Correctly

I take some heat for suggesting that the government isn't exactly the most efficient spender I've ever seen (stating the case mildly.) I've said many times before that I wouldn't mind paying the taxes I do (and I pay a fair amount) if I felt the government wasn't wasting a good portion of them.

Well, here's an example of what I'm talking about:

Kazanji and his Brighton Medical Center staff chuckled most of the weekend thinking about the "FINAL NOTICE AND DEMAND FOR PAYMENT" from Brighton that threatened legal action if unpaid personal property taxes weren't paid.

What would it take to put Kazanji in the right? Two quarters and a penny. Fifty-one cents.

The doctor and his staff said the funny part is the city spent $5.21 to send the letter via certified mail.

Ronda Gutzke, office manager, said the city should have taken the 51 cents from the mail costs, and it would have been ahead.

Yeah, I know that this example is from a city government. My bet is that the federal government has many worse examples.

The Biggest Problem in Healthcare

I've said before that healthcare has the potential for changing retirement in a big way, but more than that, it's starting to greatly impact the current lives of many people. Politicians are waking up to this fact and the three potential presidential candidates all have plans at trying to fix the myriad of problems around the issue. But are they focusing on the right problems? If not, then there's no way they can come up with a workable solution. Here's a sentence from the end of a CNN article that expresses my thoughts exactly:

And Fronstin is concerned that all three campaigns place too much emphasis on the uninsured and not enough on the biggest problem in America's $2 trillion health care system: runaway costs.

If they don't get runaway costs under control, then we're simply going to have more and more people unable to afford healthcare. But how to do it? Ahhhh...that's the trillion-dollar question. Anyone have any ideas?

Stimulus Spending

Now I've seen everything.

My CPA Made It Right

As I promised in the comments, I wanted to let you know the outcome to my tax mess. My CPA originally sent me a bill for the extra work, but when I detailed the issue and the facts, she ultimately didn't charge me anything for the extra work.

I'm now a satisfied customer again. ;-)

Tax Freedom Day 2008

The following is a guest post from Marotta Asset Management.

This year we celebrate Tax Freedom Day on Wednesday, April 23. That's the day we stop working for the government and start working for ourselves. For average workers, all of our earnings for the first 113 days of the year go to pay federal, state and local taxes. Starting April 24, we are free--at last--to take care of our own family's needs.

The nonpartisan Tax Foundation based in Washington, D.C., measures the tax burden on Americans every year. According to its 2008 report, published in March, this year's federal Tax Freedom Day comes seven days later than it did in 2003. Interestingly, the day falls three days earlier than it did last year. This decrease in taxes is the result of the slowing economy and a onetime fiscal stimulus tax cut.

Because of our progressive tax system, Uncle Sam usually collects more taxes as inflation rises, owing to "bracket creep." As your income growth keeps up with inflation, your purchasing power remains unchanged. But as inflation drives you into a higher tax bracket you pay higher taxes.

On average, taxes take nearly 31% of a worker's gross income: 20% for federal taxes and 11% for state and local taxes. For every eight-hour day, 2 hours and 28 minutes of our labor is spent paying taxes. Without taxes, you could leave your job at 2:32 p.m.

Only since 1992 have Americans paid more for government programs than we spend on food, clothing and medical care combined. For the amount of money we pay in taxes, the federal government could provide universal health coverage and feed and clothe us as well.

At the state level, Tax Freedom Day varies depending on location. California has moved up from the 7th to the 4th highest level of state taxes with its Tax Freedom Day now delayed until April 30. Virginia has risen from 17th to 12th in the race for the highest state tax rate, even though its liberation day arrives on April 25, only two days later than the national average.

The Virginia tax rate continues to climb higher each year, despite claims of no new personal taxes because of both bracket creep and the significant increase in state business taxes. This situation reflects a national trend. Business tax receipts have risen sharply over the past two years.

Most non-economists vastly underestimate the negative impact of taxes on the U.S. economy. Taxes encourage every American to do things themselves, outside of the taxable economy, even if specializing and working together would mean greater productivity. If you add the costs of complying with the complex web of regulations, the federal government costs us Americans collectively more than 50% of our wealth.

