Being a tax consultant and preparer for over 20 years, I can tell you that there have been a number of times that I've had clients who were surprised by how much they money they owed at tax time. Why did they wind up owing so much money? There are numerous reasons. What it all comes down to tax planning or the lack of.
Tax planning is very similar to financial planning. It involves taking a close look at your tax situation from one year to the next. People who have financial investments are always checking with their financial advisors to improve their financial situation. If you're going to check with your financial advisor, you should also check with your tax advisor and so see how your financial investments are going to affect your taxes.
Tax planning is not only for those people with financial investments. Tax planning is for everyone, especially if you're undergoing financial changes that could affect your tax situation. Some of these financial changes could be the purchasing of a home, it could be the purchase or sale of rental property, it may be the withdrawal of money from a retirement account, or it may be starting a business. Anyone of those financial changes as well as others could significantly affect your tax situation.
The best time to check with your accountant is before you take any kind of financial action to see how it could affect your taxes. Many times people call their accountant after the fact. That's like closing the door after the horse has left the barn.
There are two things that I always tell my clients. First, I always tell them if that if they have any tax questions to call me. The second thing I tell them is if they are going to do anything that they think could affect their taxes to contact me.
Why is it important to check with your accountant before you do something? It's important because your accountant can advise you of the tax consequences of your actions. They can analyze your tax situation and tell you what action to take so you don't get caught owing a lot of money at tax time.
Here's a story that I always tell my clients to emphasize this point. Several years ago I had a client who took money out of retirement account (which was fully taxable) in late December. I was not aware of this action until he came to see me at tax time. As a result, he ended up owing a lot more money than he anticipated.
I told my client that I wish he had consulted with me prior to making the withdrawal, because I would have advised him to wait until January to take the out the money. Why should he have waited? By waiting until January, the money he withdrew would not have been taxable until the following year. By waiting a few weeks to the next year, we could have done tax planning on ways to reduce his taxes during the year and save him some money. This is why it's important to consult with your accountant during the year.
Tax planning is also important when it comes to paying your taxes. Many people are under the assumption that they have until April 15th to pay their income tax. That is not entirely correct. April 15th is date when your taxes must be paid in full.
The law requires that you pay your taxes as your earn the money during the year. For those of you who are paid as employees, you have your taxes withheld from your paychecks. Your employer withholds the income tax from your paycheck and he pays that money to the government throughout the year. However, for those of you who are self-employed (work for yourselves) or have passive income from investments, you may be required to pay your taxes during the year by making estimated tax payments.
What are estimated tax payments? Estimated tax payments are quarterly tax payments made throughout the tax year (January through December). The law requires that you make an estimate of your tax liability and pay it as you go during the year. The tax laws require that you make your payments on April 15th, June 15th, September 15th and January 15 (of the following year).
The tax laws allow you to base your estimate on your prior year's tax. If you income is basically the same year after year you can do this. However, if your income and tax situation changes from year to year you should consult with your accountant when it comes to estimating your taxes. The IRS has a publication on Estimated Income Tax, it's Publication No. 505 and you can download it for free from the IRS website, http://www.irs.gov.
Tax planning should be done during the year. It should be done by those of you who are self-employed or have passive income from investments, because your income can fluctuate from year to year. For those of you who undergo any financial changes which could affect your tax situation during the year, you should consult your accountant or tax advisor. Tax planning is important because can save you quite a bit of money come tax time.
The Author: Larry Zinamon has been involved with taxes for over 35 years. He is a registered tax preparer and authorized e-filer with the IRS. Larry has had his own tax consulting and preparation business for over 20 years. Prior to starting his own business, Larry worked for the IRS. During his 14 years with them, he worked as a Revenue Officer, Taxpayer Service Specialist and Tax Examiner. Within the past couple of years, Larry has been doing some network marketing.
By: Larry Zinamon
Friday, June 14, 2019
Sunday, May 12, 2019
Taxes: A Suggestion for Ethical Reforms
What is the best tax policy? Most might answer one that taxes them less and others more.
Now that answer falls apart on its own logic, since if applied to everyone, there would be no "others" to tax more. But the answer does bring up a point. The fairness and utility of taxes - and fairness and utility are key ethical concerns - those items are often in the eye of the beholder. So as I described in a companion article ("Taxes: A Calculation in Ethics") establishing an acceptable, and ethical, tax policy involves blending perspectives from across the social and economic spectrum to achieve a common consensus. Almost by definition no one individual can determine the optimum solution.
