Should you hire a tax preparer or DIY?

Here's a question from a Twitter follower who's striking out on his own:

I usually avoid tax questions, and for good reason: I'm not a CPA or tax preparer, so anything dealing with the specifics of a return, etc. is more than I'm qualified to answer. This, though, is a general question and important to answer since so many people are going through career transitions and need to make similar decisions.

Your employment status shouldn't necessarily dictate whether you do your taxes on your own or hire someone. You need to consider the complexity of your return and how confident you are that you can do it without errors that might hold up a potential refund or trigger an audit.

Even though I held only one full time job in most years, for example, I still used a CPA to file my taxes. It cost more than just using Turbo Tax, but I've never been comfortable enough with the dizzying tax forms to want to do even a basic return myself.

If you're uncomfortable with filing taxes on your own, hire a qualified CPA or tax preparer. It will save you headaches, and possibly money down the road. Thanks for the question.

Single mom wonders about tax withholding

With April 15 around the corner, most of us are focused on getting our returns in on time or on getting whatever refund we're owed. But right now's also a good time to think about preparing for next year's tax season by adjusting your withholding for the current year. That's what one friend asked me about recently:

I'm never quite sure how to fill out my W2 forms. I'm not sure what number I should put down for withholding, although I was told not to put down more than 2 to avoid owing the government. Also, for the state, I don't know whether it is better to claim an exemption for my dependent or myself.

My first piece of advice here is that whenever you're unsure about a tax issue, it's always best to consult with an accountant. That doesn't mean you have to go out and hire one, but most people either know someone personally or know someone who knows someone who prepares taxes for a living and asking that person for five minutes of their time costs nothing.

Now, here's my totally (non-legal, non-cpa) opinion: instead of just punching in a 0, 1 or 2 on your W-4 (that's the withholding form; the W-2 is the tax statement your employer sends you at the end of every year), read the actual instructions and follow them. the W-4 is more than a form, it's a worksheet designed to help you estimate in advance which deductions you're eligible for and to structure your withholding around those. In short, it's a way to make sure that you're keeping all the money you should keep all year long, instead of giving it to the government, which is what happens when you get a big tax refund every year.

As a single mother, it's entirely possible that you may be eligible for more than two deductions as you might qualify, for example, as head-of-household or for a child tax credit or earned income tax credit. You might also be eligible for a deduction for qualifying childcare expenses. Going through the worksheet and talking with an accountant or tax preparer might reveal that you should actually put a 3 or 4, instead of a 1 or 2.

Being concerned about owing the government is legitimate; in that case you could still do the worksheet and then subtract one or two from the number it suggests just to stay on the safe side.

Good luck.

image courtesy photoxpress

How can I save as much of my tax refund as possible?

A great question from one of my formspring followers:

As one of the fortunate folks who MAY be getting a refund, what tips would you suggest to save as much as one can of said refund?

I can't say this enough to people: getting a refund only means you've paid the government more than you should have all year long. They take that money, use it for other stuff and give it back to you months later with no interest. Great deal for them, sucks for you.

Were I you, I'd readjust my withholding to make sure you're only paying what you should and hold onto more money throughout the year. That's a better way to save because you'd get that full year to earn interest on all that money rather than getting it all at once having received no interest from the government at all.

But that won't solve the dilemma of how to save the refund you already have coming. My advice would be to start wherever you can get the biggest return. Often that's by paying down debt as opposed to putting the money into checking, savings or investments. Sounds counter intuitive but it's not.

Think about it: if you have a credit card balance that you're paying 18 percent interest on, you save more -- at least in the short term -- by paying that balance down or off than you would by putting the same amount of cash into an account or investment that returns you five percent.

If you have no credit card debt, then look to beef up your emergency savings. You should have at least three months' worth of living expenses stashed away in cash somewhere (and by somewhere I don't mean under a mattress).

If you've done both of those things, you're in great shape and might want to try this little trick that would help you save AND reduce your tax burden for next year. Open an IRA or contribute to the one you currently have by putting the money you got from this year's tax refund into that account.

When next year's taxes come around, some of that money that you put in might be tax deductible, as is the case with many IRA contributions. Check with your financial adviser of the bank handling your IRA to be sure of the rules and exact tax ramifications. Good luck.

image: Viola Joyner/photoxpress.com

Avoid these top tax mistakes

Last week I wrote about the unexpected $5,600 tax bill that's my 2010 debt burden. I did that to myself but you can avoid my mistake, and the top five mistakes that cost taxpayers each year, according to Michael Ellis, a certified public accountant and the new resident tax expert here on the Money Corner. I asked Mike to give you some tips since tax time is here.

