A few weeks ago, I offered you the opportunity to ask David Bergstein, professional tax analyst and CPA, your tax questions and a chance to get a free account at CCH CompleteTax.

Some of this is pretty technical, but I wanted to get your advanced questions answered, so here are David’s answers.

“IWTYBR readers posted some excellent questions. One of the main categories appears to be related to homes. So, I’d like to tackle that area. Before I do, let me just caution you that these are general comments not specific tax advice. For tax advice about your specific situation, you should seek the one-on-one guidance of a CPA.

Advanced tax breaks for home owners

Home ownership is both a blessing and a curse. The blessing is you have a place to live and hopefully, over time, you will build equity. As I read the questions, there seems to be a lot of interest in what happens when you sell your home. So I will give Ryan, ZT, Chris, Steve and everyone else information to start with that can be followed up with a visit to a CPA or a site such as www.completetax.com where you can access the free Tax Guide for additional detail and examples that will help you.

Starting with the basics: Generally, a taxpayer may exclude from gross income up to $250,000 (or $500,000 for qualified spouses filing jointly) of gain on the sale or exchange of a principal residence. The taxpayer must have owned and used the home as a principal residence for an aggregate of at least two of the five previous years. The exclusion applies to only one sale or exchange every two years. In the simplest of terms, an exchange is basically a swap of properties.

Ownership and Use Test. The required two years of ownership and use need not be continuous. The test is met if the taxpayer owned and used the property as a principal residence for a total of 730 days (365 x 2) during the five-year period before the sale. The ownership and use test may be met at different times (i.e., ownership of previously rented home), provided that both tests are met during the five-year period before the date of sale. Short temporary absences for vacations or seasonal absences are counted as periods of use, even if the taxpayer rents out the property during those periods.

The home that is sold does not have to be the principal residence at the time of the purchase or sale. For example, taxpayers could move into their vacation home, convert it into their new principal residence and have up to three more years to sell their old principal residence to take advantage of the exclusion. The residence also doesn’t have to be a traditional house. It can be a condominium, houseboat, house trailer or stock held by a tenant-shareholder in a cooperative housing corporation.

Amount of Excludable Gain. The entire gain on the sale of a principal residence may be excluded up to $500,000 for married individuals filing jointly if:

(1) either spouse meets the ownership test,

(2) both spouses meet the use test, and

(3) neither spouse is eligible for exclusion by virtue of a sale or exchange of a residence within the last two years.

If the spouses do not meet all three requirements, the exclusion is determined on an individual basis and equals the sum of the exclusion limitations to which each spouse would have been entitled had they not been married.

With this basic background, let’s look at a few of the questions readers asked.

Ryan wanted to know if he qualified for a prorated exclusion. The exclusion is prorated if a taxpayer does not meet the two-year ownership and use requirements in the case of a sale or exchange due to a change in place of employment, health or unforeseen circumstances. In such cases, the amount of the available exclusion is equal to the amount of the applicable exclusion ($250,000 or $500,000) multiplied by the ratio of:

(1) the shorter of

(a) the aggregate periods during which the ownership and use requirements were met during the five-year period ending on the date of sale; or

(b) the period after the date of the most recent sale or exchange to which the exclusion applied, over.

(2) two years.

The five-year period may be suspended during any period that the taxpayer is a member of the uniformed services or Foreign Service on official extended duty. A sale will be considered as occurring primarily because of unforeseen circumstances if any of the following events occur during the taxpayer’s period of ownership and use of a residence:

(1) death;

(2) divorce or separation;

(3) becoming eligible for unemployment compensation;

(4) a change in employment that leaves the taxpayer unable to pay the mortgage or reasonable basic living expenses;

(5) multiple births resulting from the same pregnancy;

(6) damage to the residence resulting from a natural or man-made disaster, or act of war or terrorism; or

(7) condemnation, seizure, or other involuntary conversion of the property.

From Ryan’s post, it appears he sold his home to study abroad. That is not one of the IRS-defined reasons for allowing a prorated exclusion. However, if additional circumstances (as outlined above) apply to his situation, he may be able to take a prorated exclusion.

Steve questioned whether he had to pay taxes on the sale of his home in one year even though he then used that money to purchase a new home the following year. Generally speaking, your tax obligation related to the sale of your home has nothing to do with whether or not you purchase a new home with the proceeds. The tax obligation on the home you sold is related to whether or not the profit you realized exceeded the $250,000/$500,000 exclusion. If not, then no capital gains are owed on the proceeds; if gains were more than this, then taxes are owed on that amount.

ZT also had a question on selling a home. Several costs related to closing are deductible. These include the interest and real estate taxes that are allocated to the seller; and for the buyer, the points, interest, real estate taxes and costs for private mortgage insurance. When you sell a house you add the expenses of fixing it up to the basis to reduce you gain. Sales commissions reduce your amount realized and thus your gain also.

Chris wonders if he should be able to take some of the home-related deductions for a home jointly owned with someone else. Generally speaking, you are entitled to deduct interest and taxes on residential property that you own as either your primary or secondary home. If this is the case and the home is jointly owned with one person having taken all the deductions, then both parties would need to file amended returns for the specific tax years if they now decide that the deductions should have been shared. Rules are different if the property is investment property, if it’s rented out, etc. In instances like this, where there are multiple parties and extenuating circumstances, consulting a tax professional is strongly advised.

Darkling, Kode and Elizabeth all have questions related to the first-time homebuyer tax breaks. I wrote about these in my previous column.