So, being consistent with my own words, I will add to that blending process by offering a few suggestions of my own.
Principles
What are the goals of a good, dare say ethical, tax policy? Here is what I would say. Taxes should be 1) fair to the individual, while they also 2) promote the general welfare, and 3) augment economic performance. They should also 4) gather sufficient revenue for the government we desire, and 5) be simple, efficient and minimize evasion.
How do I think we best accomplish those goals? Certainly a complete discussion could run not just a number of pages, but a whole book, or several books. But here would be a few ideas.
Credits verses Deductions
Like it or not, America uses taxes to promote social welfare. We promote home ownership by allowing deduction of mortgage interest; we subsidize state and local governments through the tax exclusion for municipal bond interest; we support non-profit institutions through charitable deductions.
Many an argument has been made over what should or should not be excluded or deducted from income for taxes purposes. I won't add to that here. Rather, the focus here is on the manner in which these exclusions or deductions are applied.
For deductions (like home mortgage interest) or exclusions (like municipal bond interest) we apply them as offsets to income, not to the income tax. Deductions and exclusions lower taxable income.
What is the ethical implication? Higher income individuals, in higher tax brackets, receive a greater benefit than the much larger group of individuals in the middle and lower brackets. A wealthy person donates several thousand dollars to their faith, they save twenty to thirty cents on the dollar. The everyday person donates an equivalent amount, they save either nothing, or maybe ten of fifteen cents on the dollars.
By what mechanism do upper income individuals receive greater benefit? First, obviously, upper income individuals are in higher tax brackets, so each dollar excluded or deducted saves a higher percentage. Second, there is the standard deduction. Higher income individuals most often exceed that standard amount, and thus their deductions actually reduce their taxes. Moderate and lower income individuals generally do not have sufficient deductions to exceed the standard amount. Thus, when they give to the church, or the local food bank, or make some expenditure that is deductible, those contributions or deductions save them nothing.
My suggested remedy would be to change deductions and exclusions into credits. Deductions and exclusions would no longer lower taxable income, but rather directly lower taxes, i.e. they would in whole or part become a direct credit against taxes. Thus, if one gives a dollar to charity, taxes are reduced the same regardless of income. If one receives a dollar of municipal interest, the tax savings are the same for everyone.
Minimum Tax Rates
A related step, for fairness, would be minimum tax rates. As income rises, the ability of individuals to participate in tax favored activities increases. Take the mortgage interest deduction. A good percentage of average income individuals might need to rent, while the wealthy can more likely buy a large home. Thus, while under the above "deductions become credits" approach above, mortgage interest credits would benefit all incomes equally, the average person has less financial ability to actually buy a home, much less a large home, and thus take advantage of the "deduction becomes credit".
The approach for this, to maintain fairness, would be a minimum tax. Such a minimum tax would say that when all is said and done, an individual must pay a minimum percentage in income taxes. This would apply to one's straight income, all sources (I would allow the personal exemptions, but that is all), regardless of credits, or anything else.
Credits and Minimum Tax Rates
How would these two ideas work together? Let's take a simple example.
For our example, our regular tax rate will be 25 percent for income above $75 thousand, and our minimum tax rate for the same bracket will be 15 percent. In terms of credits, an individual can take a credit against taxes equal to 50% of eligible expenditures, i.e. the items that are deductible or excluded today, for example charities, mortgage interest, extraordinary medical expenses, municipal interest, and so on.
Let's now take an individual making $175 thousand, with $30 thousand in eligible expenditures. The income amount in the 25 percent bracket is $100 thousand, i.e. $175 minus $75. The regular tax on that amount is $25 thousand (i.e. 25 percent of the $100 thousand), and the credit is $15 thousand (50 percent of the eligible expenditures, which amount to $30 thousand). So the tax, so far, is $10 thousand (i.e. $25 thousand minus the $15 thousand credit).
But we have a minimum tax, set at 15 percent for the bracket, and 15 percent of $100 thousand is $15 thousand. The individual would pay no less than $15 thousand.
Below $75k, our regular tax rate for this example will be 10 percent, and the minimum 5 percent. We will also have a $10K per person exemption. A person earning $40K, married, would pay $2 thousand in taxes before credits; that is $40 thousand minus the exemption for two people, leaving $20 thousand, times the 10 percent. The minimum tax would $1 thousand. The couple rents, so has no mortgage interest deduction, but gives a thousand dollars to the local church. Under current tax regulations, the couple receives no benefit, but if deductions were turned to credits, that contribution would save the couple $500 dollars in taxes, off the $2 thousand.
