Tuesday, December 27, 2011

Should I file jointly or separately?

Often married couples aren't sure if they should file their taxes jointly or separately.  

Rule #1 - If you are estranged from your spouse or don't trust your spouse, you do not want to sign a return with their possibly bogus information.  Once you file a joint return, you are liable for any errors and the balance due.

Rule #2 - If rule #1 does not apply, you want to save as much tax as you can. The only way to truly know is to run the numbers.  Figure the taxes both ways. It is important to compare the results for both the Federal as well as the Ohio returns.  This is the part of preparing taxes that I just love.  It's such a puzzle and it's tax savings when it works out right.

Before doing all this work, it may help to know some general guidelines.  In Ohio, if both spouses have similar incomes, they will save taxes on the Ohio return by filing separately. So, if only one spouse has income, you'll always want to file a joint return (unless rule #1 applies).

But what about the Federal?  On the Federal return, most couples' taxes will be the same whether they file jointly or separately (exceptions noted below). However, there are certain deductions and credits that are disallowed if you file separately.  What?  Yes, you must file a joint return to claim some very popular credits such as; Earned Income Credit, Dependent Care Credit, and all the Education Credits and deductions.  Also, in most cases you cannot contribute to either a traditional or a Roth IRA if you file separately.  Finally, Social Security income will be taxable at the maximum rate if you file separately.   But there are many couples that do not qualify for any of these credits.  They can save hundreds of dollars by filing separately.

There are some situations where you can save on your Federal taxes by filing separately. The most obvious cases are those returns with large amount of Miscellaneous or Medical deductions.  These deductions are subject to a floor, based on a percentage of income, and only the deductions over the floor lower your taxable income. By filing separately, your floor is much lower and more of your deductions will help you. Another area for potential savings are for couples with children, where they phase out of the child tax credit when the file jointly. By filing separately and shifting children and other deductions, the spouses' incomes are such that one spouse can claim the full child tax credit.  They'll save on Ohio tax, and hopefully will have limited adverse effects from the tax tables and AMT.  These returns can be very tricky to maximize savings, but done correctly, they can yield thousands in tax savings.

To sum up, if there are no deductions or credits that will be lost on the Federal return by filing separately, and income is similar for both spouses, you probably want to file separately.  If you have Education Credits or want to contribute to an IRA, you will probably want to file jointly.

Can't I file jointly on the Federal, but separately on the Ohio return?  No.  Ohio law requires your filing status to be the same as your Federal return.

Monday, December 12, 2011

Who is RITA and why is she bugging me?

I once had a client who's wife accused him of having an affair because of the checks he kept writing to "Rita".  She apparently was not aware that RITA is the abbreviation for the Regional Income Tax Agency.   My client was simply trying to comply with the tax laws of his city by paying his quarterly estimates.

Ohio is one of the few states where cities impose their own income tax.  There are approximately 600 different city income taxes in Ohio.  RITA administers city taxes for 198 municipalities in Ohio. Another large company that administers city taxes is the Central Collection Agency (CCA).  The city of Columbus administers several neighboring cities in addition to their own.   In northeast Ohio, RITA and CCA dominate.  And many cities choose to administer their own tax returns; among these are Euclid, Eastlake, Solon, Parma, and Lakewood.

You are required to file your city income tax return based on where you live.  Most taxpayers work for someone else and receive a W2.  Employers must withhold city income tax based on where the employee performs the work.  But what if you work in a different city than where you live?   That's where we get to the idea of reciprocity - a  fancy word to tell us how much credit your residence city gives you for work performed in another city.  If your hometown has 100% reciprocity you get full credit for withholding or payments to another city.

You are also required to file an income tax return if you are self-employed or own rental property.  Profit on these endeavors is taxable to the city in which the business or rental property is located.

Townships don't have any city tax; no tax return is required for residents. How about that?

Thursday, December 8, 2011

A Christmas Wish About Tax Law Changes

I love to do taxes.  But I don't love last-minute tax law changes.

This is the time of year tax preparers are gearing up for tax season.  To be ready, we have to educate ourselves.  What new laws are in effect?  What old laws have expired?  What is Congress doing right now that may change the laws currently in place? What might happen for 2012?  

For the past two years, Congress passed tax legislation in December, effective for the current calendar year.
While these changes were of great benefit to most taxpayers, it makes quite a scramble for tax preparers, software developers, and the IRS.  Most people don't think too fondly at the mention of "IRS", but my guess is they were not too happy about these last minute changes. It's just so inefficient.

Perhaps you remember that last year e-file was delayed about a month for some tax returns.  Certain deductions and credits that expired were extended and the IRS had to update their software to reflect current laws.  It took the IRS several weeks to get those new tax laws programmed into their system. That's really isn't too bad if you consider the scope of the project.  The cost must have been enormous.  Private software companies had to make the same last-minute changes to their software.  No doubt the cost is passed to the consumer.  Tax preparers were left with unhappy clients and unfinished returns until the changes were implemented.   Again, it's inefficient and unnecessary.

Though I wouldn't give up the tax changes that were passed at the last minute, I do wonder why they couldn't have been passed earlier.  My Christmas list this year includes a rule that all tax laws should be in place before the tax year begins.   I know it won't always happen, and in certain cases it shouldn't.  But wouldn't it be nice?