Tax Refunds

Everybody who wants an interest free loan, raise your hand. While that hand is raised, those of you who got a big tax refund, use that hand to smack yourself over the head! Why, you ask? It’s because you just gave the government an interest free loan. Let me ask you this; would you give a complete stranger a loan, and not expect to get at least some sort of market rate interest on that money? I didn’t think so, but why are you so quick to give the government your money for free? Even having that money in a savings account earning .25% (you know how low rates are these days) is better than earning zero.

For years I’ve heard clients tell me that they look forward to that big check at tax time, and how they have too much tax withheld on purpose, and it’s ‘forced savings’, blah blah blah. My reply has always been “if you want to force yourself into saving money, why not just cut a check (or set up an automatic debit) every month to invest in a mutual fund, or fund an IRA”? It’s such a no brainer that can only help people, which is why it’s confounded me for years. Obviously my job is to advise my clients, and of course they’ll do whatever the heck they want anyway (much the same way as I ignore advice!).

With proper tax planning/projecting, it’s possible to get to the end of the tax year at close to a breakeven (i.e. either very small refund or very small balance due), without incurring penalties, and having more money saved (and no interest free loans to Uncle Sam or Uncle Governor-of-your-state). By changing your withholding exemptions, you’ll have more money in your pocket each paycheck, and won’t have to wait until tax time to get your loan money back from the government.

I have a challenge; allow me to bug you on a monthly basis, to send me a check, payable to the mutual fund/investment of your choice, and I’ll make sure that check gets deposited to your account, so you can earn something on your money…more than the zero percent the government’s giving you. Better yet, you can loan me the money interest free, I’ll invest it, keep the income, and then pay back your loan at the end of the year! Just kidding, but you understand my point.

With that raised hand, give yourself one more smack over head. O.K., you can put your hand down now! Now that your hand is down, please leave a comment. I’m interested in hearing your thoughts on this.

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Love and Taxes

It’s spring, and love is in the air. You may be planning for the big June wedding right now. All the details; what caterer to choose, what color are the bridesmaid’s dresses, who sits next to whom, filing joint or separate tax returns, where to honeymoon, where to live. Whoa, back up…did I just say ‘filing joint or separate tax returns’? I sure did, and I bet you haven’t given that as much thought as you have about who gets stuck sitting next to Aunt Sophie! Well, as they say (whoever they are), there’s no time better than the present. So while you’re stressing out about which band to pick, add this to the list, and get the valium ready!

I thought this would be an interesting topic to write about, because over the years I’ve had to explain to countless newlyweds why they now owe taxes, when, in their single days, they always got refunds.

First thing to understand; when you’re married, you cannot file your tax return with the ‘single’ filing status. To quote IRS “If you are considered married for the whole year, you and your spouse can file a joint return, or you can file separate returns. There are a few examples that IRS gives for what’s considered ‘married for the whole year’, all of which pertain to the last day of the year. To simplify it, if you were married on December 31, you’re considered married for the whole year. This article isn’t meant to be political, so I would like to recognize all the same-sex partners reading this, and please don’t shoot the messenger; IRS makes the tax laws, not me.

Being a numbers guy, I threw together a very simple Excel worksheet, to compare the tax bite between single, married filing jointly (MFJ), and married filing separately (MFS). Even though you can only file jointly or separately if you’re married, I imagine there are people out there who might put off getting married if it’ll save them taxes, which is why I’m including single in this comparison.

Our love struck couple (let’s call them Bristol and Levi) each earn $100K/year in wages, each receives $3K/yr in interest and dividend income, and each have a rental property that generates $5K/yr net rental income. On single returns, they both have adjusted gross income (AGI) of $108K. On a MFJ return, their AGI will be $216K, since all of their respective income items will be on one return. On the MFS returns, they’ll each have AGI of $108K, same as single. Both claim a standard deduction, which will be $5,700 apiece, for either single or MFS. For MFJ, the standard deduction will be double, $11,400. They will each get one exemption of $3,650 on the single and MFS returns, and the MFJ return will have two exemptions (one for each) for a total of $7,300. When standard deductions and exemptions are subtracted, on the single and MFS returns, our lovebirds will each have taxable income of $98,650. On the MFJ return, the taxable income will be $197,300. Now comes the fun part!

Going to the tax charts/tables, the tax on taxable income of $98,650 will be $21,338 for single taxpayers. For MFJ, the tax on taxable income of $197,300 will be $43,488. Let’s summarize; two single returns will generate a total tax of $42,676, compared to a joint tax return which will generate a tax of $43,488. So being married and filing a joint return costs $812 more in federal tax! But wait, it gets worse. When filing separately, each return will generate a tax of $21,751, for a total of $43,502 for the two returns, or $14 more than filing jointly. Now if that isn’t a kick in the pants!

For all my unsuspecting newlywed clients, I’ve had to explain the “phenomenon” of the marriage penalty. Regardless of any attempts or claims by congress to mitigate this, it’s still there. The reason for this is that tax brackets for MFJ aren’t exactly double the brackets for single. What winds up happening is that on a joint return, more dollars wind up being taxed at a higher bracket than on a single return. And MFS is even more, which is why it comes out with the highest tax.

The moral of this story is, Bristol and Levi got scared off by the taxes, and decided to not get married! For all the “real” people out there; obviously there are a lot of other factors to consider when getting married, but when tax time comes, at least you’ll understand better why you just got smacked with taxes. Now go and enjoy that wedding. I’ll be here to talk taxes when you return.