Our turning deductions into credits thus spreads out the base of individuals who benefit from tax advantaged expenditures, and the minimum rates prevent any one individual from excessively benefiting from the credits.
Abolition of Cash
An unavoidable part of taxes is that individuals seek to avoid them. Each of us actually becomes part of that when we pay a contractor in cash to receive a reduced price, or pay for a restaurant meal and tip with cash. We suspect, and in cases we are correct, that the cash payments are not fully reported for tax purposes. Significant amounts of transactions occur on a cash basis, and some percent, maybe very large, escape taxes.
Is that okay? Possibly, in that within industries with large amounts of cash transactions, say tips, the lack of taxes likely is offset by lower pay. So the waiter's actual pay scale, as well as tip expectations, have been adjusted down, an implicit and tacit recognition that tip income can escape taxation. If this changed, if 100% of tips were suddenly taxed, tip levels would likely, through various social and subtle signals, gradually adjust themselves up, and waiters themselves would argue for a higher base pay.
That being said, a general principle is that all income should receive equal consideration. While we accept the leakage that cash transactions create, fairness indicates that leakage should be minimized or eliminated.
But how?
I would argue for the eventual abolition of cash.
Now this idea is neither new nor unique. In the United States, regulations require reporting cash transactions over $5,000. Beyond that, governments worldwide have and are considering, and have implemented, various limitations and prohibitions on cash transactions.
And controversy exists. Cash transactions provide a mechanism for privacy. We certainly are in an era where our electronic footprints - what we buy, what websites we visit, even our current location - are of substantial and increasing interest to marketers, law enforcement and the like. Abolition of cash thus raises privacy concerns, and privacy concerns are not trivial.
Cash also provides choice, at times necessary. Not everyone desires to use credit or debit cards, and some can't readily obtain them, due to social status, credit issues, etc.
So why suggest this abolition?
Because over the coming years cash will increasingly abolish itself. We see the trend clearly already. Increasing numbers of outlets accept credit cards, including cabs, fast food restaurants, convenience stores, parking meters, and transit systems, along of course with the normal large chain stores. That acceptance will continue to grow, as numerous firms are competing for a breakthrough to convert Smartphones into transaction accepting devices that even the corner hot dog stand can use.
At some point, electronic transactions will become so efficient, so available, so socially expected, so quick, that those wanting to use cash will increasingly be those who do so for a nefarious purpose, i.e. to avoid taxes, to commit a crime, to embezzle funds, to immigrate illegally.
At the same time, privacy issues over electronic information will need some resolution other than cash. If one needs to use cash for privacy, then what would that say concerning the privacy of thousands of non-financial electronic bread crumbs one leaves. These include medical records, employment records, emails, drivers license records, voting registration, social media postings, and on and on.
So fast forward a decade or two or even three. It is not inconceivable that kids will grow up not knowing what cash is. Thus abolition of cash at some point will not hurt the common person, but will create added fairness in taxation by preventing those looking to evade taxes from using cash to do so.
Assessment
At the beginning, I listed five principles: 1) increase fairness, 2) promote social welfare, 3) augment the economy, 4) collect revenue and 5) operate efficiently. How do the ideas above stack up? Let's see.
I would claim that changing deductions and exclusions from income, into credits against taxes, combined with true minimum tax rates, would achieve the first two goals, in spades. Those two changes make available to all income levels tax advantaged expenditures. That promotes fairness across the base of tax payers and widens the reach of the social benefits that accrue from the tax advantaged expenditures.
The abolition of cash achieves the last two. That step allows capture of cash transactions now lost to the tax base, and reduces the enforcement and compliance efforts needed to combat cash-based tax evasion.
The ideas are likely neutral to economic activity. Economic stimulus involves steps like capital investment, or business formation, or job creation. And admittedly, in this short piece, those item aren't directly addressed.
But impacting four out of five goals isn't bad.
So there we have it, a few suggestions to improve and make more ethical our tax structure. Some may agree, others not, but most might concur these ideas are worthy to put on the table as part of the ongoing discussion of the despised reality of taxes.