Let’s start with Kode’s question about the timing of taking the first-time homebuyer credit. If you purchased a home in 2009 and already filed your 2008 tax return without taking the credit, you can file an amended return to claim the credit on your 2008 tax return. But you do have to have purchased the home before July 1, 2009, to take the credit on your 2008 return. You do use the form F5405. There is confusion because the initial F5405 for 2008 only included the $7,500 credit, which also was to apply to homes purchased in 2009. Earlier this year, however, legislation changed the rules for first-time homebuyers who purchased their home in 2009, increasing the credit to $8,000. This required the IRS to create a new F5405 for 2008. So, another group of people that may want to file an amended return are those that purchased a home in 2009 and are eligible for the $8,000 credit but used the old F5405, taking only the $7,500 credit. The IRS may issue specific instructions here on whether they will automatically do this but there is nothing at this point in time

Darkling bought a home in 2008 and asked whether he could take the more generous $8,000 tax break for 2009 or was stuck with the $7,500 tax credit offered to first-time homebuyer in 2008 that needs to be paid back. Timing is everything. As of this point, the new rules for 2009 are not retroactive. So, if you purchased your first home in October 2008, then the $7,500 credit that must be repaid applies, assuming you meet the other criteria for this credit.

Finally, Elizabeth asked whether there are downsides to taking the first-time homebuyer credit on the 2008 tax return if you bought the home in March 2009. If you take the credit on your 2008 tax return, you will lower your tax bill immediately, and you will still be able to take the home-related deductions in 2009.

These were all great questions. The above should provide you a general starting point at the least. As always it’s a good idea to follow up with a CPA if you have complicated tax issues or use a site like www.completetax.com to help you with preparing your taxes.

About the Author: David Bergstein, CPA, is a tax analyst for CCH CompleteTax.

Winners: As promised, we’ve chosen the 10 best questions we received and are giving them each a free accout with CCH CompleteTax. The 10 winners are:

Uriel, Laura, Chris, Henry, Karen, Andrew, Deb, Candice, Satya, Amanda

Congratulations to our winners! We will be contacting you within 24 hours with your free codes.

While Ramit focuses on teaching you how to be rich, I can share with you a few pointers on taking advantage of tax breaks that may be available to you, because paying more in taxes than you owe is a sure way not to get ahead.

One of the first things to understand is that not all tax breaks are created equal. For example, there are tax credits and deductions. Credits are a dollar-for-dollar reduction in your tax bill. Deductions, on the other hand, reduce your taxable income. Say you are in the 25-percent tax bracket. A $500 deduction reduces your tax bill by $125, while a $500 credit lowers your tax bill by the full $500. If ever forced to choose, go for the credit.

So what credits and deductions do you need to know about? Well, that depends on your specific circumstances, but following are a few that apply to many individuals, particularly younger taxpayers.

It’s important to note that the tax code is now more than 70,000 pages and includes not only what is taxed, but also the tax breaks. So, to really hone in on the tax breaks best for you, your best bet is to get some help. Tax software, such as CCH CompleteTax, that walks you through the tax prep process can be an incredible time saver because it asks you questions specifically designed to identify tax breaks for which you may be eligible.

That said, here are a few credits and deductions you should be thinking about as you prepare your 2008 tax returns.

Credits of Note
Two special tax credits worth noting for 2008 are the recovery rebate and first-time homebuyer credits.

• You may be able to claim the recovery rebate credit if you did not receive a full economic stimulus payment last year. For example, say you made too much money in 2007 to get the full stimulus payment, but were laid off in 2008. Your 2008 reduced income may make you eligible for the recovery rebate.

• If you bought your first home in 2008, after April 9th, you may be eligible for a first-time homebuyer credit of up to $7,500, which must be repaid after 36 months in the home. The economic stimulus package enhances this credit for 2009, increasing the credit amount to $8,000 for taxpayers buying their first home in 2009 and removing the payback requirement, so long as you stay in the home for at least 36 months. Also, a bit confusing, but if you buy your first home in 2009 before July 9, 2009, and before you file your tax return, you can take the first-time homebuyer credit on your 2008 tax return. For both years, the credit begins to phase out for taxpayers with adjusted gross income above $75,000 ($150,000 for joint filers).

Other credits important to know about, particularly for younger taxpayers, include credits for post-secondary education expenses. These include the Hope Credit offering up to a $1,800 credit and the Lifetime Learning Credit offering up to a $2,000 for 2008. Both have specific restrictions, including income eligibility, and, if you take one, you can’t take the other. Looking forward to 2009, the economic stimulus package renames the Hope Credit the American Opportunity Tax Credit and temporarily increases the credit to $2,500.

Deductions You Want to Consider
Even though credits save you more than deductions, you still want to take deductions when you can.

Two common deductions that have special twists for 2008 are the standard deduction and the standard mileage deduction.

• The 2008 standard deduction ($10,900 for joint filers and $5,450 for single filers) adds a temporary property tax deduction, which allows taxpayers who do not itemize deductions a limited deduction for state and local real property taxes. Taking this deduction can increase a single filer’s standard deduction by $500 ($1,000 for joint filers).

• The standard mileage rate also has a twist for 2008 thanks to a mid-year rate change. For the first part of the year, the deduction was 50.5 cents per mile for business and 19 cents for medical and moving travel; and for the last half of 2008, the deduction was 58.5 cents for business and 27 cents for medical and moving travel.

Also worth noting, if you moved to take a new job, the cost of your moving may be deductible. If you were one of the unlucky ones and lost your job, the cost of your job search may be deductible.

In addition to the education credits mentioned above, there also are post-secondary education deductions. These include a higher education tuition deduction for up to $4,000 in qualifying expenses and a student loan interest deduction of up to $2,500 base on interest paid on the loan.

