I have been professionally preparing tax returns for 9 years. Averaging between 900 and 1000 personal tax returns each year and another 100 corporate/partnership & non-profit returns, I am exposed to a lot of personal and professional circumstances that wanted me to write/blog about what is really going on with our financial health at the ground level.
Some general stats of my clients through April 15th, 2010:
1623 returns prepared (company-wide)
4 over $200,000 (.2% vs. 2.4% nation)
127 over $100,000 < $200,000 (7.8% vs. 9.4% nation)
212 over $75,000 < $100,000 (13.06% vs. 8.2% nation)
338 over $50,000 < $75,000 (20.8% vs. 13.6% nation)
186 over $40,000 < $50,000 (11.46% vs. 7.8% nation)
235 over $30,000 < $40,000 (14.48% vs. 10.3% nation)
521 under $30,000 (32.1% vs. 47.40% nation)
As you can see my client base is very “middle-class” only about 15% owed additional taxes with their return and most of them were self-employed business owners who had not made enough estimated taxes during the year.
We Americans are in just as crappy shape financially as our government. Too much debt, whether it is credit cards or mortgages and car loans that are underwater, we have been in a bad spot for years. The good thing about this recession is that it has pushed many over the cliff and they can now get their act together.
I use to be one of those that said, “I will pay all my debt” but after the last 18 months I challenge that belief. The game of credit card interest rates is one area that is completely made up in its logic.
Your credit score, which is used to determine your “riskiness” of default and is used to determine your interest rates and is used by other industries like car insurance to set rates, are based on this: The amount of available credit as a percent of your total credit line. So if you have $10,000 of total credit and have a balance of $2,000 you are a good risk. If you have $100,000 in credit but a balance of $60,000 you are a riskier credit so your score is lower and your rates are higher. What is wrong here is your total income and assets. You could make only $15,000 a year have a debt of $2,000 and be in serious trouble to pay it, however, if you make $150,000 per year and have net assets of $250,000 you would still be seen as a credit risk as your income and assets have no effect on your credit score.
Over the last 18 months I’ve had 4 accounts closed (two I had not used in a long time) and initially I was okay with that as I did not use them. However, the effect was to drop my credit report 50 points and making me appears to be a credit risk. I do not pay late and our balances over all were going down and our personal income was going up.
If you were thinking of dumping your credit cards, just tell the collection agent that you have been talking to a lawyer that usually puts them on red alert. If you can get the money to negotiate, do it. Don’t worry about them losing money, Citibank and Bank of America have a lot of taxpayer money and they are doing almost nothing to help their clients who are in trouble. Just be ready for your credit score to go down.
If you do bail on the credit cards do expect a 1099-C “cancellation of debt” and it is income to you. If I loaned you a hundred bucks then said forget it. It is income to you, so it is taxable. But the tax on $5,000 is a lot less than paying the $5K.
Use this time to put yourself into better financial health. People seem to understand as they too are struggling and will not think badly of you as they might have in the past. However, our government seems to just keep on spending and push programs that will cost a lot of money over the next decade. I am afraid that if it doesn’t stop voluntarily it will be forced to by lenders and taxpayers as there will be no money to find and no money coming into the government and it will collapse.
The best tax credits:
Child tax credit – The good part is that it helps families making under $60,000 pay very little tax. The bad part is that it doesn’t help families making over $106,000 as it starts to be limited. In Iowa, $106,000 is a lot of money, but a family of 4 in New York or San Francisco making that amount would still be struggling with the higher cost of living. It also confuses people because it ends the year the child turns 17 but they confuse it with claiming the child as a dependent which continues as long as you can prove 51% support.
Residential Energy Credit:
The good is that for the amount of tax it wipes out is equal to a lot of taxable income. $1500.00 for an average family would like having a kid or reduce your taxable income by $10,000. The bad thing is that salesmen don’t understand that you have to have tax to pay to get the credit. I had a client that spent $4,000 on a furnace and had not taxable income so they didn’t get the credit.
The most unknown credit that can be used to help everyone:
There is a retirement credit for people who put money into an IRA or 401K and make less than $50,000. It can credit back as much as 50% of their retirement money to them. It is a sliding scale so those making more get less of a credit and ends at $50K. However, if this was used to “privatize” the retirement system, I could put money away like Pres. Bush had proposed, and it would be effectively funded by the money I paid to social security. It would need to take the limits off income restrictions. But if one makes $100,000 and paid in $12,600 in social security (half you, half the employer) you could receive a credit of $5,000 (5%) too offset that investment effectively privatizing your retirement. You can’t make any claims on the SSI and the rest goes to pay for those that are currently in the system and over time you phase out the system and everyone has to privately fund their retirement or elect to pay in to the SSI.
The most misunderstood concept:
Extensions on filing are just that, an extension to file, not an extension to pay! If you owed $6,000 in taxes last year and you think you will owe the same but just haven’t got the info together, pay the $6,000 to avoid penalty and interest. If you send nothing you will just be hit with all the penalties. If you don’t have the cash, file (avoid the non-filing penalty) and set up an installment agreement. You can always pay it off faster.
The VAT (Value added Tax)
This idea is bouncing around and Mike Huckabee is a fan of it. The problem with it is this. If you eliminate the income tax and just have a national sales tax like the VAT, only consumers will pay tax. The poorer you are the larger amount of consumption you participate in and why people are in debt. Huckabee’s program also had items that would be taxed and Items that wouldn’t be taxed. Well all that creates is lobbing opportunities to make your product “non-taxable” and the whole reason for the system was to eliminate that stuff.
Also, to offset the poor people paying a higher amount of taxes for their income level, the government would send everyone $400 a month! EVERYONE, you, me and Warren Buffett! This does two things, 1) sends money to people who don’t need it and 2) gets every use to relying on the government for money!
People don’t want to pay taxes and will go out of their way, some legal, some illegal to do that. In my opinion most people don’t make enough to worry about avoiding taxes. I also believe that paying taxes is a sign of wealth and my making your business or life about “avoiding taxes” you are really “avoiding wealth”. What government needs to do is make taxes the cheapest cost of business or life and people will be okay with paying it.
Chris Mendelsohn © Army Post Accounting