By: David Mascone
Now that answer falls apart on its own logic, since if applied to everyone, there would be no "others" to tax more. But the answer does bring up a point. The fairness and utility of taxes - and fairness and utility are key ethical concerns - those items are often in the eye of the beholder. So as I described in a companion article ("Taxes: A Calculation in Ethics") establishing an acceptable, and ethical, tax policy involves blending perspectives from across the social and economic spectrum to achieve a common consensus. Almost by definition no one individual can determine the optimum solution.
So, being consistent with my own words, I will add to that blending process by offering a few suggestions of my own.
Principles
What are the goals of a good, dare say ethical, tax policy? Here is what I would say. Taxes should be 1) fair to the individual, while they also 2) promote the general welfare, and 3) augment economic performance. They should also 4) gather sufficient revenue for the government we desire, and 5) be simple, efficient and minimize evasion.
How do I think we best accomplish those goals? Certainly a complete discussion could run not just a number of pages, but a whole book, or several books. But here would be a few ideas.
Credits verses Deductions
Like it or not, America uses taxes to promote social welfare. We promote home ownership by allowing deduction of mortgage interest; we subsidize state and local governments through the tax exclusion for municipal bond interest; we support non-profit institutions through charitable deductions.
Many an argument has been made over what should or should not be excluded or deducted from income for taxes purposes. I won't add to that here. Rather, the focus here is on the manner in which these exclusions or deductions are applied.
For deductions (like home mortgage interest) or exclusions (like municipal bond interest) we apply them as offsets to income, not to the income tax. Deductions and exclusions lower taxable income.
What is the ethical implication? Higher income individuals, in higher tax brackets, receive a greater benefit than the much larger group of individuals in the middle and lower brackets. A wealthy person donates several thousand dollars to their faith, they save twenty to thirty cents on the dollar. The everyday person donates an equivalent amount, they save either nothing, or maybe ten of fifteen cents on the dollars.
By what mechanism do upper income individuals receive greater benefit? First, obviously, upper income individuals are in higher tax brackets, so each dollar excluded or deducted saves a higher percentage. Second, there is the standard deduction. Higher income individuals most often exceed that standard amount, and thus their deductions actually reduce their taxes. Moderate and lower income individuals generally do not have sufficient deductions to exceed the standard amount. Thus, when they give to the church, or the local food bank, or make some expenditure that is deductible, those contributions or deductions save them nothing.
My suggested remedy would be to change deductions and exclusions into credits. Deductions and exclusions would no longer lower taxable income, but rather directly lower taxes, i.e. they would in whole or part become a direct credit against taxes. Thus, if one gives a dollar to charity, taxes are reduced the same regardless of income. If one receives a dollar of municipal interest, the tax savings are the same for everyone.
Minimum Tax Rates
A related step, for fairness, would be minimum tax rates. As income rises, the ability of individuals to participate in tax favored activities increases. Take the mortgage interest deduction. A good percentage of average income individuals might need to rent, while the wealthy can more likely buy a large home. Thus, while under the above "deductions become credits" approach above, mortgage interest credits would benefit all incomes equally, the average person has less financial ability to actually buy a home, much less a large home, and thus take advantage of the "deduction becomes credit".
The approach for this, to maintain fairness, would be a minimum tax. Such a minimum tax would say that when all is said and done, an individual must pay a minimum percentage in income taxes. This would apply to one's straight income, all sources (I would allow the personal exemptions, but that is all), regardless of credits, or anything else.
Credits and Minimum Tax Rates
How would these two ideas work together? Let's take a simple example.
For our example, our regular tax rate will be 25 percent for income above $75 thousand, and our minimum tax rate for the same bracket will be 15 percent. In terms of credits, an individual can take a credit against taxes equal to 50% of eligible expenditures, i.e. the items that are deductible or excluded today, for example charities, mortgage interest, extraordinary medical expenses, municipal interest, and so on.
Let's now take an individual making $175 thousand, with $30 thousand in eligible expenditures. The income amount in the 25 percent bracket is $100 thousand, i.e. $175 minus $75. The regular tax on that amount is $25 thousand (i.e. 25 percent of the $100 thousand), and the credit is $15 thousand (50 percent of the eligible expenditures, which amount to $30 thousand). So the tax, so far, is $10 thousand (i.e. $25 thousand minus the $15 thousand credit).
But we have a minimum tax, set at 15 percent for the bracket, and 15 percent of $100 thousand is $15 thousand. The individual would pay no less than $15 thousand.
