Tax Tips Blog

Eldon writes: I graduated from college last May and have been trying to evaluate several job offers that I have. I’d like to estimate how much money I will be paying in taxes so that I can determine what my actual take home pay will be at each job, and so that I can also determine how much I’ll be able to save, how much I can budget to spend on housing, etc. I’m having difficulty finding a definite answer to a very basic question.

Here is my question: While trying to estimate my taxes I found the tax rate tables, which show marginal federal tax rates, with which I was able to estimate my tax rates. But do these rate tables include payroll taxes like medicare and social security? In the past I know that those were withheld from my paycheck but were not refunded when I filed at the year’s end. For instance, using the tax rate tables, if I plug in an income of $78000, my tax will be $15,107 plus %28 of $3800 (1064), for a total federal tax of $16,171. This is a rate of only about 21%. But when I actually have to pay taxes, will I be paying 16,171 plus payroll taxes (which I read somewhere are like 7.5%), so that my actual rate would be around 28-29%? Or does this number include payroll taxes?

Sorry for such a basic question - like I said, I’ve never had to worry about taxes and don’t want to make a stupid mistake and screw up my tax estimate. Thanks, Eldon

My reply:Hello Eldon! Thank you for visiting my site!

I have never understood why Basic Finance (a class that would teach you how to determine your net paycheck, how to balance your checkbooks, how to reconcile your bank statement, how to reconcile your credit card statements, how to make a budget, etc.) is not a high school requirement, for in such a class you would have learned the answer to your question, one which every high school graduate should know and understand. Since they don’t, please don’t feel bad that you do not know the answer to this question, as it’s not as simple as it sounds.

First, the tax rate tables that you found do NOT include Social Security or Medicare taxes. Assuming these tables were payroll tax tables, they ESTIMATE the amount of Federal income taxes that you will probably owe at the end of the year.

Second, Social Security is withheld at a rate of 6.2% of your gross income up until your gross income reaches $97,500 in 2007. Medicare is withheld at a rate of 1.45% of your gross wages, regardless of how high your wages are for 2007. Unless you have multiple employers and combined your reach over $97,500, you never receive a refund of these taxes.

The amount of your net check, or take home pay, is rarely equivalent to your annual take home pay after you file your Federal income tax return. The reason is that the amounts taken from your paycheck (Federal taxes, Medicare, Social Security, and other potential withholdings like State withholding, Flexible Spending Accounts, Medical Premiums, etc.) do not directly correspond to the income tax return which you are required to file at the end of the year. If you know what all your deductions will be, and their amounts, the easiest way to compute your tax home pay would be to plug all those numbers into a payroll calculator. You can find a free one at PaycheckCity.com, but remember, that is just an estimate. You may owe more Federal income taxes when you file your tax return or you may get a refund.

Depending on many factors, your taxable income, as determined on your annual income tax return, is computed based on your filing status, number of exemptions, standard or itemized deductions and other potential adjustments to determine your taxable income. Your taxable income is then used to determine the potential amount of federal income taxes you will owe. This amount is then adjusted for items such as AMT and tax credits. You may find it very useful to review the following IRS publications:

• IRS Publication 17: an introduction to federal income taxes
• IRS Publication 15-A: payroll withholding tables.

Best wishes, Gina www.GLGcpa.com

Dan asks:I’m debating if I should start an IRA or not. The problem is that all contributions would not be deductible. As far as I understand this, it means that any capital gains sells would not be taxed until I was ready to withdraw. My question is about withdrawing money from this account. Are the contributions I made post-tax taxed again upon withdrawal or only the earnings? It would make sense if it were only the earnings, however other than making one lump sum withdrawal, how would you determine what taxes to pay? Thanks in advance for answers to my ignorant question Dan

My reply: Hello Dan, thanks for writing.  Only the earnings are taxed upon your withdrawal.

As you make non-deductible contributions you report them on Form 8606, Part I, which you file with your individual tax return. This establishes your after-tax “basis” in your traditional IRA.

When you take distributions it is treated as if it came from both your nondeductible contributions and your earnings, in the proper proportion.

For example, if your basis is $20,000 and the year-end value of your IRA is $200,000, then your IRA is 1/10th contributions and 9/10ths earnings. If you then withdraw $10,000, $1,000 is tax free, $9,000 is taxable.

Best wishes, Gina www.GLGcpa.com

The IRS has a special form for requesting a photocopy of a previously processed tax return and attachments. If you need to obtain a copy of a prior year return, complete Form 4506 , Request for Copy of Tax Return, and mail it, along with an IRS processing fee of $39 for each tax period requested, to the IRS address listed on the form for your area. Unless the IRS has lost or misplaced your tax return, copies are generally available for the current and past 6 years.

If you need a copy of your tax return to obtain a loan, you may be able to use a tax return transcript, instead of a copy of your actual return. A tax return transcript shows most line items from the tax return as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes you, your representative or the IRS made after the return was filed.

If you, your representative or the IRS has made adjustments to your return, you may want a tax account transcript as this will shows any adjustments made after your original tax return was filed. A tax account transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income.

The IRS does not charge a fee for transcripts. You can request a transcript by completing Form 4506-T, Request for Transcript of Tax Return. Transcripts are available for the current and three prior calendar years.

www.GLGcpa.com

Steve writes: I co-own a house with my domestic partner. We live in California, but are not registered as domestic partners.

The value of the property has dobuled since we purchased it, and it is now worth approximately $1M. All costs related to the house have been split 50/50 (down payment, mortgage, taxes, improvement projects, maintenance). We are both disciplined Quicken users so we can recreate cash flows for the period we have owned the house. We are individually high net worth (over $1M).