Imagine three contractors who could build three houses if they worked separately. If they collaborated and combined their expertise, however, they could build six houses instead. It may seem incredible that these builders would not take the opportunity to double their productivity, but with any tax rate higher than 50% they have no incentive to choose the more productive partnership. Putting their production into the taxable economy means they have to pay more than three houses in taxes. A 50% tax rate halves their productivity. Envision the economic boom if the other half of workers' labor were set free!

Imagine a skilled surgeon who has a marginal tax rate over 50%. Everything she pays someone else to do costs her twice as much because she pays with after-tax dollars. From a societal point of view, it is inefficient and wasteful for her to mow her own lawn, change her own oil or paint her own house, but specifically because she is in a high tax bracket, she can save more money than the average American by doing those chores herself. Another way to look at it is that without taxes, she could afford to pay twice as much to those who provide her these services.

Economist Arthur Laffer recognized that the law of diminishing returns applies to tax rates as well. According to Laffer, at a certain point, increased taxation actually yields the collection of fewer tax dollars. As we near a 100% tax rate, we approach driving commerce into the ground and collecting no taxes.

Many economists believe we are still beyond the point of diminishing returns. In other words, tax cuts would actually result in increased economic growth and more taxes being collected.

Presidents Kennedy and Reagan understood the Laffer curve well. In 1964 Kennedy reduced the top marginal tax rate from 91% to 70% and, to many people's surprise, tax revenues increased. Seventeen years later, the Reagan tax cuts reduced the top marginal rate from 70% to 50%. Again, revenues soared. Between 1980 and 1997, the share of federal income taxes paid by the top 1% rose from 19% to 33%. The share of taxes paid by the top 25% increased from 73% to 82%.

The top 1% now pays 34% of the taxes in the United States. Do you know how to join the top 1% of taxpayers? Just sell a house in California. The top half of taxpayers pays almost 96% of the income taxes, meaning the bottom half pay just 4%. These two statistics have increased despite all the complaints that tax cuts favor the rich.

Economists understand that the optimum rate of taxation is zero. The second-most ideal is as low as possible. In contrast, many Americans seem to believe that tax rates should be increasingly punitive. One notable exception is Alaska, where Tax Freedom Day arrived weeks ago on March 29.

Low taxes should not be a political issue that divides us. Every American should agree with the goal of keeping taxes as low as possible. In 2011 all of the federal tax cuts enacted since 2001 are scheduled to expire. If this happens, Tax Freedom Day will move an entire week later. In the words of John F. Kennedy, "An economy hampered by restrictive tax rates will never produce enough revenues to balance our budget--just as it will never produce enough jobs or profits."

My Tax Mess

Most of you know that I use a CPA to do my taxes. But as I've said before, this doesn't mean that I simply turn over my receipts each year and check out. I still need to be an active participant in the process. And good thing I was this year -- it saved me $1,200 or so in over-payment of taxes. Here's the story:

• As usual, I prepared a summary of my taxable activities for my CPA and sent them to her with her 3-page questionnaire and a bunch of receipts.

• Within the packet were a few transactions where I had donated stock or mutual fund shares to a charity to avoid capital gains. I noted these accordingly.

• I submitted all of this to my accountant the first week of March.

• On April 7, I stopped by her office to pick up my returns (federal and state.) I took them home, looked over the 50 or so pages, and found that my CPA had counted one of the mutual fund gifts as if I had sold the shares first and then donated the proceeds to charity. This is NOT what happened. Furthermore, if it had happened this way, I would have owed about $1,200 in capital gains taxes, which is what she had me listed for on my return.

• I called her right away and asked what was up. She told me that the 1099 from Vanguard stated that I had indeed sold the shares first and then donated the proceeds. Thus, it was a taxable event.

• I said it was not. That I donated the shares, not cash. She said that if this was true that I needed to get a new/revised 1099 from Vanguard showing this to be the case. Otherwise, the IRS would expect me to be paying taxes on what appeared to be a sale and donation (versus a donation of shares by me and then a sale by the charity.)

• I then entered the netherworld of last-minute tax help at Vanguard. I won't go into the gory details, but let's just say it wasn't pretty. I had a week to get things solved and at first it appeared that they weren't going to move very quickly. But I pushed them to investigate the transaction and they eventually agreed that they had recorded/reported it incorrectly and that they would revise my 1099.

• I reported this to my CPA, she changed the returns, and on the evening of April 14, I picked them up. The next day I sent in my checks -- and made a payment that was $1,200 lower than originally calculated due to me catching the problem on the original tax return.

