Five Facts about the Making Work Pay Tax Credit

July 30, 2010

From the IRS (my comments on #3 are below)…

1. This credit – still available for 2010 – equals 6.2 percent of a taxpayer’s earned income. The maximum credit for a married couple filing a joint return is $800 and $400 for other taxpayers.

2. Eligible self-employed taxpayers can benefit from the credit by evaluating their expected income tax liability and, if they are eligible, by making the appropriate adjustments to the amounts of their estimated tax payments.

3. Taxpayers who fall into any of the following groups during 2010 should review their tax withholding to ensure enough tax is being withheld. Those who should pay particular attention to their withholding include:

  • Married couples with two incomes
  • Individuals with multiple jobs
  • Dependents
  • Pensioners
  • Workers without valid Social Security numbers

Having too little tax withheld could result in potentially smaller refunds or – in limited instances –small balance due rather than an expected refund.

4. The Making Work Pay tax credit is reduced or unavailable for higher-income taxpayers. The reduction in the credit begins at $75,000 of income for single taxpayers and $150,000 for couples filing a joint return.

5. A quick withholding check using the IRS Withholding Calculator on may be helpful for anyone who believes their current withholding may not be right. Taxpayers can also check their withholding by using the worksheets in IRS Publication 919, How Do I Adjust My Tax Withholding?. Adjustments can be made by filing a revised Form W-4, Employee’s Withholding Allowance Certificate. Pensioners can adjust their withholding by filing Form W-4P, Withholding Certificate for Pension or Annuity Payments.

For more information about this and other key tax provisions of the Recovery Act, visit

My thoughts:

Because the idea behind the Making Work Pay Credit was to get more money into people’s pockets to spend as quick as possible, the government adjusted employee withholding tables to account for the fact that most individuals would have their taxes reduced by $400 for the year ($800 for joint returns).  However, people with multiple jobs might wind up getting this credit paid to them throughout the year at each of the jobs, resulting in a smaller refund or balance due at the end of the year. This angers some people, but look at it this way. If I decide to give you $800 and then say, oops, I need $400 back because I only meant to give you $400, does it make sense to be angry that you’re now only $400 better off?

If you’re married and both spouses work, or you work multiple jobs, just be aware that you might get a smaller refund by a few hundred bucks, or owe a little more, at the end of the year. Sure, you can adjust your withholding to offset the effect. But is it really worth the trouble just to pay a few hundred bucks now instead of paying it later? Even if you wind up owing penalties for underpayment thanks to this additional amount due (very unlikely), the penalties on the difference are likely to be very small (less than $20). I don’t think many people consider it worth the trouble of worrying about.

Tax tips for members of the military

July 28, 2010

From the IRS…

IRS Drops and Gives You 10…Military Tax Tips

Summer is a busy time for everyone, but particularly for military members and their families. Whether it’s moving to a new base or traveling to a duty station, members of the military have many obligations that could impact their tax situation. Here are 10 IRS tax tips military members should keep in mind this summer to help with filing a tax return next year.

Moving Expenses If you are a member of the Armed Forces on active duty and you move because of a permanent change of station, you can deduct the reasonable unreimbursed expenses of moving you and members of your household.

Combat Pay If you serve in a combat zone as an enlisted person or as a warrant officer for any part of a month, all your military pay received for military service that month is not taxable. For officers, the monthly exclusion is capped at the highest enlisted pay, plus any hostile fire or imminent danger pay received.

Extension of Deadlines The time for taking care of certain tax matters can be postponed. The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended for qualifying members of the military.

Uniform Cost and Upkeep If military regulations prohibit you from wearing certain uniforms when off duty, you can deduct the cost and upkeep of those uniforms, but you must reduce your expenses by any allowance or reimbursement you receive.

Joint Returns Generally, joint returns must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return.

Travel to Reserve Duty If you are a member of the US Armed Forces Reserves, you can deduct unreimbursed travel expenses for traveling more than 100 miles away from home to perform your reserve duties.

ROTC Students Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.

Transitioning Back to Civilian Life You may be able to deduct some costs you incur while looking for a new job. Expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to the start of work at a new job location, and you meet certain tests.

Tax Help Most military installations offer free tax filing and preparation assistance during the filing season.

Tax Information IRS Publication 3, Armed Forces’ Tax Guide, summarizes many important military-related tax topics. Publication 3 can be downloaded from or may be ordered by calling 1-800-TAX-FORM (800-829-3676).

