The phone is ringing off the hook now. Mid-March is the sweet spot for Americans to do their income taxes. It’s that time when everyone thinks they are “early” and yet, they are right in the middle of the pack, right with most other people plodding along with TurboTax or schlepping down to a CPA or even popping into see the guy in the kiosk inside the local Wal-Mart. The truth is, the people who wait until April 15 are actually the minority, among my clients at least. The reason is simple. Anyone who CAN’T do their taxes until April files for an extension (you get one automatically without even having to give a reason.) Anyone who can do their taxes, doesn’t wait until April 15 is breathing down their neck. After all, there is procrastinating, and then there is procrastinating. It takes a top-level procrastinator to wait until they are writing dates that start with “4”.
The number one question? The same thing it is every year. “What can I do about my taxes?”
Ironically, every single one of my clients thinks they are “getting killed” on their taxes. After all, America isn’t cheap. Most of my clients sit firmly above the 28% tax bracket. Think about it. Twenty-eight percent! You want to ballpark the math? Easy. Take what you earn. Now, figure out what 1/3 is. (Divide by 3). That’s what you owe Uncle Sam. The top three tax brackets all ballpark out about the same (28%, 33%, 35%).
Of course that isn’t remotely true. People in the 28% tax bracket don’t pay 28% on all of their income. They pay 10% on the first 16 grand (married filing joint) then they pay 15% on the next 49 grand and so on and so on. Plus there are the deductions. They knock a little off the top. So at the end of the day, no one pays 1/3 after all. But it still is a LOT of money. Which is why the law requires you to pay out of each and every paycheck. Can you imagine how many Americans couldn’t pay their taxes if they had to come up with $10,000 on April 15? If the government actually cared about you they would make you do the same thing with your 401(k). Of course, they can’t do that because they are already supposedly helping you take care of your retirement with that huge 7.5% cut they take from each and every paycheck. Oh you forgot about that? Everyone does. In fact, you don’t just pay your 7.5%, your employer pays 7.5% too. Which is why taxes are so high for the self-employed. Since you are both the worker and the employer, you have to come up with the whole 15%! I won’t remind you how this nice big chunk of your hard earned dollars gets flushed down the toilet each time you get paid. Plus sales tax, and state taxes…well, maybe that 30% isn’t too far off after all, but there aren’t any deductions for those other parts.
But, I digress. Back to the topic at hand. What can you do about your taxes? The phony spreadsheet answer pushed by journalists and know-it-alls that you are seeing all over the place with snazzy headlines like: Top 10 Tax Breaks You Might Have Missed, or Top 10 Ways to Save on Your Taxes (why is it always 10?) is that there are tons of deductions out there. All you have to do is find them. Go ahead, read the article. Read another one. Did you find any? Didn’t think so.
The real world answer is that if you earn most of your income from a job, you don’t really have any way to lower your taxes. When I tell people this they push their eyebrows down and frown a little bit. One of the great myths perpetuated about taxes is that there are tons of tax deductions and all you have to do is know the inside secrets (sounds a little like those investing books doesn’t it?). But, here is the real deal. You get to deduct the interest on your mortgage and if you don’t make too much money you can deduct the interest on your student loans. If you are in college you get to deduct some of those expenses (but not any paid for by scholarships). You get to deduct a certain amount of the taxes (income or sales, but not both) that you pay to the state you live in. You get deductions or credits for your children and what you pay for their childcare, but I don’t recommend to my clients that they have more children to reduce their taxes. I haven’t seen any Harvard studies yet, but I’m pretty certain it costs more to raise a child over the course of a year than you save on your taxes. You get to deduct the money and goods you donate to charity. And, if you want, you can deduct money contributed to an IRA as long as you don’t make too much money or if you work somewhere where you don’t get a retirement plan (which will cost you more in the long run than the deduction on the $4K is going to save you). That is pretty much it.
What is that? You can think of a bunch of other deductions? You read some in that Top 10 article? Here comes the harsh slap of reality.
Those medical expenses you can supposedly deduct? That article you read had a nice long list of things you can deduct. But, what they mentioned in one sentence at the end could have saved you from reading that list at all. You can only deduct the amount your medical expenses exceed 7.5% of your income. So if you make $100,000 a year, you can only deduct the amount you paid over $7,500. But wait, there’s more. You can’t count any money that you paid with a medical flexible spending account. Why? You didn’t pay taxes on that money already, and you can’t double dip. So, if you put $3,000 into your flex account, you actually have to have paid over $10,500 to deduct anything. It takes some crummy insurance, or a very big health problem to hit that kind of number. Even if you do, remember that doesn’t mean you get to deduct all of it, only the amount OVER. So if you had $12,000 in medical bills in our example above, you can deduct $1,500.
What about those other deductions? Deduct what you pay to have your taxes done. Deduct the cost of those professional fees, and certificates. Have to buy your own uniforms? That’s deductible. These deductions will make up 5 of the Top 10 you’ll read about. The 3 basic categories are unreimbursed business expenses, tax preparation fees, and “other” expenses. “Other” expenses are fairly rare and generally involve suing or being sued. Tax preparation fees count. Sounds good. And unreimbursed business expenses? Got some of those. But wait, there is another floor. These expenses are all subject to a 2% floor. It’s a lot lower than the medical expenses, but unless you took some sort of class chances are you won’t hit it. 2% of $100,000 is $2,000. They charge you $150 a year to be a member of your professional association. There is a professional magazine subscription you have $55 a year. Maybe you bought a couple of uniforms that’s $150. What about those classes you are taking at the local college? Careful. Those might not be unreimbursed business expenses, especially if they lead to a degree, and especially if that degree isn’t exactly related to your job. You accountant charges you $250 to do your taxes and where are we? Anywhere near $2,000? Even if we scrape together enough to hit the $2,000, only the amount over it is deductible.
Now you’re pretty much done. All that time you spend in TurboTax or collecting receipts is wasted unless you hit those two floors. Everything else except for the deductions with phase-outs (you get less and less until you get nothing if you make too much money) is pretty straight forward. So where are all the deductions? Where do you think? Rich people get a ton of them. People with lobbyists? Yep, they get some too. Poor people? Yep, they get some, of course they don’t pay much in taxes, so nobody really notices.
About the only tax break I can ever surprise people with is to remind them that they can deduct the part of their car registration that is based on value. (You can deduct the part that is a percentage of what your car is worth, you can’t deduct any of the flat charges.)
Your only shot at having any tax deductions other than the basic ones is to own your own business, and then you need to talk to your accountant not me. Otherwise, like I tell all my clients. The best thing you can do is get your withholdings right. Have you ever noticed that election day is nowhere near tax day? Coincidence?
What about all of those ways I can save money on taxes with my investments? Sure, there are lots, but how much of your income is from your investments. If we’re having this conversation, the answer i
s probably not enough. But, if you ever get to the point where those dividends that your stocks are paying, and those interest payments on your bonds are just killing you on taxes, we can talk. Until then, I’m not sure that the $400 your IBM stock paid this year is the problem.