Some of the Most Overlooked Tax Deductions

Taxes Overlooked DeductionsA tax deduction reduces your taxable income by the amount of the deduction. So if you receive a $5,000 deduction, then your taxable income is reduced by $5,000. The tax savings is the product of the deduction and your marginal tax rate, so if your tax rate would have been 25%, then you save $1,250 in taxes with a $5,000 deduction. Some deductions are common and any preparer or tax software will remind you to claim them. But others might involve some thinking on your part. Here are some of the most overlooked tax deductions.

Student Loan Interest Paid by Parents
You can typically only deduct mortgage and student loan interest your are obligated to pay. However, if your parents pay interest on a student loan that’s in your name, you will be able to claim the deduction for the interest paid, assuming you’re not being claimed as a dependent. The payment is treated as if your parents gifted you the money, and then you used that money to pay your student loan interest.

Moving Expenses for a New Job or First Job
If you took a new or first job during the year, and your new job was more than 50 miles from your previous residence, you can take a deduction for the expenses related to your move. This includes the cost of getting yourself and your possessions to the new home. You can even deduct the mileage it takes to get there. For more information, refer to Pub 521.

State Sales Tax
Each taxpayer can choose between deducting either state and local income tax or state and local sales tax paid. For most people, it’s going to make sense to deduct their state and local income taxes. But for those who live in states with no income tax, it will make sense to deduct the sales tax paid throughout the year. The IRS allows you to use a table to estimate this deduction. But if you purchased big ticket items such as a vehicle or boat, don’t forget to include this amount as a separate entry.

Child Care Credit
Although it’s not a deduction, the child care credit is even better! That’s because a credit is a dollar-for-dollar decrease in your tax bill. The costs of daycare, preschool, babysitters, or even summer camps can qualify. Families earning more than $43k get a credit for 20% of their eligible costs (up to $3k for one child, and $6k for two).

If you think that any of these apply to you, make sure to visit that section of your preferred tax software if you’re doing your own taxes, or discuss them with your tax professional. In 2002, the Government Accountability Office performed a study and estimated that Americans overpaid their taxes by $945 million. But don’t scare this into going out and hiring a tax professional. The GOA also determined that 49% of the tax returns where people overpaid had been prepared by a third party.

(Photo courtesy of Flickr)

The Looming Fiscal Cliff 2013

Fiscal Cliff 2013With the first presidential debate of 2012 now over, I’m a bit surprised to say that the fiscal cliff was not mentioned. Perhaps this is a topic for an upcoming debate. I expect it to become a campaign issue over the next five weeks as the presidential election approaches because it’s something that will affect almost all voters.

If you aren’t familiar with the fiscal cliff, or as some have dubbed it, “taxmageddon”, let me briefly explain. In 2013, as it currently stands, nearly all of the temporary tax cuts enacted since 2001 will expire. If all of these tax cuts were to expire, approximately 90% of Americans would see their tax bills increase. If Congress and the president do not act, taxes will jump for nearly everyone and government spending will decrease significantly.

In summary…

  • Millions of families would be thrown into the Alternative Minimum Tax (AMT) bucket
  • Nearly ten times as many estates would be subject to estate tax as were in 2012
  • The 2% temporary payroll tax reduction would lapse
  • Bush tax cuts for dividends and capital gains would expire
  • Bush income tax cuts expire, increasing the nominal tax rate for high-income earners from 35 to 39.6%
  • The Affordable Care Act (Obamacare) would impose new taxes on high-earners

All told, it’s estimated (by the Tax Policy Center) that taxes would jump by $500 billion in 2013. Middle-income taxpayers would see average increases in their tax burden of approximately $2,000. Every level of income would see its tax burden increase. Low income households would see an increase of 3.5% of pretax income, while those in the top 1% would see an increase in their tax burden of approximately 7% of their pretax income.

While this cliff is significant, it’s not a reason to run for the hills. The Tax Policy Center has evaluated which provisions are likely to expire, and which are likely to be renewed, based on proposals by Obama and Romney, as well as proposals and discussions from Congress.

It appears that the payroll tax reductions that were part of the stimulus to fight off a Depression will be allowed to expire, as expected. These were temporary cuts and I think that their impact has run its course. Rolling these back will affect all workers, and represent about $115B of the total $500B in looming tax increases. The Bush dividend and capital gains reductions are also likely to expire for high-income individuals. It’s no secret that the wealthy disproportionally benefit from lower taxes on capital gains and dividends. Keeping these rates lower for those earning less than $250k per year will encourage savings without allowing the rates to be taken advantage of by those who do not need reduced rates.

As expected, the fiscal cliff may affect taxpayers differently depending on who the next President is, and which party controls Congress. The Republican party has shown its desire to repeal Oabamacare (which will increased taxes paid by the wealthy), although this seems unlikely to happen in any quick fashion. Republicans would also defer to repeal the income tax increase that is set to take effect for the top income bracket. President Obama expressed the desire to make stimulus legislation like the Earned Income Tax Credit permanent, while Mitt Romney has said that he would allow this legislation to expire. The two also differ on the treatment of Bush era tax cuts. President Obama has proposed extending the Bush tax cuts for all except those making more than $250,000 per year, while Romney supports extending these cuts for all taxpayers.

