Our Taxes with a Twist

Our taxes are done. Not yet filed, but at least they're done. This year I ran a little experiment. The good people at Intuit have been kind enough to give me a copy of TurboTax to play around with. However, knowing that I am not very good at doing this kind of thing, I figured I'd use TurboTax first, but then still visit our accountant to do our taxes. I could then compare the results of these two methods, and maybe even do our taxes on my own next year. What do you think happened?

Well, according to TurboTax we deserve a Federal refund of $2,878 and a California state refund of $5,392. Sweet. According to my accountant, we deserve a Federal refund of $3,042 and a state refund of only $2,313... Now that's one hell of a difference, especially on the state side...

So what's going on? I don't know and I think it's pretty complex to figure out exactly what the differences are. I plan to sit down with both of the returns and try to compare them. However, if I were to put my money on it (which I sort of have to, I guess), I would have to go with my accountant.

Our tax return is not hugely complex, but it's not a simple one either. In addition to W-2s, we had a veritable zoo of 1099s, foreign income and foreign trust distribution... I have a feeling that TurboTax is not meant for folks like us.

I will say this: if all you need to enter are some W-2s and 1099s, TurboTax makes the process simple and easy, in most cases simply downloading the information directly from our employers and financial institutions. I have never tried to do our own taxes before and (with the exception of the substantial discrepancy I pointed out above) the process was not intimidating or overly complex at all. Maybe I'll try TurboTax again next year if I can figure out what went wrong here.

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Tax Injustices and Strange Rules

Why should your tax liability be dependant on something that your employer does or does not do? Basic fairness demands that your tax burden be dependent on your own specific circumstances, such as your income, your number of dependents etc. However, the tax code is riddled with examples where Uncle Sam reaches into your pocket to a different extent depending on the benefits that your employer provides. Here are some prime examples, but I am sure that there are many, many others:

Childcare Flex Accounts - childcare flex accounts allow you to reduce your tax liability, by paying with pre-tax money for childcare expenses, up to a limit specified in law (I believe it's $5,000). My previous employer offered childcare flex accounts, which I maxed out annually to great benefit. My current employer is not offering a childcare flex and consequently, even though we can get a deduction for childcare expenses, my accountant tells me that our tax liability was hundreds of dollars higher than it would have been had a flex account been in place.

Medical Flex Accounts - In my previous company I was able to deposit $1,500 annually in a medical flex account, leading to hundreds of dollars in tax savings on our medical expenses. Since my current employer does not offer this benefit, the only way we would have been able to deduct our medical expenses is if they had exceeded 7.5% of our adjusted gross income. Since - thankfully - our medical expenses do not reach that minimum, we end up paying considerably more in taxes.

401K vs. IRA - why is it that if your employer offers a 401K plan you can contribute $16,500 towards your retirement but can only contribute $5,000 to an IRA if your employer does not offer such a plan? What is the rationale for tax discrimination against people whose employer does not care about their retirement? Similarly, why is it that unemployed individuals are not permitted to contribute the full 401K allowable amount?

ROTH 401K vs. Regular 401K - does it make sense that if your employer offers a ROTH 401K option you are able to make a full $16,500 in after tax contributions to a ROTH account, regardless of your income, but you cannot contribute a single cent to a ROTH IRA account if your adjusted gross income is over $169,000 (for joint filers).

The tax code is riddled with asinine and capricious tax rules. It is time for Congress to take up serious tax reform and to do away with this injustice. The amounts you save for retirement or are able to deduct from your tax liability should have nothing to do with the benefits that your employer chooses to offer. The tax treatment of individuals should be equal and based on their own unique circumstances rather than on the decisions of their company's benefits administrators.

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Three Banks, Three Customer Service Stories

This weekend I was busy preparing my tax records so I can take them to my tax professional next week. I don't do my own taxes. For one thing I am intimidated by this whole process. For another, I don't really know how to tackle the subject and prefer to pay an expert to assist me. Call it paying for peace of mind. Anyway, some of our 1099s did not yet arrive, so I decided to go look for copies online. I had three missing 1099s to hunt down from HSBC, ING and E*Trade. 

ING made my life very simple. Logging into the account takes a second, and on the first screen there was a big button titled "Tax Forms Available Now". All I needed to do was click on that button and hit print. Done in 30 seconds.