Finally, exemptions are another area of tax breaks to know about. There is a personal exemption of up to $3,500 available to most taxpayers. If you’re lucky enough to work for an employer that offers Qualified Transportation Fringe Benefits, you also don’t have to pay income taxes on these benefits. Additionally, if you are in the military, any pay you received while serving in a combat zone in 2008 is exempt from income tax.

Taking Action & Getting Help
As I mentioned, the above are just a handful of the many tax breaks that may apply to your circumstances. If you want to learn more about any of these, you can read up on them in the CCH CompleteTax Tax Guide 2009. If you just want to have CCH CompleteTax help figure it out for you, you can go to www.CompleteTax.com.

About the Author: David Bergstein, CPA, is a tax analyst for CCH CompleteTax.

Tax giveaway: Do you have tax questions? I’ve arranged to have David answer your specific tax questions — plus, the best 5 questions will get free accounts at CCH CompleteTax. Each is good for tax prep for one 2008 federal and one 2008 state tax return valued at $29.90 to $49.90. Leave your questions below.

Things will get a lot harder before they get better.
All the predictions about the recovery taking until “at least the end of the year” are horseshit. In truth, nobody knows, but it would be political suicide to admit that a recovery — whatever that means — will take a few more years. The truth is, nobody knows how long it will take. But if there’s one thing Americans love, it’s a leader pretending to know everything. And if there’s another, it’s that Americans love a quick fix…only to later complain about it not being done right.

Your questions about how “quickly” we can get out of this crisis are misguided.
Sometimes a forest needs to be cleaned out with fire before it can grow again. Again, an unpopular position. Since the government has virtually unlimited resources, it can certainly alleviate the pocketbook pain we’re feeling…but it will come back to bite us in the ass later.

Not all homeowners deserve to stay in their houses.
Renting is a perfectly reasonable alternative, but the idea of Americans “losing their houses” is politically untenable. Why? Because America perpetuates a mistaken culture of homeownership. Owning your own home is the kind of BS sacred cow that got us into this mess: Our parents tell us to buy a house. Our friends are impressed if we own a house in our twenties. The government literally encourages us to own a house by offering tax deductions. Homeownership is the American Dream!

The truth is, if you’re making the largest purchase of your life, you need more than a slogan — you need to take the responsibility to do some research. (And note that you can’t advocate for increased homeownership and also argue for Americans to keep their houses. By not reducing the prices, younger people cannot buy houses at these inflated prices.)

Yes, there was an exceptional amount of predatory lending.
For every blogger who argues loudly about personal responsibility, an angel dies and an Ogilvy executive lights a marshmallow in hell and eats a delicious snack. Wall Street and realtors are also to blame for this. But so are average Americans. It’s difficult to have a nuanced discussion about real estate on the campaign trail, so we resort to cartoonishly simplistic caricatures of things like Wall Street’s corruption. True — but also take a look in the mirror.

Homeowners are delusional about how much their houses are actually worth (see this, too).
As a wise commenter said, “I love the fact that it’s “acceptable/normal” for a home to increase its value by 100% during a five-year time frame, but it’s “unreasonable/impossible” for a home to decrease it’s value by 30-40% during a similar time frame.”

Taxes: Pandering to ordinary Americans instead of telling them to stop spending on stupid stuff
The reason Obama and McCain spent so much time talking about taxes is that most Americans are historically horrible at managing their spending. Since they make a fixed amount of money (revenue) and can control only one thing (costs), both politicans use tax breaks to pander to voters. Most people have never seriously thought about how to make more money. Fine. But what’s even more outrageous is Obama and McCain’s complete lack of honesty about what people really need to do to weather the economic crisis. Did you hear either one plainly say, “You’re going to need to buckle down and save more?” Of course not. You might as well walk into a Dave Ramsey seminar and argue that credit cards are a useful tool. It’s a suicidal suggestion. But it’s true.

Shut up about your money worries unless you’ve taken the time to read a book about how money really works
You need to read a couple of good books about money. Not read the screaming headlines of CNN.com. But a real book that explains how money works. If you don’t, do you really have the right to complain about how scared and nervous and worried you are about your money? (Note: If you want to get my favorite book recommendations, sign up for my free newsletter by Friday, 10/10/08. In fact, I’m giving away free personal-finance books in the upcoming weeks.)

Americans don’t know how to be frugal — yet
Things will get more expensive. Taxes will eventually go up. They have to. Costs of ordinary goods will go up. They always do. If you’re expecting it to get easier, you’re wrong. The key is to make more money and cut your costs. Sadly, Americans are poorly versed in being frugal. You think it makes sense to buy a new car every few years? You think it’s normal to eat out 5 times per week (lunch and dinner)? You feel good about yourself for ordering water when you go to a restaurant, but you blew $50,000 because you didn’t take the time to understand your mortgage? You’re not frugal. But a few more years of an economy like this and things just might change.

Sensible investors don’t change strategies very much — even in a market like today’s
With the market cratering hundreds of points every day — then climbing a similar amount the very next day — billions have been pulled out of the market. Yet long-term investors have the discipline to stay steady. Panicked spouses and overconfident investors think they know better by trying to time the market, but they’re wrong. In fact, here’s an excerpt from my upcoming book:

Recently, a group called Dimensional Funds studied the performance of the S&P 500 from January 1970 to December 2006, during which time the annualized return of the market was 11.1%. They also noted something amazing: Of those 36 years from 1970 to 1986, if you missed the 25 days when the stock market performed the best, your return would have dropped from 11.1% to 7.6%, a crippling difference.

Now, if only we could know the best investing days ahead of time.

