Answering Your Tax Questions
To conclude our Tax Tips series, The Saturday Early Show headed out to the streets of New York City to find out what viewers really want to know.
Financial advisor Ray Martin answers their questions:
Q: When are my taxes going to go down?
Martin: For starters, the current marginal income tax brackets, which range from 10 percent to 35 percent, are the lowest we have seen in a generation. For example, in 2005, a couple with adjusted gross income of $50,000 filing a joint tax return will expect to pay about $4,385 in federal income tax, and single filers with $50,000 can expect to pay about $7,177 - this compares favorably to what these filers would have paid in 1975, about $14,260 and $18,360 respectively.
At this point, it's unlikely that tax brackets will go any lower. That said, there are some things that can lower your taxes, such as:
- Contribute pre-tax contributions to retirement accounts – It reduces taxable income and qualifies you for valuable tax credits.
- Buy a home – It increases your itemized deductions
- Use all available deductions and credits that you are eligible to receive.
The point is, don't sit around waiting for taxes to go down. Learn about all the deductions and tax credits that are offered on your tax return and determine what you can do to qualify for them. These are the best ways to lower your taxes.
Q: Why are my taxes so high, and why can't pensions be tax free?
Martin: There are several things that can cause your taxes to appear "high":
- Not claiming all the tax deductions and tax credits for which you qualify.
- Incorrect preparation of your tax return and/or calculation of tax (which can be solved using a tax prep computer program or a tax prep pro)
- Lack of tax planning – Plan receipt of income and deductible expenses from one tax year to the next to remain in the lowest tax brackets each year. As mentioned earlier, you have to take responsibility for making your taxes as low as possible.
Income from a pension generally is taxable because when pension benefits are earned over your working years, you generally do not pay tax on them. This money has to be taxed as some point. Therefore, it follows that since this benefit was never taxed, it is taxed the year you receive it.
However, many states allow pensioners to exclude a portion of their annual pension benefits from state income tax - for example, in New York, retirees can exclude up to $20,000 of their pension income each year from their New York state taxable income.
Here's some good news. Retirees collecting Social Security retirement benefits should know that up to 85 percent of the Social Security benefits might be tax free. You need to complete the Figuring Your Taxable Social Security Benefits Worksheet in your income tax instructions to calculate this. You should also note that any portion of pension income that is a return of contributions that had already been taxed is non-taxable - this should be noted on the W-2P or 1099R you receive that reports your total pension income for the past year.
Q: Is there a penalty if you file two years' worth of taxes at the same time?
Martin: In short, if you are late paying the IRS, there is a penalty. If the tax return is filed late with reasonable cause (there is a lot of latitude here - but "the dog ate my return" doesn't cut it), the IRS may not assess a penalty. But interest will be charged on the tax you owe, at a 5 percent rate.
If there is no reasonable cause for your late payment, the IRS can asses a late filing penalty of 5 percent of the tax due for each month the return is late, up to a maximum penalty of 25 percent. There is also a late payment penalty of 0.5 percent per month on the net tax due, up to a maximum of 25 percent.
Generally, taxpayers who failed to file a prior year's return should prepare and file the late return as soon as possible - there are two very good reasons for this:
- If you owe money, you'll want to settle up with the IRS as soon as possible so that the IRS will stop accruing interest and penalties on the amount you owe. The longer you leave a tax obligation unpaid, the larger the interest and penalties can be, and this can potentially become more than the taxes owed.
- If you are entitled to a refund for that year, you'll want to get the money - the IRS generally imposes a "three year look back" meaning if you wait to file for a refund for more than three years, your request for a refund will most likely be refused.
The bottom line: File the late return as quickly as possible to settle up or get the refund you are owed.
Q: I just graduated this past year from college. And so I've been working for about six months in 2004. And I also was a student for six months. I want to know, are there any deductions that I can get for my college tuition that I paid earlier in the year?
Martin: There is a deduction of up to $4,000 allowed for college tuition and the related fees you pay if your income is less than $65,000 or less than $130,000 if filing jointly.
You may also be able to claim the Hope Scholarship Tax Credit of up to $1,500 - the trick is that you cannot claim both the deduction and the credit for the same expenses - so you'll need to determine which can save you more money.
Also, if you paid interest on a qualified student loan in 2004, you may be able to claim a deduction of up to $2,500. These deductions are allowed even if you do not itemize any deductions.