Archives For income taxes

Uncle Sam says,        With tax time fast approaching, I thought it might be a good idea to share a tax tip with you all that I’ve found useful for my clients. By combining a Traditional IRA deduction with the Retirement Savings Contribution Credit (sometimes called the Retirement Saver’s Credit), you can reduce your taxes by quite a bit after the tax year has ended because you don’t have to make IRA contributions until April 15. You may be able to reduce your taxes (and increase your refund) by up to $2,000 with this tip.

This tip works because the size of the credit increases as you reduce your adjusted gross income (AGI). Making a deductible Traditional IRA contribution lowers your AGI. Depending on your income, you can make yourself eligible for the Retirement Savings Contribution Credit or increase the amount of your credit. Here’s what you need to know.

The Drawbacks

This tip won’t work if you’re under 18, a full-time student, or can be claimed as a dependent on someone else’s tax return. Those are basic requirements for the Retirement Savings Contribution Credit. If any one of those apply to you, this won’t work.

Additionally, this tip only works at lower incomes (and it works best at very low incomes). The problem here is that people with low incomes often have a more difficult time contributing to retirement accounts. Here are the adjusted gross income limits for 2010 before counting the IRA deduction:

  • Single or Qualifying Widow(er) – $32,750 ($33,750 if you’re 50 or older)
  • Head of Household – $46,625 ($47,625 if you’re 50 or older)
  • Married Filing Jointly – $65,500 (up to $67,500 if you’re both 50 or older, $66,500 if only one of you is 50 or older)

This tax move doesn’t work if your filing status is married filing separately because the phaseout range for a deductible IRA contribution is so small.

Finally, the Retirement Savings Contribution Credit is not a refundable tax credit. This means it will only reduce your tax liability to $0 – beyond that it won’t get you any extra money. That doesn’t mean it’s useless though. If you have other refundable tax credits, this tax tip could increase the refund you get back from those credits because it reduces your tax first.

How to Do It

Assuming you meet the requirements, your income isn’t too high, and you have some tax due, the next thing you’d want to figure out is how much you should contribute to an IRA to get the most benefit from the Retirement Savings Contribution Credit. You’re going to need to do a little math to figure this out, including considering ira rates. Alternatively, you can just do your tax return several times using different IRA contributions to see how things work out.

If you’re going to figure it out manually, you’ll need to first look at your tax due to figure out how big of a credit you need. On Form 1040, you’ll find your tax due on line 60. As I said before, the Retirement Savings Contribution Credit isn’t refundable, so you only need a credit as large as your tax due. Any more than that is useless.

Once you know the maximum amount you’d need from your credit, you’ll want to figure out how much of a credit you can get. There are two things you need to keep in mind. First, the Retirement Savings Contribution Credit is calculated as a percentage of your retirement contributions. But the credit is only calculated on up to $2,000 in contributions (or $4,000 if you’re married filing jointly – $2,000 for each of you). Second, the percentage depends on your adjusted gross income (after your IRA deduction) according to the table below. You can also find this information on Form 8880 – Retirement Savings Contribution Credit.

Filing Status 50% Credit 20% Credit 10% Credit
Single or Qualifying Widow(er) up to $16,750 $16,751 to $18,000 $18,001 to $27,750
Head of Household up to $25,125 $25,126 to $27,000 $27,001 to $41,625
Married Filing Jointly up to $33,500 $33,501 to $36,000 $36,001 to $55,500

So let’s say you’re single and your AGI is $30,000. You wouldn’t qualify for the Retirement Savings Contribution Credit unless you make a deductible IRA contribution of at least $2,250 to bring your AGI down to $27,750. That would get you down to the 10% credit range. Your credit would then be $200 (10% of $2,000). It doesn’t matter that you contributed $2,250. The credit is only calculated on the first $2,000 of your retirement contributions. But you might have to contribute more than $2,000 to make yourself eligible.

Want to see a more exciting example? Let’s say you’re married filing a joint return and your AGI is $37,500. As you stand now, you’d be eligible for the 10% credit on any retirement contributions you’ve made (this credit includes 401(k) plan contributions and similar accounts). But by making two deductible IRA contributions – $2,000 for you and $2,000 for your spouse – you can bring your AGI down to $33,500. This makes you eligible for the 50% credit and would lower your taxes by $2,000 ($4,000 * 50%). You just made a $4,000 contribution to your retirement accounts at a net cost of $2,000! I’d say that’s a good deal.

I like this tax tip because I’ve seen it work for myself and many others quite well. There are a few other aspects of this tip that I didn’t cover here, but I’ve given you enough info to get started on it. It’s a great way to boost your retirement savings while reducing your taxes – sometimes by quite a bit!

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Is this the face of a tax evader?       So I was studying for my enrolled agent exam the other day and came across an interesting bit of information that I doubt many people know. If you host a sales party or product party (the kind that Pampered Chef, Tupperware, and others like them depend on), then you’re legally required to include any gift or gratuity you receive in your income. Here’s what the IRS says:

       If you host a party or event at which sales are made, any gift or gratuity you receive for giving the event is a payment for helping a direct seller make sales. You must report this item as income at its fair market value.

       Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2%-of-AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.

From the Other Income section of IRS Publication 17

       I have a feeling the IRS is missing out on tons of revenue due to all the under-reporting that happens as a result of these parties!

What Happens If You Don’t Tell the IRS?

       Now, obviously, the IRS isn’t going to lock you up if you forget to include this income on your tax return. But if you are audited and the IRS agent can somehow figure out that you hosted such a party and received cash or items for hosting, then you will have to increase your income, pay additional taxes, and possibly pay a 20% tax penalty.

