Wednesday, February 15, 2006

A Public Service Announcement Regarding Taxes
A.K.A. Surprise, You Owe Taxes and the Interest might be accruing while we Speak

I am interrupting our current discussion of "The Parenting Crisis" (I and II) and "Wedding Expenses" for a Public Service announcement.

Being that a new tax year has come and gone and most people are hopefully giving some thought to their income taxes at the very least , I thought I would post a few things regarding taxes that everyone should know, yet, for some inexplicable reason, many people remain in the dark. When it comes to taxes, innocence is not bliss.

1. Surprise! You are self-employed! While it is quite clear to the independent businessman that he is self-employed, there are plenty of people who experience the rather unpleasant surprise that they are self-employed after the tax year is over and that they owe money to the government that they didn't know they owed. Some signs that you might be self-employed include receiving checks from your employer(s) that are the full amount of the amount he agreed to pay you. If you are seeing everything your bargained for, chances are that your employer is not paying his half of your social security tax, nor is he paying your state and federal taxes for you.

If you are self-employed, you are responsibility for paying a 15.3% rate on the profits from your business, as well as the federal and state income taxes that you owe which vary by income level. If you are self-employed you need to educate yourself about the types of expenses you are allowed to take and how best to deduct the expenses over the course of your business. You also need to get organized and get those records in order and neatly filed.

Self-employment taxes should be paid quarterly. If you are behind, there is no time like the present to catch up.

2. Surprise! You Owe Taxes from the Sale of Property! If you sell a property, you might just owe taxes on it. If you have lived in your home for 2 years of the past 5 years, you can benefit from a fairly new law that allows you to exclude the gain on the property from being taxed. However, if you did not live in your home for 2 of the past 5 years as a primary residence, you owe tax on the gain. Once again, you need to have organized records so that you (or your accountant) can actually calculate the amount that you owe in tax.

You really don't want to find out you owe tax on the sale of a home when you have already agreed to put that money into another home.

Important note: If you are trying to make a quick buck "flipping" homes, you really need to consult with an accountant. Depending on the frequency of the "flipping," you may find out that you are really self-employed and that instead of owing the low capital gains taxes, your gains are actually taxed at ordinary income rates AND you owe the 15.3% self-employment taxes too. This surprise is more like a nightmare!

3. Surprise! Those investments really profited this year (I should be so lucky)! If you have investments, especially ones where the dividends and distributions are put right back into the account, you need to be watching your gains carefully. If you did not opt to have taxes withheld directly from the investment income and it is a good year, you might get behind on your taxes. So, learn how to read your bank statement so that you can keep track of any significant income.

4. Surprise! Your 401(k) loan may subject you to tax and penalties! While it may seem like a wise idea to borrow from your 401(k) to get yourself out of debt at a low rate, it might not be a wise idea at all. If you have an unpaid loan balance on your 401(k) distribution at the end of the loan term (usually 5 years), you will owe a 10% early withdrawal penalty.

Even more scary is that can end up tied to your current employer because some loans must be paid back when you leave your current employer. If you want to switch jobs and you don't have the cash on hand to pay up(which you probably don't or you wouldn't have taken this loan in the first place), you will face taxes plus a penalty.

My advice: If you find yourself borrowing money for your regular living expenses, get yourself to a debt counselor immediately to solve the problem. Don't exasperate it.

5. Surprise! The the Alternative Minimum Tax (AMT) has got you! The AMT is biting more and more upper middle class people from behind. This subject is so complicated that it is hard to predict when the AMT will bite you. But, if you have a lot of complicated investments or tax shelters, you hopefully have a financial advisor that is available for good advice.

And finally, a few things NOT to do:

1. Dependent Care Tax Credits: Do not even try to take a dependent care tax credit on your illegal babysitter (i.e. the one that you hopefully are not paying under the table). Taking this tax credit will certainly flag you for and your babysitter for an audit. One top of that, you could loose your welfare benefits that come through the tax system. Restitution could turn out to be quite unforgiving as you or your babysitter will be determined to be either an employer or self-employed. The taxes owed could be massive.

As it has been said, "honesty is the best policy." I'd avoid illegal help. Those who employ nannies need to file a Schedule H and pay the employment taxes and make withholdings. But, if you still choose to use illegal help, don't try to claim a deduction.

2. Charitable Deductions: Do not try to claim Day School and Yeshiva Tuition paid as an itemized deduction. Those who have tried to do so in the past this have lost their case again and again. Don't play the wise guy to make an important point.

3. Car Donations: Don't take the Kelly Blue Book value for a car donation. The rules have changed and while the IRS used to look the other way when the Blue Book value was used inappropriately, now you need to file the proper paperwork and the organization who sells your car must do the same.

4. Estimated Taxes: Do not forget to pay your state when you make estimated withholdings for your business, a sale of property, etc. It is easy to forget the state when most of the paperwork is at the federal level.

5. Know what you are signing (a message for wives): Unfortunately in the past few months there have been a few men arrested for major tax fraud in the frum world. While they are headed to prison, their wives are headed to a living hell as they will be stuck with kids and no husband, a financial pit. When their husbands re-enter society after a conviction, they will not be able to practice in their chosen field and will probably be eligible for very few jobs.

When you sign a tax form, you are signing under the penalty of perjury. You need to know that the accounting was done properly. If something doesn't seem right, seek advice quickly. Better yet, don't ever be in the dark. Start your marriage off involved and stay that way.

(While this message is mostly for wives, it also can apply to husbands in some households.)


Anonymous said...

Only peripherily related to the topic but certainly relevant to Orthonomics, I read an article in today's Wall Street Journal about how some private schools are allowing GrandParents to pay tuition in advance for many years, in one case 12 for grandchildren's tuition, and they do not have to pay taxes as it is a gift, and (this was new to me) it doesn't count against the $25,000 maximum normal for the tax exemption for gifts. IRS gave a tax letter oking this. Is this for real? Some Yeshiva's should look into it.

Orthonomics said...

Thanks anon for pointing this out. I have flagged this article in the Journal and will hopefully be able to follow up with a post on this way of transferring wealth.

Also, look forward to a new post about a work-study Catholic high school for low income students.

Orthonomics said...

And, I agree the topic is certainly relevant to the Orthonomics blog.

Anonymous said...

My wife and I did our taxes this week and we got clobbered by the Alternative Minimum Tax. There goes the nice Pesach vacation!

Regarding the surprise self-employment tax, many employers are supposed to withhold taxes but don't, improperly claiming that they employees are really independent contractors. The IRS has guidelines to help ascertain which status someone falls into -- and it is the employer's responsibility to deal with this! See,,id=110344,00.html

If your employer is cheating, I don't know what options one might have. Any accountants/tax attorneys out there? Ezzie?

Orthonomics said...

Good idea for a post charlie. I will try to post about the differences between contractors and employees. I feel all high school grads should know this information. More to come.