01 Feb The Myth of the Great Tax Refund (and other helpful tax tips)

Have you ever heard someone brag about the size of their tax return? Or have you yourself ignorantly boasted of the riches coming to you from our great government. There are many misconceptions when it comes to taxes and tax returns. Being as it is that time I thought I would shed some knowledge on the situation. Now, I am certainly no tax expert, and if you have a complex situation I always recommend going to an accountant for your taxes.
Check out Dave Ramsey’s ELP (endorsed local provider) for your area if you want a good one.

Before I forget let me make a list of the things I want to cover.

  1. The Tax Refund Myth
  2. Deduction vs Credit vs Write-offs and the great mortgage debate
  3. Itemizing vs Standard Deduction
  4. Education Credits
  5. I had a good topic and I forgot, maybe I will remember by the end of the article

1. The Tax Refund Myth

This one gets me every time. Everyone has that friend (or it might be you) who loves tax time because they get a huge check from the government that they usually go blow on something stupid. Sometimes these geniuses think this is free money from the government just because they are so awesome, and sometimes they understand why they are getting it but just dont care about being smart with money. Understand this, when you get a refund it simply means you paid too much to begin with, so essentially you gave the government an interest-free loan for the year of your own money, and then they just give it back. So basically if you get a $2400 tax return that is an extra $200 a month you should have been receiving in your paychecks. You could have used that money to pay down debt, or build an emergency fund, or whatever you wanted. Much easier to save up and pay cash when you have your whole paycheck to use.

So I guess if your the type of person who will foolishly spend any extra money you have, and this is the only way you can save money, then I guess keep doing what your doing (Or start being a grown up and learn to tell yourself no). But if you would responsibly use the extra money every month, then simply adjust your w-4 and add withholdings. For example instead of claiming 1, claim 3 or 4 (of course this depends on what credits you anticipate having, how many children you claim, and other factors).

2. Deduction vs Credit vs Write-offs and the great mortgage debate

People often use these terms incorrectly or interchangeably. Lets just define these clearly.

Deduction-This reduces your taxable income. For example if you earned $40,000 and you invested $2000 into an IRA, then you would now have $38,000 of taxable income, but it would not decrease your taxes by $2000.

Credit– This is a dollar for dollar return, so if you recieve a $500 credit for buying energy star windows, then the amount you owe in taxes is decreased by $500, or the amount you will recieve will increase by $500.

Write-off– You often hear people saying “its a tax write off”, what is a tax write off? Well its a type of deduction, but it may not reduce their taxable income by the amount spent. For example when a business person goes out to eat with a client, typically the 50% rule is in place, they can deduct half (the clients portion) of the meal.

The Great Mortgage Debate and 3. Itemizing vs Standard Deduction

This goes a long with my next topic. How many times have you heard people say they bought a house for the tax benefit? Or someone tell you never to pay your house off because of the tax savings. So should you pay off your house? YES! Heres the facts, you do get a deduction for the interest you pay on a mortgage. For example, if you have a $125,000 loan at 6.75% you may pay around $7500 in interest in a given year. This amount would be deducted from your taxable income. However, this deduction can only be taken if you itemize, it can not be in addition to the standard deduction. So if the total of your other deductions does not exceed the standard deduction, then it did you no good to have that mortgage. And many people who say that often use standard deductions and dont even realize what they are saying is so wrong. And heres the real kick in the pants, even if you itemize and get that $7500 deduction, you only save the amount you would have been taxed on that $7500. So if you’r in a 20% tax bracket, you saved $1500 on your tax bill. So let me get this straight, I should keep my mortgage forever so I can avoid paying $1500 in taxes but pay $7500 to the Bank? Pay your house off and free that $1000 a month to invest!

4. Education Credits/Deductions

I know several people who did not know about the education credits (another reason it may be worth it to use a competent professional to do your taxes). If you pay for your tuition or books, or sometimes it can include transportation and other expenses, then you may be eligible for such credits as the Hope Credit, Lifetime Learning Credit, and the American Oppurtunity credit. Learn more here http://taxes.about.com/od/deductionscredits/qt/education.htm. You may be entitled to several thousand dollars! If you think you would have qualified for these in the past, talk to an accountant, they may be able to refile and get you those credits.

5. I remembered-The going to jail for not paying taxes myth

I want to make clear that it is not illegal to not pay your taxes, it is illegal to not file, or to falsely file. If not paying debt was a criminal offense, half of America would have been locked up at some point in their lives. If the government finds out you havent filed your taxes in 10 years, that is a criminal offense and then you could go to jail for it. It would be more likely that they would force you to file and take care of it, however, if you filed false returns to avoid paying taxes then that is tax evasion and you are much more likely to see prison time.

I hope some of this information has been helpful, and for the record I use turbotax, very simple and easy to follow.

Message to Claire:  Although you changed our monthly budget, it certainly isn’t as damaging to our finances as some people make it out to be. In fact we have to thank you for the tax credit you got us this year. I don’t want to make all of these messages long, so I will make this one short and sweet. No matter how rich and famous your parents are (I’m just making a bold prediction here), that doesn’t mean you can act like a spoiled brat. This will mostly be our job as parents to keep you grounded assuming we do end up being successful. For example, when we have enough money saved in your ESA to send you to college, that doesn’t mean you get to slack off and take it for granted. Our hard work and saving for you for 18 years needs to be appreciated (it’s not our obligation to pay for your college), so do us proud and be a grounded, gracious person. I’m sure you will be.

Here are a few links to some articles I found today:

Another Tax article

http://20somethingfinance.com/2010-tax-guide/

Article on how to save money

http://www.mint.com/blog/goals/setting-goals-02012011/

How to reduce household energy expenses

http://www.2millionblog.com/2011/01/reduce_household_energy_expenses_1.html