Just a quick note…if you’re working on a military contract, but you’re not actually a member of the military, the non-taxable combat pay rule does not apply to you. Even if your employer says it does. Defense contractors don’t dictate tax law (yet).  However, if you’re out of the US for 330 days in a 360 day period (doesn’t have to all be in one year), then you may qualify for the foreign earned income exclusion that will allow you to treat a little over $90,000 as non-taxable foreign income.

Tax Benefits for Job Seekers

July 23, 2010

Six Tax Benefits for Job Seekers

From the IRS…

Did you know that you may be able to deduct some of your job search expenses on your tax return?

Many taxpayers spend time during the summer months updating their résumé and attending career fairs. If you are searching for a job this summer, you may be able to deduct some of your expenses on your tax return. Here are six things the IRS wants you to know about deducting costs related to your job search.

  1. To qualify for a deduction, the expenses must be spent on a job search in your current occupation. You may not deduct expenses incurred while looking for a job in a new occupation.
  2. You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income up to the amount of your tax benefit in the earlier year.
  3. You can deduct amounts you spend for preparing and mailing copies of your résumé to prospective employers as long as you are looking for a new job in your present occupation.
  4. If you travel to an area to look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the amount of time you spend looking for work is important in determining whether the trip is primarily personal or is primarily to look for a new job.
  5. You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.
  6. You cannot deduct job search expenses if you are looking for a job for the first time.

For more information about job search expenses, see IRS Publication 529, Miscellaneous Deductions. This publication is available on

Just a couple quick comments. On #5, the many people who’ve been unemployed for a considerable period of time currently shouldn’t be concerned about the “substantial break” referenced here. As long as you begin looking for work shortly after losing your prior one and continue looking, you generally shouldn’t have anything to worry about. In general, job search expenses is frequently one of those deductions that doesn’t benefit a lot of people for two reasons. First, you have to itemize to get any benefit from this deduction, which eliminates most people who aren’t paying mortgages. Second, these expenses are only deducted when they (combined with a few other miscellaneous deductions) exceed 2% of your income. So a few hundred bucks in expenses isn’t likely to help. But if you itemize and have considerable job search expenses, this deduction may help you out.

Uncle Sam’s got the best annuity deal going

July 16, 2010

There’s a little known provision to Social Security that’s starting to get some attention (see here, here, and here, for examples). It’s commonly known that you can file for benefits beginning at age 62, but the longer you wait, up to age 70, the higher monthly benefit amount you’ll receive. So the little known provision is that you can apply for benefits at age 62, collect benefits for as long as you like, then re-apply later using Form 521 and get the higher rate. Of course, you do have to repay the benefits you’ve already received (it’s not a total free lunch!), but you don’t have to repay any interest on the benefits you’ve already received and you get to claim a credit for all taxes you previously paid on the Social Security benefits you’ve already received.

I won’t spend a lot of time re-hashing what’s already been said in the articles referenced above. Basically, if you’re 70, in good health, and have enough liquidity that you can pay back the SS benefits you’ve received to date, then essentially Social Security offers by far the best annuity deal going. Essentially, when you repay your SS benefits and start over at the higher rate, you’re buying the equivalent of an inflation-adjusted lifetime annuity with a pay-out equal to the increase in your monthly SS payment.

I did a little comparison shopping on what buying an equivalent lifetime annuity at age 70 would cost, and then (since no similar tool appears to exist anywhere else) I created a spreadsheet that takes your birthday and information about payments you’re currently receiving, and spits out what you’d have to repay and how much this would increase your monthly SS benefit (now available as an online calculator here). The results are pretty amazing.

Comparing the SS repayment option to the closest comparable annuities available commercially shows the SS repayment option will typically yield about a 25-50% monthly premium. As an example, here’s the spreadsheet calculating the repayment amount for a person born in the fall of 1940, who took SS at the earliest possible date, and is now repaying SS in order to collect at the maximum monthly rate upon reaching age 70:

In this example, the person is currently collecting ~$1400 monthly, but after starting over at the new payment level will receive almost $2400 monthly. This will require about $117,000 in prior payments to be paid back. Essentially, for under $120k, this person is receiving a $1000 monthly lifetime annuity that will adjust for inflation.

For comparison, I went to which offers annuity quotes of the best available rates being offered currently for commercial annuities. I got a quote for a lifetime annuity for a 70-year old based on a lump-sum initial investment of $120k. Here’s the result:

While they don’t offer an inflation-adjusted annuity choice, the 3% option closely approximates historical inflation of recent decades (2-3%). Here you see the same investment of $120k in a commercial annuity would yield a monthly payout of $681…not even close to the payout offered through Social Security!