Of course, we can’t. That’s why I continue to dollar-cost-average money into the market, slowly. Will it go down in the short-term? Almost certainly. But as my funds get cheaper and cheaper, I’ll pick up more and more shares. And eventually — over a 10, 20, or even 50-year time horizon, I’ll make a significant amount.

But encouraging people to continue investing during times like this wouldn’t be received well. More often than not, politicians need to seem to be doing something — ANYTHING!! — in order to keep you happy. Frankly, with a balanced portfolio, there’s really not much to change. But that’s not sexy enough to tell most people. (Plus, they have no idea what a balanced portfolio is.)

Sorry if I was too harsh. I’m usually not political, but I’m tired of the bullshit around our money. Every single one of us knows co-workers, family, or friends who are worried about their money. It’s time to get honest about what’s going on. (Want to read more? Check out my popular articles, personal-finance links, and my forum.)

More to come in future posts.

I’m trying something new: If you liked this, please digg this article.

Get an automatic 6-month extension by filing a simple IRS form.

And if you still haven’t picked up a copy of the 2008 Tax Makeover Guide, check it out here:

My college roommate JRK sends me some interesting thoughts about the upcoming government tax rebates from an MIT report. As usual, it’s not just about rationality, but about the form in which the money is delivered (debit card vs. check):

• [The 2001 tax rebates] “show that taxpayers spent about two-thirds of their rebates within six months of receiving checks.”

• “The 2008 rebate program is aimed at low-income households, because these households are the least likely to save the rebates.”
• “…rebates that are received as electronic deposits may seem less like spendable cash, and more like potential savings, than checks that taxpayers receive in the mail”
• “I suspect that giving people a prepaid debit card will do more to rejuvenate the economy than mailing out checks, but direct deposits wouldn’t be nearly as effective,” Ariely said in a recent commentary for the Marketplace radio program. “I also suspect that if we added a line on the debit card that reads ’spend the government’s money’ this would work even better.”
• “If consumers save rather than spend the money, there will be no stimulus”

Anyway, how often have you heard this phrase?

“If you get a tax refund, it means you’ve given the government too much money.”

This oft-repeated phrase assumes rationality: ‘If you get a refund, it means you sent extra money to the government! Why would you let them make interest off your hard-earned money? You should only send the minimum amount!’ Then these people are usually out of breath because of their own self-proclaimed brilliance.

Technically, they’re right. I live in a world of reality, however, which means that “technically” isn’t always correct. Here’s why I’d rather get a tax refund than owe the government money:

First of all, if you end up owing the government money at tax time, most people don’t have extra cash lying around. We know this because they are horrible at managing their money and have record debt rates. Sorry, it has to be said.

Second, how much interest are we really talking about? Let’s say you get a government rebate of $600. At my high-interest ING account, that’s $1.50/month in interest. Oooh, the government is making bank off my money! Get a life.

And, in fact, people’s opinions reflect this:

…when asked if they’d prefer to owe taxes, get a refund or break even, none said “owe,” according to the USA TODAY/Gallup Poll. Fifty percent hope they break even, and 45% hope they get a bigger refund this year than last.

In real life, $600 that you owe to the government would affect your life far more than getting $600 back, meaning it’s better to get money back than to owe it. So if you end up getting a tax refund, don’t feel bad. And don’t just follow what the pundits say. We live in the real world, and there’s a difference between the best decision and the financially smart one.

Read more or buy now.

Bonus: The first 5 people to purchase the ebook will receive free copies of H&R Block’s TaxCut software (a $59.95 value, free).

Today, this article is specifically for college students. I know, I know. You feel guilty because your parents are paying thousands every semester while you're busy napping all day and trying to spit game at the girl next door. And failing.

Your parents may be able to save on taxes if they follow some of the instructions below. Take a look and send them this article.]

Are you in college or about to attend college? Are you in your junior or senior year? Consider sending this to your parents. This article has a lot of with ideas that may help save your parents thousands of dollars each year and may even put some extra money in your pocket.

I can sense it now. You must be feeling some pride (or bewilderment) that your college student is thinking about how to help you financially and how to make your life a little easier. Who would have thought that your student would start to get a financial clue?

I’ve coached many families who already have college students or will soon have at least one child in college. There are ways to successfully navigate the waters of paying for college. In this article, I will share a game plan with you, the parents, to make your life easier and to help your student get off to a strong start in the real world. I will also provide you with some tax-savings ideas that may speed up your progress even faster.

Let’s first look into the financial future of your college student once they graduate.

Post-Graduation Snowball

As you are probably aware, the typical college graduate has both credit card and student loan debt. Recent graduates have an average of over $19,000 of student loans and over $3000 of credit card debt. The typical graduate degree student leaves with $24,000 to over $100,000 of student loans.

So, your college graduate begins the new season in their life and the snowball builds….

Then, your graduate buys the new car (take it from someone who bought the new car one month after walking the stage – it happens a lot). Another $300 per month in payments out the door.

Then, your graduate rents the nice apartment as they are sick and tired of dorm life or the college apartment. Oh yea, that nice apartment makes the college furniture look nasty. New furniture on the MasterCard – PRICELESS.

Then, your graduate starts making payments on the student loans (sure, the interest rate might be fairly low, but the payment still stinks). Potentially hundreds more of outflow each month.

Then, all of their friends start to get married and everyone starts dropping serious cash on wedding gifts, parties, travel, dresses, and tuxes. The numbers here really add up when you multiply by the number of friends.

Maybe it’s none of these events – maybe they spend $300 per month eating out. Maybe it’s buying cool gadgets. I’ve coached many clients in their 20’s. Their stories are different, but the result is generally the same. The debt adds up quickly and the minimum monthly debt payments grow substantially.

About this time the two big “M-words” might sneak up – Marriage and Mortgages. You get the picture.