       But now you have a problem. You know about this tax rule and you should follow it. That’s going to sound ridiculous to some people, and I’m not saying our current tax system is great or makes sense. But as Christians, we must follow the laws of the government that is over us unless those laws would force us to act contrary the laws of God. This is a matter of conscience and our witness to the world – not an issue of whether the law is stupid.

       I doubt income tax laws will ever cause us to violate God’s commandments, so our aversion to an admittedly silly law is mostly because we don’t want to do it. And that’s not a very good excuse (and not one the IRS will accept either!). So as crazy as it sounds, we ought to follow these laws and report our income accurately as the IRS requires.

What Do You Think?

       I know most of you will think this is a dumb rule. I agree with you. But it’s still a dumb rule we ought to follow. My question is this: Now that you know, are you going to report this income on your tax return? Let me know in the comments below!

P.S. I’m not going to report you to the IRS either way…I just thought it would be interesting to discuss!

photo credit: (Athenamama on Flickr)

This post was included in the Carnival of Financial Planning.

What Is an Enrolled Agent (EA)?

Corey —  October 18, 2010 — 3 Comments

What Is an Enrolled Agent (EA)?       After hemmin’ and hawin’ about it for a while, I finally signed up to take the exams to become an Enrolled Agent. I’m excited about it (and a bit nervous), but I’m guessing most of you have no idea what I’m talking about. That’s because I didn’t even know what an Enrolled Agent was until I had a couple years of experience doing taxes and working as a financial planner. So here’s a basic overview of what an Enrolled Agent is and why I decided to become one.

What Is an Enrolled Agent (EA)?

       An Enrolled Agent is a person who has been authorized to represent taxpayers (without the taxpayer’s presence) before all administrative levels of the Internal Revenue Service (IRS) for audits, collections, and appeals. They aren’t restricted on which taxpayers they can represent and what types of tax matters they can handle.

How Is an Enrolled Agent Different from Other Tax Preparers?

       Until 2011, Enrolled Agents are the only tax preparers required to demonstrate their competence in tax matters to the IRS. (This is changing – see my note in the section below on why I decided to become an EA.) Attorneys and CPAs may or may not specialize in taxes, but all EAs specialize in taxation. They’re also required to fulfill continuing education requirements by law – at least 72 hours every three years. While CPAs have continuing education requirements for their license, the courses EAs take must be related to Federal tax laws. CPAs often take courses on a variety of topics not related to taxes.

       Unlike other tax preparers, Enrolled Agents (along with CPAs and attorneys) can represent taxpayers before the IRS even if they didn’t prepare their return. This is important because these other tax preparers can’t represent a taxpayer before appeals officers, revenue officers, or IRS Counsel. A tax preparer must be an Enrolled Agent, CPA, or attorney to do that. Also, an unenrolled tax preparer cannot execute claims for refund, receive refund checks, execute consents to extend the statutory period for assessment or collection, execute closing agreements, or execute waivers of restriction on assessment or collection of a deficiency in tax.

How Do You Become an Enrolled Agent?

       There are two ways to become an Enrolled Agent. You can pass a three part exam (called the SEE or Special Enrollment Examination). The three parts cover individual taxes, business & other entity taxes, and representation, practices, and procedures. Each part of the exam contains 100 questions. It’s a very comprehensive and difficult exam. Here’s a list of the documents the IRS recommends reviewing before taking the exam.

       The other way to become an Enrolled Agent is to work for the IRS for five years in a position that regularly required you to interpret and apply the tax code and its regulations. Regardless of which method you choose (exam or IRS work experience), you have to undergo a thorough background check on both your criminal history and your personal tax filing history. You can be sure you’ll be denied if you didn’t file, didn’t pay your taxes, or filed a fraudulent return. (You’d think they would have run this kind of check on Timothy Geithner before Obama nominated him to become the Secretary of the Treasury!)

Why I Decided to Become an Enrolled Agent

       I have three main reasons I decided to become an EA. Here they are:

  1. Provide Better, Higher Quality Service – I didn’t want to be in a position where I couldn’t represent my tax clients if they had an issue with the IRS that involved appeals or collections. Becoming an EA ensures that I can help my clients no matter what tax issue comes up. (Except for going to court – you need an attorney for that.)
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  3. Strengthen My Tax Knowledge – Taking the Enrolled Agent exams requires you to carefully study all aspects of Federal taxes. I’m familiar with most individual tax issues and some business, trust, and estate issues, but there’s still quite a bit that I’m not 100% comfortable with. Passing the exam won’t magically make me an expert, but it, along with the continuing education requirements, will ensure that I have a more complete and deeper knowledge of Federal taxes.
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  5. Upcoming IRS Requirements for Tax Preparers – Starting in 2011, the IRS is going to require all paid tax preparers (except EAs, CPAs, and attorneys) to register, pass a knowledge examination, and complete continuing education. The test likely won’t be as difficult as the EA exam, and the continuing education requirements aren’t as stringent either. But these tax preparers will still be limited in which taxpayers and tax matters they can represent before the IRS. It seemed to me that it would be better to just become an EA in the long run.

       Obviously, I’m not doing it for the marketing advantage as I’ll probably spend the rest of my professional life explaining what an EA is. But that’s OK with me because I know it’s valuable and will help my clients.

       Well, now you know what an EA is. What do you think? Sound like it was a good thing for me to pursue?

photo credit: (Alan Cleaver on Flickr)