There were several things that went wrong to make this situation wose than it had to be including:

1. Vanguard reported the transaction incorrectly. The thing that eventually convinced them that I was right and they were wrong is that I had two other transactions with them where I'd sent out the exact same paperwork and they had reported it correctly. I pointed them to these and showed them they simply messed up on this one.

2. When I received the 1099 early in the year, I should have asked about it instead of simply filing it in my tax folder and going on.

3. My accountant should not have taken so long to do my taxes. It took her over a month before I got them. If I had had them even a week earlier, there wouldn't have been such a last minute rush.

4. Instead of just reporting the transaction as a sale based on the 1099, my CPA should have noticed the discrepency between the 1099 and my instructions. She could have called me as early as mid-March and we could have settled this way in advance.

All this to say -- even if you use a professional to do your taxes, you still need to know what goes into your taxes and be familiar with how they are filled out/calculated. You also need to review the final results before giving your approval. This is what I do, and usually they're fine. But this year, being a bit more diligent saved me $1,200.

Two Types of Poor

Here's an interesting comment I received on my post titled Poor and Middle Class Incomes Down:

"Poor" is a relative standard. I am a social worker and work with a lot of "poor" families that receive cash aid, food stamps, government-paid health insurance and live in government-subsidized housing. Among this group, most of the families have cell phones (usually much nicer than mine), cable television (something I choose to live without) and rely on more expensive prepared foods to feed their families. I am disturbed by how entitled many of these people feel. Somehow it has become their "right" to have luxury items despite not working for them.

I grew up in a household that had many financial ups and downs (my parents are self-employed). When money was tight we ate a lot of beans and pasta. We went without new clothes. One year the kids were told there would be no Christmas presents. My family's experiences were a real-life lesson in fiscal responsibility.

Very interesting thoughts indeed.

Obviously there are many people (millions) in the U.S. that are desperately poor and are struggling just to have their basic needs met. But there are also the "poor" that are needy simply because they can't (or won't) control their need to have items that are way beyond what most people truly need to survive (cell phones, cable TV, etc.) It's stories/people like this, especially right after tax season, that get me a bit upset. I truly don't mind paying taxes as long as the money is going to do what it's supposed to do, but there's just so much waste in government spending that taxes are often very tough to stomach. I don't tolerate myself or my family wasting our money and I hold our government to the same standard.

Politicians, stop wasting our money!!!!

Do You Do Your Own Taxes? Should You?

Now that tax season is over, I'm starting to be able to write about the topic without steam coming from my ears. ;-)

Seriously, here's a good article from MSN Money that gives thoughts on whether or not you should do your own taxes. They offer three questions designed to help you decide if hiring a tax professional is for you or if you're better off doing your taxes yourself. Their questions:

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?

My personal answers are:

1. No.
2. Yes.
3. No.

This is why I hire a CPA to do my taxes.

And I was surprised that the majority of Americans do use tax professionals:

Because the tax code is so complicated, more than 60% of Americans have professionals do their tax returns. That's more than 80 million out of the 134 million individual returns filed in fiscal 2006.

By the way, just because I use a CPA doesn't mean I stop studying the tax code. I know it fairly well and am a vital part of making sure my CPA has a complete picture of my income, deductions, etc. so we can minimize the amount of taxes I owe.

The piece also lists what a good tax preparer should do including:

A good tax preparer starts by asking a lot of questions. The only way you'll get your money's worth is if the preparer understands what you do and how you do it -- and then scours for every legitimate deduction.

A good tax preparer is a teacher who educates you not only on what's allowable as a deduction but also on how to structure your activities to minimize your tax exposure.

The good preparer should focus not only on your 2007 transactions, but also on how you can reduce your 2008 taxes.

I would say that my CPA is "ok" in these areas. She'll certainly answer any questions I have (and I have many each year because I'm pretty up-to-speed on the general rules, but not well-versed on how they apply to my specific case), but she's not very pro-active. That said, the firm does have a three-page questionnaire I fill out every year that's meant to identify new deductions/potential tax issues, so perhaps that's the "pro-active" part of the service.

For me, here's the bottom line:

Clearly, a tax attorney is going to be more expensive than an enrolled agent or a storefront tax preparer. But if your income justifies it, the more sophisticated advice and direction should more than offset the additional cost.

