Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for October, 2005

Planning Ahead

Posted by taxguru on October 31, 2005

This email exchange was from early August.

Q-1:

Subject: 2005-1040

Kerry,
I have doing some tax planning and have been trying to find out what amounts that the IRS will use for tax year 2005 for standard deductions and exceptions. The only place I could find what I was looking for was on your website, which I am a bit skeptical about. One reason for my skepticism is you show “Updated Tuesday February 01.” I doubt that the IRS would have known what those numbers would be last Feb. It shows the 10% bracket extended to $14,600 which was surprising, as I didn’t know it was indexed to inflation, and if it were would indicate an inflation rate of 4.3%. 

 

A-1:

The current update date showing up on that page is just the last date I made any modifications to that page.  My FrontPage program automatically inserts the date whenever I change anything.

The info on that page was actually posted on 9/23/04, as mentioned in this blog post.

Thousands of people have linked to my page with the 2005 rates since I posted it on 9/24/04 and you are the very first to express any doubt as to its accuracy.

You can see the same info on the 2005 1040-ES form.

What may have you confused is the fact that when things like the standard deduction are adjusted for inflation, that can only be done in increments of $50, which does often give us a little more bump up than the actual change in the CPI.

I hope this clears up your confusion.

Kerry Kerstetter

Q-2:

Kerry,
 
Thank you for your prompt response. My skepticism was in part because I tried to Google that information up and hit a dead end everywhere but for your website. I thought if this information were valid that I would have likely also found it somewhere else.
 
The reason for my wanting to know this is for tax planning purposes. A couple of years ago I made what for me was a surprising discovery. Going through the 18-page worksheet to determine how much of my S/S was taxable was not difficult but I could not understand just what it was that they were doing to me. In order to help comprehend what was going on I put together a spreadsheet increasing taxable income (line 3) $1,000 per column and the results was surprising.
 
As an accountant you may be aware of what follows, if so I have wasted my time but if not I think you would be interested in this.
 
I knew that when they started taxing S/S that you are taxed on $1.50 for every extra $1.00 of income. What I did not realize was that this also effectively caused a narrowing of the 10% bracket. Suppose the bracket is $14K wide and you start pay taxes on S/S after using $8K worth. You only have $4K of the 10% bracket left as the taxing S/S effectively narrows the bracket by $2K.
 
When S/S begins being taxed your effective marginal rate (EMR) is 15%, (10% of $1.50). Once you get to the 15% bracket, your EMR is 22.5% (15% of $1.50). If you reach the trip point where $1.85 is taxed for every $1.00 of income you EMR is 27.75% (15% of $1.85). After 85% of you S/S is taxed you go back to 15%.
 
I realize that knowing this is of no use to most people but I find myself in a unique situation where I think I can use this to my benefit or the benefit of my heirs. Instead of minimizing current taxes I am trying to optimize taxes for the longer term. As I receive a non-taxable disability benefit from the VA we have adequate income without paying any income taxes. I have about $500K in regular IRAs and as I am not yet required to take minimum distributions I think it is to my benefit to move regular IRA money to a Roth. I feel that if I don’t move those assets now it is likely to cause me or my heirs to pay more taxes later on. I feel that at a minimum I should move enough money to use up the 10% bracket. However I am less sure that I am on the right track doing what I am doing, which is to have a target income that just avoids the EMR of 22.5%.
 
I did read your letter opining that Roths will likely be taxed in the future and I fully realize that tax planning is often futile because of the fickle ways of Washington.
 
A-2:

You certainly do a lot of number crunching to work with that nefarious penalty on “evil rich” SS recipients.  You are absolutely right that the effective marginal tax rates are frequently higher than those in the official IRS schedules because of the things triggered by AGI, such as credit and deduction phase-outs, as well as the taxability of SS.

Converting conventional IRAs to Roths would compound these ripple effects for the years in which you report the income on the conversion.  Whether the tax hit now will be worth it down the road is a bit of a guessing game.  However, I do still have serious doubts that our rulers will leave the tax free status of Roths intact for those they consider to be evil rich.  I hope I’m wrong; but you are already experiencing the effects of the exact same kind of  promise-breaking with taxes on your SS.

I hope you have set up a computerized worksheet for these calculations because this would be a lot of work by hand.
 
Good luck.

Kerry

Q-3:

Kerry,
I spent quite a bit of time laboring over this spreadsheet and now the number crunching is all done automatically. I imagine it would have been pretty easy for someone that is fluent in Excel but I am kind of a self-taught klutz so it was slow going for me. The first 18 lines mimic the 18-line worksheet in instructions for 1040. The added lines compute your EMR and the dollar amount of taxable income that triggers the change in EMRs. Anyone can use it by inputting the dollar amounts into those cells shown in red to reflect their personal situation.

