Filing Your Taxes: The Fun Stuff

Part Three – Other Fun Stuff

Prosecutor : You haven’t been paying your taxes.
Chico : Taxes. I have an uncle who lives in Taxes.
Prosecutor : No, Money. Dollars.
Chico : Dollars, Taxes. That’s where my uncle is a-from.

[The Marx Brothers; Duck Soup]

Estimated Taxes

On the off-chance that you have income from sources other than wages and salary, for which no income taxes are withheld, you might find that the IRS wants some of their potential tax money in advance of April 15. In that case, they will require you to calculate and pay “estimated taxes.” These are quarterly payments that have deadlines of their own. There are a couple of ways to calculate how much you owe. Until you start making money in the stock market or selling collectible ash trays, you probably won’t need to worry about estimated taxes.

Refunds

Tax refunds are the Siren’s song of the IRS. It feels great to get a nice big fat check from the IRS. It’s Christmas in May. It’s cash found in the pocket of an old coat.  But as good as it feels, it’s a bad thing. The money you get from a refund was yours to begin with. But the IRS took it from you, held onto it and used it for their own purposes, neglected to pay you any interest on this de facto loan, and won’t give it back to you until and unless you demand it by filing your return. The IRS is currently holding onto $1.3 billion in unclaimed tax refunds from 2006 alone. That’s an interest-free loan that the feds use to fund your favorite boondoggle. The interest alone is more than any of us will make in our lifetime. You should be striving to break even – no refund, no tax due.

Refund Loans

There are a few ideas that entrepreneurs have come up with that are tempting at first blush, but are – at least in my opinion – really stupid. Refund loans are high on that list. Here we are talking about tax preparation firms who offer to lend you a portion of your anticipated tax refund. This has a few implications:

  1. You’re going to have to pay them to do your taxes first ($50-$150) – something you could do for free.
  1. You’re not going to get the full value of your refund because they are going to take the interest for the loan out of the refund.

III.                  If your refund is not as big as they said it was going to be, you could end up owing the tax preparer more than the value of the refund.

Last. If you consistently have a refund that is big enough to borrow against, then you should
have your Form W-4 adjusted to have less withheld in the first place (see Refunds above).

Paying Yourself More and the Government Less

You’ve heard it before; I’ll say it here too – to the extent that you can do so (and even if you can’t) you should be contributing to a 401(k) plan. Most employers offer them and when you are 73 (cuz that’s what the Social Security “Normal Retirement Age” will be by the time you get there) you’ll be able to go fishing instead of being a greeter at Wal-Mart.

The important thing about your contributions to a 401(k) Plan is that they are made with “pre-tax” money. (OK – truth is, you don’t actually make a contribution, your employer does. You sign a contract wherein you agree to take a cut in pay in exchange for the employer’s making a contribution.) Because your take-home pay is less, your taxable income is less and – voila – your taxes are lower. The tax man is like the grim reaper however. You won’t avoid those taxes forever, just until you withdraw money from your 401(k) at retirement. And Dad’s Dad always says, “Never pay taxes today that you can pay tomorrow.”  I won’t get into it here, but you should also look into IRAs and your employer’s Section 125 plan.

Audits

The IRS can do a lot of mean things if you don’t play by their rules. One of the things that they like to hold over your head to compel compliance is the dreaded audit – a review of prior filings in search of boo-boos. According to Eileen Bailey, the IRS will audit 1%-2% of all returns. But they are less likely to nab you at random and more likely to revisit you if you have done something that raises a red flag. These include, but aren’t limited to:

  • Inordinate deductions
  • Ongoing business losses
  • Blatantly bad math
  • Input values that don’t jibe with reported values
  • Year-to-year inconsistencies (e.g., each year you report a different number of kids)

When the IRS comes to call, they will likely have a specific issue that they want to follow-up on. If they specify, then that’s what you are responsible to review with them. So keep those receipts and bank statements handy (7 years is the amount of time you want to hold on to your records). Dad’s Dad has, on more than one occasion, proven the IRS wrong in their assertions. He has also come out of an audit with the IRS owing him money. But the IRS will never flag you if the error they found was in their favor. Hmmm. I wonder why that is?

Questions

There are few definitive correct answers. Even the Internal Revenue Code is subject to interpretation and judgment. And remember, even if you call the IRS with your question, you can get an incorrect answer. In a 2005 test of the system by the Treasury Inspector General, 35% of answers were incorrect.  And if the IRS gives you a bogus answer, you are still responsible.

So that’s taxes. Aren’t you glad you asked?

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4 Comments

Filed under Money, Taxes

4 responses to “Filing Your Taxes: The Fun Stuff

  1. Marie

    I wish I could have seen the look on the IRS agents’ faces when they found out they owe the guy they audited…or even better, the smug look on your Dad’s face!

  2. Matt

    As a young professional that just started my first position with a ‘real’ company, the section on 401k was particularly helpful.

    How much should someone in their early 20’s be putting away? It is tough to fight the temptation to not contribute and see the money now

    • Dad

      Matt,
      Simple. Put away as much as you possibly can. OK, maybe that’s too simple. Contribute as close as you can to the maximum that your company will match. If you don’t, you are leaving free money on the table. It’s a free lunch Matt, you know what they say about people who could blow a free lunch. If the full 5% or 10% seems too painful (parties deferred) then try a ratchet approach. Go for 2% this year – you’ll never miss it. Next year, 3%. Year after that 4%. The most important thing is that you start now. That’s more time for your money to build up tax-deferred. Otherwise it’s, “Oh, is that WalMart calling you in for the second shift?”

  3. Matt

    That makes a lot of sense, given that I am currently contributing to the retirement of all of the baby boomers and will never see any of it with the way that Social Security is going. I think I will tweak my current contribution and try to increase it each year.
    Thanks Dad!

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