Sunday, January 15, 2012

Adjusting Withholding Allowances on the IRS W-4

Is Getting a Big Income Tax Refund a Good Idea?

U. S. Income Taxes that are withheld in excess of the tax liability are refunded each year. Some taxpayers intentionally overpay their taxes to get a large refund.

In the United States, persons who are employed are required to file a W-4 form with their employer. The form provides information on the employee, including social security number, name and address, as well as tax information.

The W-4 includes how many withholding allowances the employee is claiming and marital status. This choice, along with their wages earned, determines how much tax will be deducted from the paycheck. Allowances are similar to exemptions on the tax form, but do not have to be the same. For instance, the taxpayer can claim zero allowances even though they claim an exemption on the return.

Underpaying Income Taxes

Claiming too many allowances will result in underpayment of tax. Significant underpayments are subject to penalties and interest. It is therefore important to claim enough allowances, or to make estimated payments.

Overpaying Income Taxes

Claiming fewer allowances, or withholding additional tax than necessary to meet the tax obligation, will result in a refund. Some taxpayers intentionally claim more than necessary in order to get a large refund. The reason for this is to get a large amount of money at one time. Receiving the money spread over the whole year may result in the money being spent, not saved. For example, a $2,600 refund may get deposited for a special occasion, but $50 a week may just be put toward the bills.

The standard response for those getting a big refund is that they “are giving the government an interest-free loan” since the there is no interest earned. To some employees, a forced savings program may be an advantage over earning a few pennies in interest.

The Withholding Impact of the 2009 Stimulus

For taxpayers earning less than $75,000, the IRS will be reducing taxes with the Making Work Pay Tax Credit in the American Recovery and Reinvestment Act of 2009 (the 2009 Stimulus). There will be credits of $400 to $800, depending on income. In order to accomplish the goal of stimulating the economy, the tax tables will be adjusted for the credit some time in spring.

Taxpayers who do not adjust their W-4 will receive more in their paychecks, and can anticipate the same refund that they would have gotten without the stimulus. If taxpayers adjust their W-4 to receive the same amount of taxes taken out, they would receive a larger refund. The government allows taxpayers to adjust their W-4s at any time, although employers may have restrictions on how often they can be changed.

Taxpayers should determine how important refunds are compared to having the cash in their pockets. Underpaying carries great risks, but wisely choosing withholding allowances can result in bigger paychecks and the option of stimulating the economy.

Increase your Income Tax Refund by Proper Timing

Lower your Taxes by Deferring Income and Maximizing Deductions

Using discretion when recognizing income and paying expenses can help reduce payouts and maximize refunds on United States income taxes.

Taxpayers who use the cash basis of accounting can reduce their United States federal tax burden by adjusting when income is received and expenses are incurred. Sometimes the effect will only be temporary, but in other cases permanent savings will be generated.

Cash basis accounting is a different method from accrual accounting. In cash basis, income and expense are recorded when they are paid. Accrual accounting recognizes these when they are incurred.

The following examples relate to the taxpayer using cash basis accounting.

Effect of Timing on Income

The simplest example of timing is in delaying taxable income until the next year. If there is any ability to defer taxes until after the end of the tax period (usually January 1), money received will not be taxed until the next year.

If the taxpayer falls into a lower tax bracket in the next year, this will result in actual savings. Alternatively, it may actually be better to move taxes into the current year if income (and the resulting tax rate) is low.

This is the principle being 401Ks and IRAs, which defer taxable income until after retirement. This is not true for Roth IRAs, which do not feature tax deferral.

It may be rare to find a circumstance where income can be deferred, but if the situation applies, it is smart to take advantage of it. In cases where the alternative minimum tax situation applies, consulting with a tax professional may be appropriate.

Effect of Timing on Deductions

There is much greater flexibility in determining the timing of expenses for deductions. Expenses are recorded when paid.

Generally, paid means when the funds leave the taxpayer’s possession. Checks that are mailed are based on the postmark date. Credit card transactions are considered to be as of when the charge is made, not when the balance is paid off.

Why is this important? Creating deductions before the end of the year lowers taxes in that year. Paying real estate taxes, estimated state taxes, or employee expenses early can defer taxes for the cash basis taxpayer.