By the way, the date and other figures in yellow in the spreadsheet were picked entirely at random to generate an example of somebody turning 70 soon. It was not picked to maximize the results…the result is fairly typical! Please visit the online calculator and compare the results with commercial annuity quotes yourself. You only have to enter the information in the yellow, highlighted boxes. Everything else will be calculated for you. There are basic instructions in the spreadsheet itself, although I’ll be posting again soon with more detailed instructions. Actually, I’ll probably have this tool available in a web-based format in the next couple weeks.

Find out if it’s worth it for you, and then contact me for details about the tax impact and how you claim credit for all the taxes you paid on SS benefits that you’ll be repaying.

UPDATE: If you downloaded the spreadsheet that was originally posted, it has been replaced with an online calculator. If you’d
like a copy of the original spreadsheet, please contact me.

Top tax filing mistakes for tax software users (part 3)

July 11, 2010

And now for the third installment of the Top 10 tax filing mistakes to look out for…

Since this began as a Top 10 list, and I quickly realized 10 wouldn’t be enough to capture the common errors I frequently see, this third installment is the Bonus 5. These 5 aren’t the result of misunderstanding the tax code, but misunderstanding tax software.

[Bonus #1] Duplicating/missing expenses from 1099’s or W-2’s. Numerous deductible expenses are reported on a taxpayer’s W-2 or 1099 Forms. Sometimes software is clever enough to pick up these items, but then the taxpayer duplicates the item later in the program resulting in an overly large deduction that results in penalties when caught. Other times taxpayers assume the software picked up a deduction when entered through a W-2 or 1099 and doesn’t enter the information later. But if the software didn’t pick up the deduction, the taxpayer winds up missing out on it entirely.

[Bonus #2] Not entering 2a from 1099-R in tax software, or entering $0 instead of leaving it blank. I’ve done a lot of work reviewing returns for people who believe their tax software made an error because something they thought was entered didn’t wind up on the final return, resulting in re-assessments and penalties from the IRS or state tax authorities. By far the most common source of this error is when people enter payments reported on Form 1099-R, but don’t complete Box 2a, Taxable Amount. Sometimes, this box is left blank on purpose to indicate the taxable amount is not known but must be calculated, so people enter $0. A blank in 2a is not the same as $0! And occasionally the bank issuing the 1099-R completes box 2a incorrectly (entering $0 when it should be blank)…but that doesn’t mean the IRS will let you off the hook.

[Bonus #3] Missing carryover items. If you use the same tax software from year to year, this usually isn’t a problem. But if you use new tax software, or if you don’t import your information from the previous year, you might miss very valuable tax breaks that should be carried forward from the previous year. Many very valuable tax breaks aren’t taken all in one year, but instead are taken over a period of years.

[Bonus #4] Self-Employment expenses as employee expenses. One of the advantages to being self-employed as an independent contractor versus being an employee is the tax break for work expenses is much more generous. As an employee, you can only deduct work-related expenses that exceed 2% of your Adjusted Gross Income (AGI), and then only if you itemize deductions. Plus these deductions have no impact on your AGI, so you might miss out on a credit based on a high AGI even though after deductions your income isn’t that high. Independent contractors can take these expenses directly off their income, which reduces AGI, and doesn’t require itemizing. However, some people when using tax software will put their expenses under “job-related” or “work-related” expenses instead of “business expenses” because they don’t realize they are considered a business when self-employed.

[Bonus #5] HSA issues. Frankly, it’s too difficult to describe some of the ways HSA accounts get mangled by people using tax software. But the results are commonly things like being penalized for excess contributions when no excess contributions were made, being penalized for ineligible contributions even though you were covered by a qualifying plan and only made eligible contributions, not getting credit for contributions, and having distributions treated as taxable even though they were for qualifying expenses. My best advice is simply check your completed return from tax software before submitting it, and if you see additions to income, or penalty taxes, that you don’t understand, then get a professional review.

In fact, for all of the common items listed in this series of posts, your best protection is to take advantage of the services of a professional who can offer advice and guidance, along with the peace of mind of having a professional guarantee you’re not making foolish mistakes.

Top tax filing mistakes for tax software users (part 2)

July 9, 2010

This post is the second in a three part series of most common tax mistakes made by people using tax software. Part 1 included the first five common mistakes. Unlike most lists of common mistakes, this list is specifically geared to people using tax software, so you won’t find mistakes that software prevents you from making, but you will find mistakes unique to users of tax software.