The good news is that the snowball does not have to claim your graduate. They can thrive financially if they live off a budget, get out of consumer debt, and avoid going into additional student loan debt.

The best financial coaching advice that I can share with you, the parents:
Help your child graduate with as little or no debt as possible.

Why? Because when they are free of consumer debt and student loans, they can really begin to thrive financially and to build a hopeful future for themselves.

Let’s say your graduate didn’t have that “normal” student loan payment, the “normal” MasterCard payment, those 2 payments could can easily add up to several hundred dollars per month. Instead, he or she invested $300 per month from age 25 to age 65 in a retirement account earning 8% per year. At age 65, they could have approximately $1 Million in retirement savings. Obviously the cost of living will go up, so it won’t feel as big. But it gets them off to a great start towards retirement savings.

Winning with College Expenses
Here is the overall game plan I share with my clients. It does take some work, but it is truly worth it to follow as many of the strategies as possible.

• Save-Save-Save. If you have time before one of your children heads off to school, save aggressively with an Education Savings Account (ESA) or a 529 College Account, or even just a high-yield savings account. My favorite resource for these 529 and ESA plans is www.SavingForCollege.com. If you are just a couple of years away, I would avoid investing in 529’s or ESA’s as the value could go down if invested in stock mutual funds. I would stick with a high-yield savings account in that case.
• Proactive Scholarship Hunting. Get proactive and diligent about applying for scholarships and grants, even if your student is midway through college. Don’t give up!

• It’s possible to find thousand of dollars in scholarships and grants. I recommend Ramit’s postings on these topics. He really knows how to win in this area.
• Hire a scholarship coach. I send some of my clients to a productive scholarship coach. She consistently helps her clients find $10,000 to over $40,000 of scholarship and grant money.

Review Tax Savings Ideas
Make sure you research every possible income tax savings opportunity – this could save lots of dollars every year of college. By making tax-smart moves, you can free up more money to pay cash for college.

Here is a list to review that may help to boost your plan. Some are best handled by your personal tax accountant.

• Maximize your Hope and Lifetime Credits. These are great credits if you qualify – see IRS Publication 970 for details. The Hope Credit may only be claimed for 2 tax years per child and can only apply to the first 2 years of post-secondary education.
• Deduct Student Loan Interest. If you are already making student loan payments, you may qualify to deduct a certain amount of interest paid on student loans. See Publication 970 for limitations.
• Continue to Keep Your Student as a “Dependent”. This assumes that you continue to provide at least one-half of their support. Refer to Exemptions in the Form 1040 Instructions.
• Hire your student. If you are self-employed or own your own business, hire your child to perform bona-fide work at a reasonable salary. Keep records of time worked, duties, etc. You can deduct their wages as a business expense. This is a more complex strategy that probably would best be handled by your personal tax accountant.
• Buy-off campus housing. This is for wealthy parents only. I recommend that you do not consider this option unless your primary residence is paid for (no mortgage), you have a substantial emergency fund, you have no consumer debt, and have accumulated a large retirement account (Yes, I know this advice is very conservative). You can “hire” your child to be the property manager. You can also potentially deduct the housing property taxes on your Schedule A. This strategy requires a clear game plan – take your time and don’t rush in. Once again, this one is best handled by your personal tax accountant.
• Make sure your student has health insurance coverage. This is not a tax strategy, but important enough to mention as a “protect yourself from a financial blow-up” strategy. One serious trip to the hospital could set you back from $5,000 to $20,000 or more without health insurance on your student.

Tomorrow’s article will outline a financial game plan for the newly engaged and the newly married.

Todd Doerr is a personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at todd_doerr@yahoo.com or at www.taxmakeover.com.

[Update]
1. See the two other articles Todd wrote:

• What to do before you file your taxes this year
• What to do, tax-wise, if you’re recently engaged or married

2. Then check out his eBook, The 2008 Tax Makeover Guide

[From Ramit: Since tax season is here, I wanted to write something about the tax issues we face. But since I'm not an expert, I've typically turned to guest posters to help. Last year, David Bergstein answered your tax questions.

This year, I've invited Todd Doerr to guest-post for the next three days. Over the next 3 days, he'll write about taxes for three situations: people in their twenties, college students (I know you're lazy so you can just point your parents to the article to do all the work), and recently married couples. And on Friday, after the three posts, I'll announce something pretty cool.

I like this post below because Todd points out that if you're already saving, why not take a small extra step to dramatically increase your returns?]

Stop. Turn off your ipod. Turn off your phone.

This one post will help you win with money – guaranteed – if you take ACTION. If you are in your 20’s or 30’s, this is going to rock your world.

I coach many individuals and families in my financial coaching practice – they pay me to help them quickly get out of debt and build wealth. Hopefully you are already saving some each month towards retirement. Why not spend an hour to setup a simple, automatic wealth building plan that will double your return?

I’m amazed that only 31% of Generation Y workers (born 1978 or later) are saving for retirement in their 401k, according to Hewitt Associates. You can be light years ahead of your friends if you follow the coaching advice that follows. It will only take an hour of your time – your friends will be amazed!

Let’s dive in – stay with me!

Let me go ahead and spell out the entire purpose of this post:

The Roth IRA is one of your most important wealth building tools. Maybe even the most important. If you consistently invest in your Roth IRA during your working years, you will build substantial wealth.

OK. Maybe it was a little heavy, but I want to get your focused attention for a few minutes. Let’s cover the basics first.

The Nuts and Bolts of the Roth IRA

Here are some of the common questions that I get about the Roth IRA:

Q: Why should I care about a Roth IRA?