There are other opportunities for real savings, not deferrals, built into the tax code. Deductions from federal tax can be used two ways:
  • The Standard Deduction
  • Itemized Deductions
The taxpayer is entitled to take the greater of these two. It is legal and smart to consider whether tax can be reduced by combining as many deductions in one year to maximize itemized deductions, and then claiming the standard deduction in the alternate year.

For example, a taxpayer may have $5,000 in deductions in each of two years, but has the option of prepaying $1,500 in real estate taxes in year one.

If the standard deduction is $6,000, it makes financial sense to pay the taxes early. Then the itemized deduction of $6,500 can be taken in year one. In year two, the standard deduction of $6,000 is greater than the remaining $3,500 of itemized deductions.

Other savings can be garnered from areas where there are limitations. Medical deductions have to exceed 7.5% of adjusted gross income (AGI) to be deductible.

The taxpayer with high medical costs will benefit by maximizing payment in one year, even the amounts exceed the threshold. Similarly, the category of other deductions must exceed 2% of AGI.

Although taxpayers are obligated to pay the appropriate amount due to the Internal Revenue Service, the tax code has provisions that enable honest taxpayers to reduce their burden by the effective use of timing. Always consult a tax professional for specific questions on your situation.

Stock Trading and the Wash Sale Rule

Why the IRS Law is Important to Short-term Traders

The Wash Sale Rule prevents taxpayers from deducting losses on some investments that are repurchased. When does it apply and what are the reasons behind the rule?

The Internal Revenue Service is the governing body with respect to United States tax laws. The IRS allows many legitimate deductions from income, but as investors have developed ways to take advantage of the rules for inappropriate benefit, the IRS has issued regulations to enforce the spirit of the laws.
One of the legitimate deductions is allowing a taxpayer to deduct losses on investments, up to a current annual maximum of $3,000 for a single taxpayer.
The law also allows losses on investments to be used to offset gains. The wash sale rule was instituted to make sure this is not abused. Losses cannot be deducted from sales or trades of stock or securities in a wash sale.

IRS Definition of Wash Sales

IRS Publication 550 defines a wash sale as:
When an investor sells or trades stock or securities at a loss and within 30 days before or after the sale they:
  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade, or
  • Acquire a contract or option to buy substantially identical stock or securities.

The Importance of the Wash Sale Rule

Because the IRS allows taxpayers to deduct losses against gains, the IRS issued the rule to prevent traders from taking sham losses in order to reduce taxes on gains.
For example, an investor might have a $5,000 in realized gains (based on sales that have already occurred), and have an open position in XYZ stock that is sitting at a $5,000 loss. With no additional transactions, the investor would owe taxes on the $5,000 in realized gains.
The investor could sell the open position and realize the $5,000 loss, netting his taxable gain to zero. However, the investor may believe that XYZ stock will recover and does not want to give up his position.
If he buys back the stock within 30 days, even after the year has ended, he cannot deduct the loss, and will still have to pay taxes on the $5,000 realized gain.
To be clear, the law does not prevent him from selling or buying back the stock, but does not allow the deduction. The IRS only prevents the deduction of sham losses, which it defines as buying back in investment in 30 days.

Strategies Regarding Wash Sales

Wash sales can occur any time of year, but are most significant near and just after the end of a tax year. The law is based on facts, it does not matter what the intent of the trader is.
In order to fully comply with tax law and still minimize taxes:
  • Consider selling an investment and buying back more than 30 days after the sale. The rule is hard and fast, anything over 30 days does not count as a wash sale, whatever the intent.
  • After selling, buy an investment which may be similar in nature but not substantially identical to the investment sold during the 30 days period. Retail giants Walmart and Target may be similar, but their stocks are anything but identical.
  • Remember, at best tax loss selling is a delaying strategy. The decision to delay recognition of taxable income should take into account the taxpayer’s entire situation.
This article is informational only. Always consult a tax advisor for specific situations and questions.

Home Mortgage Interest Tax Deduction

The United States IRS offers a deduction for home mortgage interest. Does it make sense to buy a home just to benefit on the tax savings or save money on rent?

Renting has been compared to throwing money away. Homeowners can build equity and in the United States, can deduct home mortgage interest off their income taxes.