The house is bigger than we need, so we may sell it at some point. Both of us are in good health, and hopefully will be so for another 25 years. The problem lies in that only one of our names is on the title and mortgage.

Under California law the property will not be reassessed if a new owner is added to the title (verified by our county tax assessor). We both have excellent credit (800+ FICO) so I don’t think adding a name to the mortgage would be a problem. My biggest concern is federal taxes.

We have met with several local lawyers and accountants, but I think we sometimes get answers they think we want to hear. We want to make sure this is handled properly so that we don’t have to deal with it again. We know this was a mistake, but years later what are our options for fixing the problem?

Thank you for your opinions on our situation.

My response: Hello Steve!

Just to be sure that I answer the question you are looking for I’ll answer several common questions regarding personal residences and the federal law.

First, real estate taxes are generally only deductible by the owner of the property [Regulation Section 1.164]. The owner would be the person who has title to the property; thus, if you add your partner’s name to the title both of you will be able to deduct, assuming you can itemize, the amount you pay for real estate taxes.

Second, mortgage interest payments for acquisition indebtedness after 10-13-1987 are deductible, assuming you can itemize, as long as the loan is less than $1 million.  You can usually use tracing rules to show the payments were made to pay off the mortgage interest and thus be allowed this deduction.

Third, single individuals can exclude up to $250,000 of the gain on the sale of their principal personal residence (IRC §121). If each of you wished to use your $250,000, then each of you must own and use the property as your principal residence for periods totaling at least two years out of the five-year period ending on the date of sale. You do not both have to be on the mortgage, you both just need to live there and own the home. Thus both of your names must be on the title to the house.

The problem with simply adding your partner’s name on the title is that tax law will automatically assume that you gifted your partner half of the house. This is where your impeccable records will be necessary to retain in case you are questioned about this at a later date. You may have to show this to document the fact that both of you actually purchased the house together and that there was just an error with the recording of the original title (at least that is how I read your email - if this is incorrect, so is my response).

If your records are as good as you claim, then although you may face a hassle or two, you should be alright. Adding your partner’s name to the title will make your partner half owner (joint tenancy) and his basis will be the same as yours.

Fourth, if you use your home for business purposes (home office deduction?) you may be able to take advantage of both the home sale-exclusion as well as a like-kind deferral (§1031) if you acquire a similar property. How to go about this is way beyond this medium, but I did write a general article about the tax free exchange of real estate, which you may find useful.

I hope I have satisfactorily answered your question.

Best wishes, Gina http://GLGcpa.com

Jake asks: Assume at the age of 60 I retire to a country that does not have an income tax and other than the 401K account, I have no assets in the US. At age 65, as a non-US citizen, I liquidate my entire 401k account and transfer it to a bank in the new country. Do I pay any penalty / tax to the US gov’t? It would seem that there must be some provision that prevents total tax avoidance in that scenario.

My reply: You are correct in that you will not be able to avoid federal income tax in this situation.

You can withdraw the money from your 401(k) without penalty as early as age 59.5. However, you will have to pay US tax on the money withdrawn from your 401(k). Thus, it is usually wise to withdraw it over several years to keep yourself at the lowest tax bracket possible for your situation, in order to minimize the taxes.

As a non-citizen with assets in the US, if you do not elect to have taxes withheld from your 401(k) withdrawal, you would be subject to backup withholding. You would then be required to file a US tax return to get a refund of any over withholding, if applicable.

Please be careful when dealing with taxes and foreign countries. This is a very complex area of the tax law and advice from a qualified professional should be sought before any decision are made.

Best wishes, Gina www.GLGcpa.com

Trent asks:Suppose I make about $100,000 in a salaried position where my employer pays 1/2 FICA. But then I also have a sole-proprietorship where I make about $100,000 and current pay “both halves” of FICA. How do I work this into the FICA limit of ninety something thousand (for SS of course…no limit on medicare/caid)? Would I pay the roughly 15% up to the limit? I am currently paying estimated taxes (income plus FICA) on the SE job, and having FICA withheld on the salaried job. So I am going to have to get SOMETHING back…but how do I calculate it?

My reply:Hello Trent! If you have wages as well as self-employment earnings, the tax on your wages is paid first.

For example, if you had $100,000 in wages and $100,000 in self-employment income in 2007, you do not pay dual Social Security taxes on earnings more than $97,500. Your employer will withhold 7.65% in Social Security and Medicare taxes on your first $97,500 in earnings and 1.45% in Medicare taxes on your remainder earnings of $2,500. Your employer will also be withholding Federal taxes.

You must pay 2.9% in Medicare taxes on your entire earnings from self-employment and your appropriate Federal taxes. For more information please visit the Social Security Administration Electronic Fact Sheet for Self Employed people: ( http://www.socialsecurity.gov/pubs/10022.html ).

As for calculating the amount of your refund, that would ultimately be determined when you complete your Federal income tax return. Obviously, estimates can be made ahead of time and it would be best to ask your tax professional to help you with that calculation.

Best wishes, Gina www.GLGcpa.com

Ray wonders: If I “gift” some shares of a mutual fund via a broker to broker transfer is this a taxable event (regular or AMT) for me?

My reply:Hello Ray! Since you have the word gift in quotes and you did not provide me with any more information, I will assume that you are speaking of a plain old-fashioned, “Here, I want you to have this” gift; however, if it’s something else, then the correct answer to your question may get more complicated.

If it is a true gift, then it is not taxable for Federal or AMT purposes; however it may be subject to gift tax if the value of the gift is more than $12,000. Please make sure that if you make the gift, the recipient gets a separate letter from you detailing the cost basis and purchase dates of the shares transferred.

Best wishes, Gina www.GLGcpa.com