A: The short answer: You don’t want to work the rest of your life. Using a Roth IRA consistently, in addition to your 401k, will make you very rich and will change your life. I would argue that if you save aggressively in a Roth IRA, you will open up new options and freedoms in life that you cannot fathom today.

Q: What is a Roth IRA?

A: A Roth IRA is simply a retirement savings account offering amazing “back-end” tax breaks when you take money out at retirement age (59½ years and older). The Roth is a “bucket” – you fill that bucket with good conservative mutual funds (I don’t recommend individual stocks).

Q: How hard is it to setup?

A: 1 Hour – I’m dead serious. I’ll cover the specifics later in this article.

Q: What are some specific benefits?

A: You can withdraw funds without taxes or penalties once you’ve reached age 59½ and held the funds in the Roth for five tax years after the year you make your first contribution. Here’s an example. Let’s say that you worked your buns off for 30 years and had $1 Million dollars in your Roth. When you retire at age 59½ years (or older), you can take out the $1 Million TAX-FREE. It also grows TAX-FREE each year during your career. Don’t think you can save $1 Million? Keep reading on.

Q: What are the limits on a Roth IRA?

A: You can contribute $5000 annually to a Roth ($10,000 for married couples), whether you participate in an employer plan (like 401k) or not, if your AGI (line 37 on Form 1040) is less than $116,000 (joint filers, $169,000).

Q: Anything else I should know about it?

A: You can withdraw your contributions penalty-free should you need them for an emergency. You can contribute at any age as long as you have earned income. There are some

A Sweet Retirement

OK. Onto the cool stuff. Go ahead – take a peek. Wow.

The tables below show what you could have in your Roth IRA if you invested monthly or annually during your career. These numbers assume you invested in a diversified, conservative set of mutual funds that could average 11% annually (stock market has averaged over 11% for over many decades).

You must really like that $400 car payment! Or, maybe the gym membership isn’t looking so fiscally fit anymore. And for sure, the minimum payment to Visa could be put to better use! Maybe the $200 per month for eating out is not so appetizing.

Here are some specific and exciting ways to boost your savings plan.

• $100 – $200 – $300 – $400 per month of savings: Go through your budget and find the “luxury” items – you will be amazed when you cut a little here and there. These things add up. My favorites include: driving a used car and dropping the fat car payment, drop the premium cable channels, cut back on the cell phone plan or drop your land line at home, selling the cat (just kidding!), bring your lunch to work except 1 day per week, drop the gym membership, take basic vitamins instead of $100 per month, only buy clothes that are mega-bargains, cancel subscriptions that you don’t really have time to read – the list goes on. You won’t miss these and will truly enjoy knowing you have a plan to win with your money. Get yourself motivated and start making changes now!
• $200+ per month of savings: Work a part-time job to speed up your progress. Ask your employer for overtime opportunities. Provide a tutoring service. Deliver pizzas (you can make $750/mo doing that). Mow yards or provide handyman services. Start a pet sitting business. Get creative. Get your real estate license. Write software on the side. Don’t analyze this too much – just go for it. If you don’t like your first part-time job – just find another one. This is not a FOREVER job.

Anyone in America with a decent income can win! The key is to start TODAY and not hesitate. Set your goal and don’t stop until you reach it – $100 – $200 – $300 – $400!

Annual amount – Assuming 11% return

Monthly Investing Results – Assuming 11% return

My

To Get Started in less than 1 hour

STEP ONE: Don’t file your taxes yet. The good news: You can still make a “2007” contribution if you open a Roth IRA before you file your income tax return.

STEP TWO: Open an account TODAY. The sooner you start, the sooner you start the magic of compound interest.

• Find $5000 $4000 (the new 2008 limit is $5000) for your “2007” contribution. If you don’t have $5000$4000 right now, just put in whatever you free money that you have. $500 – $1000 – it doesn’t matter. You must get started!
• Autopilot for 2008. Setup an auto-draft from your checking account each month and have the money invested automatically. It’s too easy to get distracted during the year to write a check each month – set it up once and let it run. Your target amount should be $416 per month ($5000 divided by 12 months). If you have to start small, that’s OK. As you can see, even $100/mo is HUGE at retirement. And don’t forget the next time you get a raise, bump up your monthly investment by even more.
• Open an account at a low-expense, customer friendly mutual fund company. Simply tell them “I would like to open up a new Roth IRA and make a contribution for 2007. I would also like to setup an automatic investment plan each month for 2008 and beyond.” I highly recommend T. Rowe Price and Vanguard as a great place to open a Roth IRA.
  • T Rowe Price. You can start with as little as $50 per month on most mutual funds. Contact them at www.troweprice.com or 1-800-638-5660.
  • Vanguard – They have higher minimums amounts to start, but offers lower annual expenses than most companies. Contact them at www.vanguard.com or 1-877-662-7447.
• Choose a conservative “growth and income” mutual fund or balanced fund to get started. These should be funds you plan to hold for a lifetime. You can diversify later into different flavors and styles of mutual funds. For right now, these will work fine.
• Leave it alone! If you look at the long history of the stock market, 97% of any 5 year timeframe had a positive return. Don’t try to get fancy, time the market, buy individual stocks – stick with the basics. You want your foundation to be strong – don’t tinker with it. Invest and leave it alone.

Retirement Savings Goals

In case you are wondering how much you should save each year for retirement, your overall savings goal should be about 15% of your gross income (most of my clients are in the 10% – 20%), in the following order:

• Fund your employer 401k plan up to your maximum employer’s match.
• Max out your Roth next up to $5000 (or start with a Roth if no company match).
• Finish out the 15% by investing more in your 401k.

Friends, Laziness, and Boosting Returns

OK. You now have a vision for building significant wealth.