HSBC was a nightmare. First of all, logging into the account is a pain - you need to enter two separate passwords, one using your keyboard, the other using a virtual keyboard on the screen. Idiocy. After searching the site for about 10 minutes, I still wasn't able to find the tax forms. I called the customer service number, and it took me about another 10 minutes to find my way through a byzantine maze of voice menus. After finally getting to an agent he explained to me that my troubles were because, when prompted, I entered my social security number first and my account number second. If I had done these in reverse order I would have been able to ask for an agent directly. WHAT?! Seriously? This is a known issue and rather than fix this they explain to me how to avoid their trap in the future?

I vented a little, and then asked the agent if there was an online copy of my 1099. He confirmed that there was a way to download the 1099 and directed me to my downloadable January account statement. Apparently, the 1099 is page 2 of that statement, but there is nothing on the website that tells you that this is the case.... way to hide it guys... would it kill you to put a little button on your website ING style? 

Anyway, E*Trade was a solid middle. I had to search around for about 3 minutes before finding out where the form could be downloaded. Not as easy as ING but certainly not close to the HSBC nightmare.

Here's a pointer: if you are going to put together a website or a voice menu, how about using it yourself first before inflicting it on your customers? Design and customer service really do matter.

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GMAC Bail-Out: My Personal Share

It's no news by now, the government is bailing out those Detroit dinosaurs known as the auto companies, in spite of my sound advice. Don't those slackers in D.C. read Money and Such? One part of this bail-out is the rescue of GMAC - GM's financing arm - to the tune of $6 billion. I decided that it would be interesting to figure out how much of my own personal money the government is handing over to the shareholders of GM, the private equity firm Cerberus (which owns Chrysler)  and to the United Auto Workers... Bear with me as I run the numbers on the back of this handy envelope (which I also use to accept bribes for appointing U.S. Senators):

There are approximately 330 million people living in the U.S., which means that each of us is paying about $18 to this failing company. There are five people in my household, and since our three kids are not currently paying taxes (living at the expense of the working class), my wife and I would be paying about $90 to stave of the evil creditors of that noble establishment. But wait! Not all U.S. residents pay a similar share of this nifty Christmas bonus to GMAC owners, I happen to be a bigger tax benefactor than most. 

According to Kiplinger's our household income places us in the top 5% of tax payers. Good for us. However, we are not quite lucky enough to be in the top 1% of the pyramid. The same article suggests that the top 1% of tax payers account for 40% of taxes (yikes) and the top 5% accounts for 60% of taxes. This means that excluding the top 1% my income group accounts for 20% of all income taxes paid. Now we are ready for some real action: there are about 100 million households in the U.S. - 4% of us or a total of 4 million account for 20% of the bills paid, which means that our personal share in the GMAC bail-out comes to a tidy sum of about $1,500. Sweet. Will that be cash or credit?

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We Need a Carbon Tax Now!

If you thought that the spike in oil prices would have a lasting effect on people's energy use habits, think again. No sooner had gas prices retreated from their historic highs, and in the middle of the toughest recession in recent memory, American are back to their ol' tricks: buying gas gulping monster trucks for their daily drive to the office. A couple of days ago CNN reported that SUV and truck sales are going to account for more than half of all vehicle sales in December - reversing a recent trend.   

This will simply not do. At a time when the world seems to finally be getting ready to do something about global warming, it is clear that high gas prices had a profound impact on people's driving and car buying habits. The best way to ensure that such good habits are maintained in what is destined to be a temporary (but possibly not a short) period of oil price collapse, is for government to impose a carbon tax - possibly in the form of gas taxes, with the objective of getting gas prices closer to about $4 per gallon.

Now before you all come screaming at me about the stupidity of raising taxes in a recession, there is no reason why this increase should impact consumers. For example, government could pass the funds raised by this tax back to taxpayers, in the form of an income tax reduction, sales tax reduction or some form of rebate. The trick is that we should not be causing financial hardship for those who can least afford expensive gas, but gas itself must become dearer so that folks will continue to have an incentive to save energy, buy reasonable vehicles and reduce carbon emissions. To read more about why I think a carbon is necessary, see this previous post. 

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Cutting My Tax Bill

In 2002, as the dotcom bubble was going through its painful deflation, I took my first steps into stock investing, and what painful steps those were. After it was already down by about 50%, I bought a sizable stake in the NASDAQ index fund QQQ. I figured: how much more could it fall? Well, it turns out the a lot more. At the bottom, my position was worth a staggering 67% less than my original investment. Worse, we never recovered those losses. At its best point - in October 2007 - more than five years after the original investment, the position was still about 20% under water. After the crash of 2008, that position is now 56% down.