5) Not recognizing when tax benefits can give a “domino effect.” Many tax benefits both depend on, and effect, your Adjusted Gross Income. A common example is IRA deductions, where making a contribution can not only reduce your taxable income, but also make you eligible for an additional credit for making the IRA contribution. By not fully appreciating how taking a particular deduction or credit can affect other deductions and credits, taxpayers often miss out on tax breaks because they only considered the first effect (first “domino”) of a particular decision.

4) Not deducting real estate taxes or car sales tax. Many people with a small mortgage (or none) realize they don’t have enough deductions to itemize, so they’re better off just taking the standard deduction instead of listing individual deductions. However, beginning in 2008, taxpayers have been able to increase their standard deduction by adding in the amount of real estate taxes paid and (in 2009) the amount of sales tax paid on a car.

3) Not maximizing tax benefits from education expenses. Since there are literally over a dozen ways to receive tax benefits from education expenses, it’s not surprising that many people with education expenses fail to find the optimal way to use these benefits. Most software does a pretty good job of comparing the most common benefits, but there are additional strategies too complex for tax software that can save you hundreds, and sometimes thousands, of dollars.

2) Not filing because you can’t pay. Many people don’t file because they don’t think they can pay the tax due. But the penalties for not filing on time can be as much as ten times greater than the penalties for not paying on time. Submit your taxes on time. File an extension to get them done if you have to. The penalties and interest can be over 5% of the amount due per MONTH if you don’t file, but if you file you have numerous options to pay off the balance over time with much lower penalties.

1) Paying tax on state refunds. State refunds are only taxable if you received benefit from deducting state taxes in an earlier year. For most simple returns, your tax software can determine this for you if you use the same software year after year. But often taxpayers don’t know how to figure out whether or not a state refund is taxable, so they just report it as income and pay tax on it…often unnecessarily.

That’s it for the top ten tax mistakes. The next post is five additional errors specifically related to the way people use tax software. In my work supporting tax software users, I’ve seen certain mistakes in the way people use tax software are quite common, and the next post will cover them. Continue…

Top tax filing mistakes for tax software users (part 1)

July 7, 2010

This post and the two that follow will address the most common mistakes made by people who prepare their own returns. The IRS has published a similar list that is widely published. However, this list is specifically geared toward people who use tax software…so some common mistakes on the IRS list like using the wrong mailing address or forms are not relevant. I’ve focused on the mistakes we most commonly see when reviewing returns for people who have used popular tax software programs.

The result is a Top 10 list of most common tax mistakes that can affect all taxpayers, plus 5 bonus items that specifically affect people using tax software. If you’re doing your own taxes, you do yourself a big favor by looking out for these common mistakes.

10) Failing to get the maximum Homebuyer Credits. This one is surprisingly common for a situation that only affects certain taxpayers who bought homes in a relatively short period of time. These mistakes are especially troubling because the amounts involved are quite large, typically several thousand dollars. Two common mistakes are often made. One, taxpayers think they can’t claim a homebuyer credit based on income, even though their income qualified in the previous year. One of the provisions of the credit is you can actually claim the credit on the previous year’s return by amending that year’s return. The second common mistake is many non-married individuals often don’t realize that if they purchase a home together, they can split the credit however they want. So if only one person qualifies for the credit, the other person can claim the full $8,000, not just half of the amount.

9) Not using insolvency exclusions for canceled debt. Beginning in 2008, we’ve been seeing a lot of 1099-C’s from people who’ve had debt canceled. Often they’re unaware of all the different ways they can exclude the amount on the 1099-C from being treated as income. This is another one that can easily cost thousands.

8 ) Not using retirement account penalty exceptions. People who’ve had to take an early withdrawal from a retirement account often qualify for one or more of the penalty exceptions to avoid the 10% non-qualified distribution penalty. Often taxpayers aren’t made aware of the possibility they may qualify when they take the distribution so they don’t even investigate whether or not they qualify.

7) Filing separately when married. While there are a few (very rare) instances when filing separately can be advantageous, many couples, particularly newly married couples, file separately simply because it’s more convenient. In most cases, this will be a costly mistake worth far more than the inconvenience of both spouses getting their tax information together at one time.

6) No basis/wrong basis used for employee stock sales. Usually when stock is sold from an employee stock plan, the gain from the transaction is treated as ordinary income and included in your W-2. However, many people report the gain a second time as part of the stock sale associated with the transaction. Because the gain was recognized as ordinary income, the basis will nearly always be equal to or greater than the proceeds, resulting in no gain. Instead, many people pay tax twice on the same income.

Continue to the next 5 common mistakes.