Underpaying your taxes

As an employee:

1.) Underpaying taxes or under withholding taxes. Whether you're self-employed or an employee, your taxes are due throughout the year to the IRS and your own state. The IRS requires that taxes be paid as taxable income is earned, which is why instead of receiving your actual “gross” salary, taxpayers you get your “net", which is the amount you are entitled after state and federal taxes are withheld every pay period.

However, the amount of taxes withheld is determined by you when you fill out the W-4 with your employer. Claim too many allowances and you may underpay your taxes and find that you owe a significant amount more -- including penalties and interest for underpaying your taxes. The easiest way to fix this pitfall is to pay close attention to your W-4 when you fill it out and reassess your allowances every year to account for changes in your tax situation.

As a self employed taxpayer:

2.) If you're self-employed, you are responsible for making your own tax payments. The simplest way to do this is to make quarterly estimated tax payments to the IRS and state. Estimate your tax liability for the year based on either previous year's earnings or current year known taxable income and write quarterly checks to US Treasury and your state's revenue department. This is done with a voucher issued by IRS (1040-ES) and most state tax agencies. You may also make your payments online.

Failure to make these deposits usually results in substantial underpayment of taxes and subsequent penalties and interest. You will find yourself in a constant uphill battle to bring your tax payments up to date as you will probably still be earning taxable income as you try to catch up. The key to avoiding this issue is withholding at least 25% of every self employed check your receive in a separate account to use for paying your taxes. In some situations you may need to withhold up to 40% of your self employed income depending on your deductions and amount of income.

Missed deductions:

As a self-employed taxpayer:

3.) When self-employed, you are responsible for keeping your own records and receipts for business deductions that directly and indirectly relate to your business activity. Keep three things in mind when trying to determine what's deductible: Is the expense “ordinary” and “necessary” for your business to operate and is the expense “reasonable” in amount?

Use this criteria to be sure your expenses are deductible and you will substantially reduce your tax liability.

An easy way to avoid this problem is to always have a separate bank account for business activity that you use exclusively for business transactions. This way you will have a 12-month record of all income and expenses. Lastly, be sure to keep receipts for your business transactions and stay organized! Once the receipts get out of control, the likelihood of missed deductions increases.

Credits

4.) Tax credits are available for a variety of common expenses and situations that go unnoticed every year. Depending on your tax preparation method (tax preparer, CPA, boxed software, etc.) you may need to do a little research yourself to see what’s available.

The best way to do this is to simply Google “2009 tax credits” and you will find an abundance of tax credit-related articles that may help you plan and keep records for eligible spending like education, energy efficient property expenses, child tax credits or retirement savings credits.

Finally, if you use a qualified tax preparer, you may be able to plan for refundable credits such as the earned income credit and first time homebuyer credit by analyzing taxable income and delaying or accelerating income to help force you into eligibility. This is a tool best offered by tax professionals that may save you thousands of dollars.

Refunds

5.) The way you receive your refund may also save you money. Over the past 5 years, Refund Anticipation Loans, or RALs, have become very popular among eager taxpayers. These loans (usually issued by affiliated banks) will immediately issue your refund to you instead of waiting for the refund to be issued from the IRS or state.

But BE CAREFUL! The cost of these loans can vary widely but expect to pay between 3 percent and 5 percent interest for the benefit of a very short term loan. If you file your taxes electronically, your return could get to you in as little as a week. Meanwhile, the cost of a refund anticipation loan could be equivalent to a 97% to 2000% APR depending on the size of the refund and the actual refund dispersing date. In short, it's not worth it.

Michael C. Ellis is a CPA with Ellis and Company LLC in Germantown, Maryland.

image: Michelle Meiklejohn/freedigitalphotos.net

What do you wish you knew about money 10 years ago

Finally back from all that traveling: one week, four cities, three states. Yeesh.

The last leg of my trip inspired this post. I spoke to students at my alma mater, Coppin State University, about 10 things they need to know in life and about budgeting and money. What was interesting was that of all the questions I got on that trip, the thing students were most curious about was when I told them I don't like getting a big tax return at the end of the year. They didn't understand (like I didn't at that age), that getting a tax return only meant the government was giving them back money that they shouldn't have paid in the first place.

That got me thinking: what are some other things that you wish you'd known about money, say, 10 years ago, that you didn't know now? Leave your answers in the comments.