Yes, it's expensive to hire a good tax professional. But as they say above, "the more sophisticated advice and direction should more than offset the additional cost." I have certainly found this to be true.

Taxes Cost Us All Time and Money

Here's a piece from MSNBC that tells us how much preparing taxes costs us all in time and money:

Tax season became a little more taxing this year, with the average person spending more than a day and more than $200 collecting, calculating and compiling those numbers for the tax man, according to a report based on Internal Revenue Service figures.

IRS figures showed that all taxpayers, from those using the simplest 1040-EZ form to those using longer forms, spent 26.5 hours in record keeping, studying the law, and preparing and sending their forms for the 2006 tax year. That was up from 25.4 hours three years earlier.

The average out-of-pocket cost, including for those taxpayers doing their own taxes, was $207, up from $185 three years earlier. The self-employed taxpayer paid an average $444 to put his taxes together.

This is one reason I use a CPA to do my taxes -- it saves me time and money, not to mention frustration.

Here's the way I look at the situation:

• Assuming that my taxes are average (which they aren't -- they're much more complicated), I would have spent $207 plus 26.5 hours doing them.

• Now I still have to do some record keeping and organizing, no tax professional eliminates everything -- but it's not much since I use Quicken and most of my information is available with the push of a few buttons. So let's say I only spend 10 hours doing my share of the taxes. So my net savings is $207 and 16.5 hours.

• If I'd be willing to pay $20 per hour to save those 16.5 hours, that would be worth $330.

• $330 + $207 = $537

• My CPA charges me $700 per year, so for $163 I get all the other benefits of having a CPA AND I don't have the frustration of having to do my taxes. It's a great deal for me.

Happy Tax Freedom Day

From MSN Money:

Tax Freedom Day, the made-up holiday after which Americans start working for themselves, comes three days earlier this year thanks to a slowing economy and the $600-a-head tax-stimulus checks soon headed our way. By April 23, says the Tax Foundation, a research group, Americans will have earned enough, on average, to pay all of their federal, state and local tax obligations for the year.

The more you earn, of course, the later your freedom comes. Residents of the richest state, Connecticut, will toil away on government behalf until May 8, but those in the poorest, Mississippi, began earning real money on April 7.

A combination of moderate incomes and very low state and local taxes makes Alaskans the first to claim their tax freedom, this year on March 29.

Yeah, but it was still winter in Alaska on March 29. Wait, I'm from Michigan. It was still winter HERE on March 29 too!!! Yikes!!! ;-)

Tax Roundup

Since it's April 15, I thought I'd share some good/interesting tax-related posts from around the blogosphere:

• The Simple Dollar lists six things he thinks after filing his taxes.

• Five Cent Nickel has put in for an extension.

• Wallet Hacks lists 50 fun facts about taxes.

• Boston Gal's Open Wallet has some tax saving offers for us all.

Enjoy!

The Best and Worst Tax States

Here's a chart from MSN Money that lists tax burdens by state -- including major state taxes and federal tax burdens. This analysis yields the following five as the best states to live in if you want to minimize your taxes:

1. Oklahoma
2. Alabama
3. Alaska
4. Mississippi
5. Tennessee

And here are the five worst:

1. Connecticut
2. New York
3. New Jersey
4. Nevada
5. Vermont

FYI, my state of Michigan ranks #21 overall, but is #14 (14th worst) when ranked on state taxes alone. Thanks, Jenny G., your plan to drive our economy into the ground certainly seems to be working.

A few thoughts on these numbers:

1. I've lived in Tennessee and if I could I'd move back in a heartbeat. It's a GREAT place to live.

2. The rest of the "best" list looks like places I wouldn't want to live (especially Alaska -- simply too cold!), though I'm sure they each have something good to offer. I'm just not aware of what.

3. Looks like the Northeast is tax-central. I guess that's why all the extra services are so great in those states, huh? Oh, wait a minute...

4. Seriously, the high taxes in some states are reasons why you wouldn't want to live there -- and could get rich by moving elsewhere.

5. As our economy becomes more and more information-based, I think companies (with less hard assets and more intellectual assets -- making moving easier) will consider taxes in a major way as they decide where to locate and/or whether it's worth it to move the company for cost reasons. I have friends already considering these issues since Michigan is becoming more and more unfriendly for small businesses.