Below $75k, our regular tax rate for this example will be 10 percent, and the minimum 5 percent. We will also have a $10K per person exemption. A person earning $40K, married, would pay $2 thousand in taxes before credits; that is $40 thousand minus the exemption for two people, leaving $20 thousand, times the 10 percent. The minimum tax would $1 thousand. The couple rents, so has no mortgage interest deduction, but gives a thousand dollars to the local church. Under current tax regulations, the couple receives no benefit, but if deductions were turned to credits, that contribution would save the couple $500 dollars in taxes, off the $2 thousand.
Our turning deductions into credits thus spreads out the base of individuals who benefit from tax advantaged expenditures, and the minimum rates prevent any one individual from excessively benefiting from the credits.
Abolition of Cash
An unavoidable part of taxes is that individuals seek to avoid them. Each of us actually becomes part of that when we pay a contractor in cash to receive a reduced price, or pay for a restaurant meal and tip with cash. We suspect, and in cases we are correct, that the cash payments are not fully reported for tax purposes. Significant amounts of transactions occur on a cash basis, and some percent, maybe very large, escape taxes.
Is that okay? Possibly, in that within industries with large amounts of cash transactions, say tips, the lack of taxes likely is offset by lower pay. So the waiter's actual pay scale, as well as tip expectations, have been adjusted down, an implicit and tacit recognition that tip income can escape taxation. If this changed, if 100% of tips were suddenly taxed, tip levels would likely, through various social and subtle signals, gradually adjust themselves up, and waiters themselves would argue for a higher base pay.
That being said, a general principle is that all income should receive equal consideration. While we accept the leakage that cash transactions create, fairness indicates that leakage should be minimized or eliminated.
But how?
I would argue for the eventual abolition of cash.
Now this idea is neither new nor unique. In the United States, regulations require reporting cash transactions over $5,000. Beyond that, governments worldwide have and are considering, and have implemented, various limitations and prohibitions on cash transactions.
And controversy exists. Cash transactions provide a mechanism for privacy. We certainly are in an era where our electronic footprints - what we buy, what websites we visit, even our current location - are of substantial and increasing interest to marketers, law enforcement and the like. Abolition of cash thus raises privacy concerns, and privacy concerns are not trivial.
Cash also provides choice, at times necessary. Not everyone desires to use credit or debit cards, and some can't readily obtain them, due to social status, credit issues, etc.
So why suggest this abolition?
Because over the coming years cash will increasingly abolish itself. We see the trend clearly already. Increasing numbers of outlets accept credit cards, including cabs, fast food restaurants, convenience stores, parking meters, and transit systems, along of course with the normal large chain stores. That acceptance will continue to grow, as numerous firms are competing for a breakthrough to convert Smartphones into transaction accepting devices that even the corner hot dog stand can use.
At some point, electronic transactions will become so efficient, so available, so socially expected, so quick, that those wanting to use cash will increasingly be those who do so for a nefarious purpose, i.e. to avoid taxes, to commit a crime, to embezzle funds, to immigrate illegally.
At the same time, privacy issues over electronic information will need some resolution other than cash. If one needs to use cash for privacy, then what would that say concerning the privacy of thousands of non-financial electronic bread crumbs one leaves. These include medical records, employment records, emails, drivers license records, voting registration, social media postings, and on and on.
So fast forward a decade or two or even three. It is not inconceivable that kids will grow up not knowing what cash is. Thus abolition of cash at some point will not hurt the common person, but will create added fairness in taxation by preventing those looking to evade taxes from using cash to do so.
Assessment
At the beginning, I listed five principles: 1) increase fairness, 2) promote social welfare, 3) augment the economy, 4) collect revenue and 5) operate efficiently. How do the ideas above stack up? Let's see.
I would claim that changing deductions and exclusions from income, into credits against taxes, combined with true minimum tax rates, would achieve the first two goals, in spades. Those two changes make available to all income levels tax advantaged expenditures. That promotes fairness across the base of tax payers and widens the reach of the social benefits that accrue from the tax advantaged expenditures.
The abolition of cash achieves the last two. That step allows capture of cash transactions now lost to the tax base, and reduces the enforcement and compliance efforts needed to combat cash-based tax evasion.
The ideas are likely neutral to economic activity. Economic stimulus involves steps like capital investment, or business formation, or job creation. And admittedly, in this short piece, those item aren't directly addressed.
But impacting four out of five goals isn't bad.
So there we have it, a few suggestions to improve and make more ethical our tax structure. Some may agree, others not, but most might concur these ideas are worthy to put on the table as part of the ongoing discussion of the despised reality of taxes.
By: David Mascone
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