But what about your friends? Many of your friends probably don’t get it. Why? Because they haven’t seen that significant wealth is possible for the “average” person with an “average salary”. Share this article with them. I’ve found that it helps to have like-minded friends shooting for a hopeful future.

If you are feeling lazy – you better wake up! I have made it abundantly clear that 1 hour of your time will rock your world. You don’t have to do heavy analysis each month – set up this plan on autopilot and let it run. If you are so lazy that you can’t spend 1 hour on this, then, whew, life is not going to be easy in your later years.

If you are already saving some, you can turbo charge your results by using low-cost mutual funds that I recommend in this article. Using mutual funds that cost 1% less per year than the average mutual fund could boost your total nest egg by nearly 25% over a 30 year time span. Instead of $1,000,000, you could end up with another $250,000 for a total of $1,250,000.

Final Thoughts – Keep it Simple and Automatic

It’s amazing, but you can actually thrive and build wealth with a simple, “boring” diversified portfolio in your retirement accounts. The Roth IRA should be a serious part of most wealth building plans. Open your account today.

Be sure to join us tomorrow. I will be sharing some specific ways to find $1000 Dollars for college expenses.

Blessings,

Todd

Todd Doerr is personal finance coach. He helps his clients to rapidly get out of debt and to build serious wealth. He tells his clients, “It’s not always easy or pretty, but it always works.” You may reach him at todd_doerr@yahoo.com or at www.taxmakeover.com.

[Update]
1. See the two other articles Todd wrote:

• How college students can save their parents tax money
• What to do, tax-wise, if you’re recently engaged or married

2. Then check out his eBook, The 2008 Tax Makeover Guide

Here is post 3 of 3 from David Bergstein, professional tax analyst and CPA. Below is an overview of how to think about taxes generally, then David’s answers to specific questions from iwillteachyoutoberich readers on this post.

See David’s previous posts here and here.

A special thanks for David and Mary at CompleteTax.com, who gave us not only these great posts and answers to specific questions, but also gave away 5 copies of their tax software at http://www.completetax.com.

It’s time for the last post in this series of how accumulating wealth requires you consider taxes. We started off discussing that “taxes are a fact of life” and then continued by stating that the only way for you to become rich is to “take responsibility for building your wealth” yourself by becoming financial literate as it relates to taxes and money. At this point it is time to look at what resources you have available to accumulate wealth.

Investments are an ideal way to accumulate wealth. The suggested types of investment, I will leave to Ramit to cover in more detail. Another important aspect of investment, though, is whether and to what extent your investment is something that produces taxes now or something that defers the tax on the gain until you are in a lower tax bracket. The younger you start to invest in an IRA or a 401K plan of one type or another, the sooner you start to accumulate tax-advantaged principal.

The first step is understanding what different types of 401K and IRAs you may want to consider, which depends on your income and your objectives.

A traditional IRA allows you to contribute up to $4,000 for the year 2006 and 2007 to an IRA account, with that money coming from pre-tax dollars, meaning you get to deduct it from your income for income tax purposes in the year you make the contribution. To be eligible for the tax benefits of a traditional IRA, single filers need to make under $52,000, with the benefit phasing out completely for those making $62,000 or more for 2007 (for 2006, the income limits are $50,000 phasing out at $60,000). If you’re married, then you need to make under $83,000, with the benefit phasing out completely for those making $103,000 or more for 2007 (for 2006, the income limits are $75,000 phasing out at $85,000).

There is also a Roth IRA, which has the same $4,000 contribution limit for 2006 and 2007. With this type of IRA you are not allowed a deduction from income but the money you invest will accumulate tax free. To be eligible for the tax benefits of a Roth IRA, single filers need to make under $99,000, with the benefit phasing out completely for those making $114,000 or more for 2007 (for 2006, the income limits are $95,000 phasing out at $110,000). If you’re married, then you need to make under $156,000, with the benefit phasing out completely for those making $166,000 or more for 2007 (for 2006, the income limits are $150,000 phasing out at $160,000).

The decision of which IRA is best depends on your income level and objectives: would you prefer to put in pre-tax dollars, and allow the income to grow tax-free, paying taxes only as you withdraw funds during retirement? If so, then a traditional IRA is more likely the route to choose. If, though, you’d prefer to pay taxes now, let the funds grow tax free but then have to pay taxes on the interest income when you’re in retirement, then the Roth IRA is worth considering.

There’s no right or wrong answer and, in some instances, individuals choose to contribute to both types of IRAs over the course of their lifetime. In both cases you accumulate wealth and principal through tax-advantaged investing.

One word of warning, though: The ultimate goal of IRAs is to save for retirement, so there are generally taxes and penalties assessed for early withdrawal. But there are ways to take money out early without penalties, for example, up to $10,000 can be withdraw for buying your first home.

If you are working for an enterprise that has a 401K plan (or a 457 or 403(b), which are similar types of saving programs) then you have additional tax-advantaged saving choices, which don’t limit your investments based on income.

Investments take many forms and contributions to a retirement plans are only among a few of the choices. There are many other choices including investing money in the bank or bonds, earning interest that is either taxed or tax exempt or investing in stocks that appreciate or pay dividends or, better yet, both. If you hold stock for over a year it is considered long term and the tax rate is lower for long-term gains than it is for short-term gains. So another principal of accumulating wealth is being patient, and knowing how to off-set gains with losses for tax benefits.

Investing in real estate is another choice and renting it out another. Investing in rental property yields a double benefit if you do it wisely. It appreciates and it produces a positive cash flow through rent. Additionally, it can produce a tax loss because you can depreciate the property over its estimated useful life.