A-3:

Thanks for sharing that Excel worksheet.  That is a very interesting approach to looking at the effective tax rate on your SS benefits.

I hope you’ve seen the 2006 tax rate schedules which I have posted on my website.

Kerry

 

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Reamus – God of Taxes

Posted by taxguru on October 31, 2005

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Scary Halloween Sayings

Posted by taxguru on October 30, 2005

Number Six – “Your future Social Security check depends on us landing high-paying jobs” – wouldn’t be so scary if we were ever allowed to drop out of the current Ponzi Scheme arrangement and set aside our own money for our retirement.

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38 New TaxMan Songs

Posted by taxguru on October 30, 2005

For the many people who appreciated the live version of Nickel Creek’s rendition of George Harrison’s classic TaxMan song that I posted a few months back, I have found the Mother Lode.

Being so far in the boonies, I’m not able to make it in person to many live concerts.  However, many artists are willing to have their performances taped and shared with fans for free.  For the past several months. I have been downloading concerts from the Live Music Archive and playing them through my computer and office surround sound system while I work. 

A few weeks ago, I noticed the search function, which I had previously thought was only for finding bands, and typed in “TaxMan.” It came up with 38 hits, many by groups I had never even heard of.  Over the past few days, I have finally been able to download all 38 to my main computer.

The cuts each range from a little over three minutes to almost 16 minutes in length.  Altogether, they total almost four and a half hours if you stack them up and play them back to back, which I am doing right now.

As you can see by the list below, there are several versions by the same groups.  However, that doesn’t mean they sound the same. The reason these groups allow their concerts to be taped and shared is the fact that most of them are of the jam-band ilk, where no two performances are done the same way.  They are the complete opposite from the more famous pop stars of today, who charge their fans huge sums of money to see them lip-synch to their studio recordings while dancing around the stage.  The jam-bands, most famously represented by the Grateful Dead, make each performance completely unique, and thus encourage their fans to capture them for posterity.

As with all of the concerts on the Live Music Archive, some give you a choice of formats to download, including MP3 with the smallest file size, while others only have the much larger SHN format, which music purists claim is of higher quality.  I haven’t noticed much difference in quality, so I choose the MP3 when given the chance.  SHN files can be played with the free WinAmp program.

The 38 songs that came up in the search are by:

String Cheese Incident – 13
Steve Kimock – 1
The Green Onions – 1
Moonshine Still – 4
Mutual Admiration Society – 12
Bockman’s Euphio – 3
Virginia Coalition – 1
Myoclonic Jerk – 1
Ruder Than You – 1
Go There  – 1 (Instrumental)

These music files are legal to download and use for your own personal non-commercial entertainment.

 

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Posted by taxguru on October 29, 2005

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Posted by taxguru on October 28, 2005

Four Key Factors to Consider When Hiring a Listing Real Estate Broker – Some good ideas for finding someone who is competent to help you sell your type of property.

 

Small-Business Owners Aren’t Saving Enough – I’ve never been a big fan of saving lots of cash or considering anyone who doesn’t to be unprepared for retirement if they have instead used that money to invest in their business or in quality assets, such as real estate.  Selling off one’s business for either cash or monthly payments can produce much more retirement income than any cash type savings.  Ditto for real estate.

 

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Official IRS Inflation Adjustments For 2006

Posted by taxguru on October 28, 2005

For those who have been hesitant to rely on the computations by outsiders as to the 2006 Federal tax rate schedules and other things that are adjusted annually for inflation, IRS has released its official calculations.  As this announcement mentions, the annual gift tax exclusion will be raised to $12,000 as of 2006, just as predicted by the wizards at CCH a month and a half ago.

Full IRS schedule – 19 pages pdf

 

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Posted by taxguru on October 28, 2005

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Changing tax systems isn’t easy

Posted by taxguru on October 27, 2005

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Posted by taxguru on October 27, 2005

Bush Eyeing Low Tax ‘Legacy’ Excellent goal.  It’s too bad that his other legacy has already been cemented as the highest and most reckless spending president ever in the history of our country.  Refusing to veto any of the out of control spending bills from Congress makes him just as guilty in violating his fiduciary responsibilities in regard to the taxpayers’ money.

 

IRS Discussing Early Concept of Information Return Clearinghouse – Having one big central location for everyone’s tax records couldn’t ever go bad, right?  Doesn’t anyone recall all of the other big IRS screw-ups when it came to computer technology and guarding information confidentiality? 

 

Schwarzenegger Nixes Tax Enforcement Bills – Protecting the people against increasing the already Gestapo-like powers of the PRC tax collectors.

 

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