Tax Questions Common During Tax Season
As 2016 is quickly drawing to a close, we are preparing for another busy tax season. In just a few more weeks, it will be time to begin gathering all of your important papers. Employers will be mailing out the year’s W-2 forms. Your year-end statements will come from your mortgage company. Before you know it, it will be time to schedule your appointments with your tax professionals. Here are some of the most common tax questions we get during tax season.
Is a Bigger Refund Better?
It would seem like getting a bigger refund is better than a smaller refund.. A bigger refund is not necessarily better. It means you have had too much money taken out of your wages. You have basically given the IRS an interest-free loan over the course of the year. The most important line on your return is the “tax liability” line. A smaller liability is always better than a larger refund. However, it is always better to get a refund than to owe money to the IRS. Sometimes in an effort to break even you may actually end up owing the IRS money. Additionally, many people use their income tax returns as forced savings to make big purchases, remodel, or take vacations. In the event of having an interest-bearing savings account, you are better off stashing your money and gaining interest. Unfortunately most savings accounts these days earn little to no interest.
Why is my State Refund Taxed?
This is a common question. Taxpayers often assume they are being taxed twice, and this is not the case. Your state refund is added back into your income, and you are taxed on that income. This is only the case if you itemized in a previous year and deducted that overpayment. Here is where it may get a bit hairy, so bear with me here. If you deducted state or local tax withholding or you estimated tax payments on your return by itemizing on Schedule A you deducted an amount as withheld. This was later returned to you as a refund, which means you must un-deduct it. Of course there are some more complication nuances to this question, particularly when talking about partial deductions or benefits. But we won’t get into that right now.
Why am I Paying Tax on Social Security?
Many people feel that this is THEIR money. They were already taxed on that money, and they feel they are being taxed a second time when they receive the benefits. The truth is, it’s not ALL your own money. Your employer matched what you paid into Social Security, and you did not pay taxes on the employer’s share. Additionally, people who are currently retiring are getting a real return on the money they paid into social security. So while up to 85% of your social security benefits can be taxed, rest assured that you have not been taxed on that money twice.
Is it Worth Paying Off My Mortgage if I Lose the Mortgage Deduction?
Having a mortgage for the sole purpose of a tax deduction is a bit backwards. For every dollar of interest you pay on your mortgage, you only get about 25 cents back as a refund (assuming you itemize). If you only have a small mortgage, you may do as well by claiming a standard deduction. That means you get little or no benefit from your mortgage deduction. Overall, there may be some good reasons to maintain a mortgage payment instead of paying it off. But keeping a mortgage for the sole purpose of a tax write off is not really beneficial.
Should I Dip into Retirement Savings to Pay Off Credit Cards?
Short answer? No. Don’t cash in your retirement or dip into it to pay off credit card debt. During the recent market crash, a lot of people got nervous about their abilities to pay off credit card debts. If you decide you need to reallocate some of your assets so they are more conservative, you can do that within your individual retirement account or 401(k) without incurring the taxes or penalties on retirement account withdrawals. The argument many people may have is that it seems backwards to pay high interest on credit cards while accruing low interest on 401(k) investments. However, withdrawing money early from your retirement account means you lose the chance to let your investments grow. Furthermore, a large portion of what you take out will go to the IRS. You have to pay state and federal taxes on any money you take out PLUS a 10% penalty. Depending on your tax bracket, this could be 30% for a 15% tax bracket and 40% for a 25% bracket in the state of Colorado. If this is something you are planning on doing anyway, there are some strategies to help alleviate some of the tax liability.
If you are considering taking money out of your retirement account, speak with a tax professional. They can give some advice on the best way to do it without having to pay too much in interest.
Now that we are about to be in the midst of another tax season, it is a good time to reflect and consider what types of questions or concerns you may have about taxes. What are some of your biggest tax questions or concerns?