Well, I have decided to make some money on that miserable investment decision. Or at least, I have decided to cut my losses. Last week I sold off enough of that position to take advantage of the $3,000 ordinary income deduction for the 2008 tax year. We typically buy and hold for the long term, but I figure it's time to admit a mistake and at least harvest some of this loss. By the way, I did not remove this money from the market, I used the funds coming out of QQQ to beef up our REIT index fund which has been badly beaten down over the past year. Rebalancing.

There is another lesson hidden in this little fiasco: no matter how much you think the stock market is beaten down, it might surprise you and fall a lot more. This lesson is not lost on me, and the comparison to the current situation may be a good one. My mistake in making the QQQ investment was to place all our eggs into one basket - investing in technology stocks. My other mistake was moving into the market in one lump sum, rather than moving in gradually over time. I have tried to learn from that mistake and we are now broadly diversified. In addition, I am now very careful about moving money into the market gradually, over time, through monthly, fixed contributions. Still, it is possible that six or seven years from now I will be selling positions I am buying today to offset a looming tax bill. Let's hope not.

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Over Contributing to Your 401(k)

A company 401(k) is the basis for many people's retirement planning strategy, and for this reason investing your 401(k) assets wisely is something you should take the time to plan and execute. However, today's post is not about investing your 401(k) money more efficiently, it's about making sure that you don't over contribute to your plan. In 2008, the contribution limit is $15,500 per individual, and if you are over 50 you are entitled to make catch-up contributions of an additional $5,000. Contribute more than this limit and you find yourself in a little bit of a bureaucratic nightmare.

First up, how can one even over contribute? Plan administrators typically ensure that employees cannot over contribute, by stopping all excessive contributions. However, they can only do this if they are aware that you are over contributing. If, for example, you switched jobs mid-year, there is no way for administrators to know the amount that you already contributed to your 401(k) before you joined your new employer. In fact, my wife and I each ran into an over contribution situation in exactly this way.

So, how do you avoid this over contribution situation?

(i) Calculate Your Limit - if you contributed to more than one plan during the year, deduct your earlier contributions from the maximum allowed contribution to determine how much you can still contribute. Once you have this number, divide it by the number of pay-checks remaining in the year and make sure that your contributions do not exceed this number.

(ii) Mind Income Changes - if your contributions are set as a percentage of your income, and you receive a raise before the end of the year, be sure to adjust your contributions to account for this increase to avoid over-contribution.

(iii) Pay Attention to Bonuses - if you are lucky enough to receive an unscheduled bonus, be sure to check if 401(k) contributions have been deducted from your bonus, and adjust your contributions accordingly.

What to do if you over contribute? Contact your payroll representative as soon you discover the error. Your 401(k) plan will issue you a refund check, which will be taxed at your normal income level. In some cases, if you discover the error after the end of the tax year for which contributions were made, you may also receive income that will be attributable to the following tax year. It's a hassle best avoided. Trust me. Last year, after switching jobs in the middle of the year, my wife unintentionally over-contributed to her 401(k). We only discovered the error in February when doing our taxes, the error took until early April to correct, and the changes will also impact our 2008 tax return. As I said, best avoid this hassle if you can.

By the way, if you are interested in improving your company's 401(k) plan, you may also be interested in this previous post.

The U.S. Tax System is Screwed Up

Before I start down this path, let me say that I consider myself very fortunate. What follows is meant as a critique of the U.S. tax code, and should not be read as a personal complaint, although, I must say that I do find this situation both frustrating and perplexing.

Today is tax day. Yesterday our returns were finally completed by our tax advisor (the reason that they were so late is another story which I will cover at a later time), and it turns out that we owe... wait for it... over $12,000. Yikes. So how could this be? A number of reasons but here is the biggy: Alternative Minimum Tax. Good ol' AMT.

Yes, in absolute terms my wife and I make a very good living. Most people in this country would trade places with us pretty quickly. In other parts of the country our income would certainly make us wealthy, however, here in Silicon Valley we are not even close to wealthy. As readers of this blog know, I have written many times against buying a house as an investment. My wife and I rent. However, on Sunday we went to see a model house in a new development in our neighborhood. Let me put things in perspective. The house, while new and nice, was a three bedroom townhouse, with no yard. The cost? $1.3 million. Let me be very direct here: there is no way on earth that we can afford to pay that price for a house (or for anything else), and this was NOT a fancy house.