The fiscal cliff in its entirely is unlikely to materialize. We aren’t going to see $500B in increased taxes in 2013. However, there are definitely some proposals that I would like to see pushed through, and others I hope will be left alone to be as they are, or expire. The payroll tax has run its course and should be allowed to expire. While this will impact all workers, I don’t think that the payroll tax cut is having as much impact anymore as it is currently costing us. This tax cut costs 5x as much as the increased taxes on the wealthy as part of Obamacare. I would also like to see dividends and capital gains increase on those earning more than $250k per year because there is no reason why we need to encourage investment amongst those who are earning that much. I do hope that an AMT patch is pushed through to keep millions of Americans from being forced into AMT, and I also support extending the tax cuts for the working class.

Where do you fall in regards to the looming fiscal cliff? Should everything be extended? Should nothing be extended?

(Photo: Flickr)
Check out the analysis from the Tax Policy Center

The Capital Gains Tax Rate is too Low

I will never be one to “punish” people for becoming wealthy. I don’t believe that obtaining wealth is some type of sin. But when Warren Buffet speaks, I tend to listen. In 2010, Warren Buffet paid $6,938,744 in taxes, which was a 17.4% effective tax rate. His tax rate was lower than any of the 20 other people in his office. In his op-ed, Buffet claims that he and his friends “have been coddled long enough by a “billionaire-fiendly Congress” and calls to a tax increase on those making more than $1 million, and an additional increase on those making more than $10 million. This increases would affect 250,000 households.

If you’ve been following the presidential campaign of 2012, then you have probably seen capital gains being discussed. A lot of this stems from the tax rates that President Obama, and particularly Presidential Candidate Romney have been paying. In 2011 Obama paid a 23.37% tax rate ($184k in taxes on an AGI of $789k). While not as low as many super wealthy, it’s still considerably less than someone earning $150,000 working a normal daily job with no capital gains. Last year I paid a 22.2% effective tax rate. However, Romney’s tax return shows that he has kept his tax rates quite a bit lower by taking advantage of low capital gains tax rates. Last year Romney paid a 15.4% tax rate, and claims that he hasn’t paid less than 13% in the prior ten years, although he won’t release any prior returns.

Obviously, taking advantage of capital gains and paying a lower tax rate isn’t a crime. But that doesn’t mean that the capital gains tax rate should be kept so low. And frankly, I’m not quite sure why some people support the tax rates. Okay, actually I do. I’ve heard the same soundbites and arguments. I used to believe them. But over time, some of my philosophies have changed and I prefer to look at the data rather than the theories or soundbites. We all know that the government has some current revenue and spending imbalances that have to be corrected. To help increase tax revenues, President Obama has proposed extending the bush-era tax cuts for households making less than $250,000, while allowing them to expire for those making over $250,000. This would increase the capital gains tax rate from 15% to 23.8%.

I understand why people making $260k aren’t big fans of this proposal. If they’re like many people, they aren’t saving as much as you might think, even with their high income. That means that they aren’t getting significant amounts of their yearly income from investments. But what about those people who do earn a significant amount from investments? I find it difficult to comprehend why someone who earns $500k on investments during a year should pay $75k in taxes, while a world-class heart surgeon should pay $200,000 or more on the same income.

And trust me, I really have heard the arguments…

  • lower capital gains tax rates encourage risk-taking and entrepreneurship
  • lower capital gains tax rates offset double taxation of company profits
  • lower capital gains tax rates would encourage people to move assets to other countries
  • lower capital gains tax rates would decrease tax revenues because fewer people would sell assets with gains

These arguments are dreamed up in order to try to justify a belief that some people have…for whatever reason. Unfortunately, many of these people hold high positions in our government. Paul Ryan, Republican Vice Presidential Candidate, introduced A Roadmap for America’s Future in 2010, which proposed eliminating taxes on capital gains and dividends. Romney, in a debate with Newt Gingrich, said that “under that plan, I’d have paid no taxes in the last two years.”

Here are some facts that I think make the case against low taxes, particularly capital gains taxes, pretty clear:

  • Between 1950 and 2010, in years when the top marginal tax bracket was 25-39%, average real GDP growth rate was less than 2.5%
  • Between 1950 and 2010, in years when the top marginal tax bracket was 39-100% (some years were 90%+), the average real GDP growth rate was above 3.5%
  • Between 1929 and 2009, the correlation between higher overall tax rates and the growth rates for that year and the next has been positive.
  • In 2010, 97% of all capital gains went to those with incomes above $1,000,000.
  • Forbes found that there is a positive correlation between higher capital gains taxes and real GDP growth, which means that growth was typically better when capital gains were higher – and growth certainly wasn’t slower.
  • Total government tax revenues over the past few years have been at the lowest level seen in the last 40 years.
  • Government spending is higher than at any point since World War II, but it’s less than 5% higher than it was during the 1980s and the first half of the 1990s.
  • During the 1950s and early 1960s, marginal tax rates for the super wealthy were over 90%, yet both the economy and stock market boomed. High tax rates didn’t didn’t thwart the boom.
  • Super low tax rates on the wealthy or correlated with high levels of inequality.

With no correlation found between lower taxes and actual growth in the economy, and the fact that lower capital gains benefits the rich at an insane proportion, I am not sure why anybody but the super rich would argue for lower capital gains taxes or argue against increasing the capital gains taxes on the wealthy. I know that many people hear soundbites on TV or the radio and love to bring those up as “evidence”, but from what I’ve seen, the facts just don’t support the ideas and theories.

What do you think? Should capital gains taxes be increased, decreased, or kept the same? Have you seen an evidence to support either opinion? I am quite open minded and absolutely love for my existing beliefs to be challenged with facts.