The Internal Revenue Service allows taxpayers to deduct mortgage interest from adjusted gross income (AGI) on Schedule A. The deduction is limited by the actual amount paid and AGI.
The tax savings may be beneficial, but the way taxes are calculated can reduce the positive impacts.

The Standard Deduction versus Itemized Deductions

One of the key calculations relates to the Standard Deduction. The Standard Deduction is an amount that any taxpayer can subtract from AGI in order to arrive at Taxable Income, without itemizing deductions.

For instance, the Standard Deduction for 2008 returns was $5,450 for single taxpayers and those married filing separately. If Adjusted Gross Income was $56,450, a taxpayer taking the standard deduction would have Taxable Income of $51,000.

However, taxpayers are allowed to take the greater of itemized deductions or the standard Deduction. Itemized deductions are computed on Schedule A and include home mortgage interest, real estate taxes and medical expenses over 7.5% of AGI, as well as other deductions.

Example of Deductions from Taxable Income

For example, itemized deductions on Schedule A may be:
State Taxes - $2,000
Real Estate Taxes - $1,000
Home Mortgage Interest - $2,500
Charitable Contributions - $500
Total $6,000
The taxpayer above would be able to deduct the itemized amount of $6,000. This is an increase of only $550 over the amount they could deduct without the home deductions.

The tax savings are only $550, which is multiplied times the tax rate, which may be 28%. $3,500 in home taxes and interest result in a savings of income taxes of only $154.

For these set of circumstances, it can be seen that there is a very small amount of tax savings generated by the home mortgage interest and tax expense. Rules can be complicated. Individual help is available by phone at 1-800-829-1040.

Positives of Home Ownership

Tax savings are likely to be greater in the first few years of a mortgage, because as the loan is amortized, interest is higher and principal payments are lower then. As more of the principal is paid off, interest, and the corresponding tax savings, are decreased.

There are other reasons for buying a home rather than renting, including the gain in equity from paying principal, and the possibility of appreciation. The mortgage payments can be fixed, as opposed to rent, which can be increased by the landlord (although real estate taxes are subject to increase).

People considering buying a home should take these factors in account and not just assume that buying will generate substantial tax savings. Each person’s situation will be different, and some may find that renting is a better financial choice.

Thursday, January 12, 2012

Excel Help on Arranging Worksheets

The window management functions are located on the Window menu on the main toolbar. Features such as Freeze Panes, Split and Arrange allow users the ability to see all their data at one time and make spreadsheets easier to use.

How Do I Freeze Panes in Excel?

Freeze Panes allows users to always see the titles in a spreadsheet even if there are too many columns or rows to fit on the screen. Click in the cell just after where you want to freeze the sheet.
For instance, if the title for the columns you want to see is in Row 1. Click in row 2 and select Freeze Panes. If you have many columns of data and want to freeze the titles on the left, click in Column B and then freeze. If you want to fix both rows and columns, click in Cell B2.
Excel allows the user to go back and change the data in the frozen cells at any time. Going back to the menu and selecting Unfreeze Panes will return the spreadsheet to its original condition.

Split Windows in Excel to See Information Easier

Splitting is similar to Freeze Panes, but creates multiple windows that the user can move about. The windows are linked with each other, in that if there are two windows side by side, going toward the bottom in one will result in the other window going down as well.
Splitting is useful if you are working with a large spreadsheet, where calculations in one section bring results in another. Split the worksheet so the cell you need to change and the result are visible in different windows. When you make the change, you will see the result without hunting through the spreadsheet.

Arrange Windows in Excel for Easy Use

A little used feature in Excel is arranging windows, located on the Window menu. Excel allows multiple spreadsheets (workbooks) to be open at the same time. Arrange gives the user the option of seeing those multiple workbooks on the same screen. It is important to understand that worksheets are the individual pages of a workbook.

This is useful for transferring data between spreadsheets using copy and paste, or with links. It can function that way the Split Windows command works when calculations flow from one workbook to another.

The choices for arranging worksheets are Vertical, Horizontal, Cascade and Tiled. Tiled is likely the best choice for most uses, but the user can easily test each method for what works best for each purpose.

A related feature is New Window, also in the Windows menu, which allows users to see multiple views of the same workbook, so that each worksheet within can be its own workbook, enabling the use of Arrange to see different worksheets in the same workbook easily.