So here is the way I see it. We cannot afford to buy even a modest house in the town in which we live - in my mind that means that we are not wealthy. However, because we have three kids and live in a state with high income taxes (California), the Federal Government considers us wealthy and hits us with the penalty rich man's tax.

In my business travels, I spent much time in South Carolina, Ohio and other places around the country. If we made anywhere near our income level elsewhere in the country (with the exception of Manhattan), we would be able to afford very nice houses, and could legitimately be considered wealthy. However, here in Silicon Valley we are simply middle class.

Why is the Federal tax code not indexed for cost of living in the various states? Why are citizens living in expensive parts of the country being penalized?

This is What's Wrong with the Tax Code

A couple of days ago CNN published a story about a speech given by Warren Buffet at a recent campaign event for presidential hopeful, Senator Hilary Clinton. Here is a quote from the CNN article:

"Buffett said he makes $46 million a year in income and is only taxed at a 17.7 percent rate on his federal income taxes. By contrast, those who work for him, and make considerably less, pay on average about 32.9 percent in taxes - with the highest rate being 39.7 percent."

What kind of tax system allows such ridiculous outcomes to exist? Although I disagree with their arguments, I understand why some people support a flat tax rate. However, is there any rational person that can justify a system under which the rich pay a LOWER tax rate than the poor?

Buffet did not stop there. He actually offered a reward of $1 million to anyone who could demonstrate that any one of the nation's wealthiest individuals pays a higher tax rate than that person's secretary...

As far as I am concerned, this is proof positive that the entire tax code must be scrapped and rebuilt from the ground up. This is not something that you can address with a quick fix. Our tax system is full of loop holes, and is fundamentally flawed. Unfortunately, the reason that our tax code is broken is that Congress has sold itself to special interests of all flavors. It is now lobbyists that control policy, not our so-called elected officials.

Is there no hope for tax justice for the middle class? Sadly, I don't think there is. It appears that paying a lower tax rate is yet another reason to try to become rich...

Big Ouch...

Today I had my meeting with our tax preparer. The title of this post summarizes the results well. Between state and federal tax returns it appears that we owe the government a total of about $6,700. I was actually pretty shocked as this result became apparent. Our tax returns this year were very simple with only work and capital gains income, and no unanticipated items. I am still not exactly sure how this could have happened, but apparently our withholding in 2006 was substantially off.

We are taking a big hit and worse still we will need to increase our withholding for 2007, which means smaller pay-checks. Luckily both my wife and I anticipate a substantial increase in our salaries in the relatively near term. We expect these pay hikes will more than off-set the increased withholding, so not all is bleak.

Overall, not a great day in the kingdom of Shadox, but at least the stock market cooperated today and gave a nice big boost to our portfolio.

Do You Do Your Own Taxes?

I don't. I hate tax season. It's not so much that I am worried about whether we will need to pay outstanding taxes, although this year there is a good chance we will find ourselves caught in the AMT net, it's more the hassle of it all. I am a fairly organized guy, and I have all of our financial records but there is always SOMETHING.

Last year for example, E*Trade sent us 3 separate 1099s. This year they sent us none, and it's only today that they finally posted a digital copy of our 1099 on the web. If it's not E*Trade it's something else, but there is always something. Somehow, I always get to the beginning of April before the whole tax situation is straightened out. On occasion, I have been known to stand in the huge line at the post office on April 15th. Seriously, I hate tax season.

Every year I consider doing our taxes myself. In the past we had some tax complexities that required a professional, and so for the past 8 years we have been using an accountant. These days the situation is pretty straight forward (minus the possible AMT fiasco) and I could probably handle the task myself. However, I will probably give our good ol' accountant a call.

The way I see it, I am a business professional. I deal with complex business issues, manage a team, own a budget. That's my specialty. I don't know nearly enough about taxes to make me feel like I am the best man for the job. Yes, I could save $300 but I could probably save that much money every year by cutting my own hair. Thankfully, so far I have chosen to go the more expensive route there too.

I guess it is a combination of apprehension, laziness and the comfort of knowing that I am paying someone else to keep me out of trouble that make me go back to the accountant every year. This year will doubtless be the same. But you know what? For $300, it's totally worth it.

Would love to hear from you on this issue. Am I being a wuss?