I can go on and on with different scenarios but you should make it a practice to regularly read up on the different vehicles or places to invest your money. Ramit’s blog is a great resource as is regularly reading financial papers like the Wall Street Journal. To learn about specific tax benefits of each choice you can consult a tax guide either in print or if you prefer, CompleteTax has a free guide at http://www.completetax.com/taxguide/text/c60s10d405.asp).

Hopefully these columns on taxes have started a number of you on the road to financial wealth as it relates to taxes. Minimizing your tax liabilities and accumulating wealth is hard work and involves planning so take the time to do the reading and studying. It will reap benefits as your assets accumulate.

Now, let’s address a few specific questions submitted on taxes on investments as well as taxes related to marriage, education and charitable donations.

Question 4. Even though retirement is a long way off, I would like to know how the IRAs – traditional and Roth would be taxed when taking the distribution. If you could write about this and other tax related information with regard to capital gains all your readers would greatly benefit.

Posted by JM at March 23rd, 2007 at 8:42 am

ANSWER (EDITED BY DAVID BERGSTEIN FROM FIRST POSTING): I’ve addressed this in detail above, but the basic difference is that you would use pre-tax dollars to fund a traditional IRA (assuming you meet the income requirements) and the dollars – both the amount you invested and any interest earned – would then be taxed upon distribution at retirement. With a Roth IRA you would use after-tax dollars. Those dollars would not be taxed (again) upon distribution, but any interest would be taxed.

Question 112. Could you give a general explanation of how various retirement account contributions (in Roth IRA vs. Traditional IRA vs. 401(k) vs. 403(b)) affect tax filing? Which have deductible contributions and which factors are considered in eligibility requirements for those that do?

Answer: A 401K is a plan that is generally established by a profit-making entity whereas a 403(b) is established by a non-profit entity, such as a church, public school, etc. From the IRS site http://www.irs.gov/retirement/article/0,,id=108942,00.html: “With a 401(k) plan, employees can choose to defer some of their salary. So instead of receiving that amount in their paycheck, the employee defers, or delays, getting that money. In this case, their deferred money is going into a 401(k) plan sponsored by their employer. This deferred money generally does not get taxed by the federal government or by most state governments until it is distributed….Basically, 403(b) plans are similar to 401(k) plans maintained by for-profit entities. Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary. In this case, their deferred money goes to a 403(b) plan sponsored by the employer. This deferred money generally does not get taxed by the federal government or by most state governments until distributed.”

With both, you can contribute as much as $15,500 for 2007 ($15,000 for 2006) as well as an additional $5,000 if you are over 50 years old. Your contribution is made with pre-tax dollars if you use a traditional 401(k) or 403(b) plan. If you use a Roth version of these plans, then your contribution is made with after-tax dollars.

Question 118. If I start an IRA for myself and my wife can I subtract that from our adjusted gross income and pay a lower tax rate?

Posted by Marshall Middle at March 29th, 2007 at 5:43 am

Answer: There’s no easy answer to this. It depends on several factors, including your joint income, contributions you’ve made to other retirement plans and your age. Some information on the rules and tables that may help you is accessible at http://www.completetax.com/taxguide/text/c60s10d582.asp.

Question 43. I did a 401(k) rollover this year. I got a 1099-R form for the distribution, but no paperwork for putting it back in. Should I have? If not, how do I show that I shouldn’t be taxed on this distribution?

Posted by Dustin L. at March 15th, 2007 at 10:19 am

Answer: Smart move on your part to rollover. But it sounds like you took possession of the funds for a period of time as you indicate you put it back in. Generally, the best approach is to do a direct rollover of any money in retirement plans because if you don’t have it rolled over into the new retirement account within 60 days you will have to pay a tax and a 10% penalty on top of that. If you had done a direct rollover your 1099-R would have a distribution code in Box 7, which would be the letter G. If you did not do a direct rollover then the 1099-R would have a different distribution code in Box 7, which is explained on the back of the 1099-R. So you do not need additional paperwork.

Question 47. For 2005, I was employed at 12.48/hr from 1/1-3/31; unemployed from 3/31-7/31, employed at 32k/year from 7/31 to present. My son lives with my sister in another state, but I pay his college tuition. I am also a student, but the Dept. of Labor pays mine. How do I file; can I take a credit/deduction for his tuition? How do you maximize donations?

Posted by Carol at March 15th, 2007 at 12:11 pm

Answer: Wow. You’ve got a lot going on. There are a number of different education deductions and credits that you may be eligible to take related to paying your son’s tuition, assuming you claim him as a dependent on your income tax. You can read more about these at http://www.completetax.com/taxguide/text/c60s10d756.asp. However, if you do not claim him as a dependent – either because your sister or another family member does so, or because he is no longer a dependent, then you won’t be able to take any of the deductions or credits. As for your question on donations, the rules have tightened, so it’s all the more important to keep records of your donations. For example, you must have receipts for any property donated that’s valued at more than $250; starting for 2007, all cash contributions of any amount must be substantiated. Also as of August 18, 2006, generally household items or clothing that are not in good used condition can not be deducted.

Question 13. I’ll be getting married this year. Is there anything I should do this year to minimize next year’s tax payments?

Posted by AJ at March 14th, 2007 at 5:22 pm

Answer: Congratulations. One thing you should do is change your W-4 form to reflect that you are married if necessary. The reason I say “if necessary” is because I’m assuming you and your spouse will now file a joint return which will have to take into account both of your incomes and deductions. Generally speaking, it’s advantageous for most married couples to file jointly. There is a W-4 calculator located at http://www.completetax.com/calc.asp. Another consideration – though many couples shy away from it – is to draft a prenuptial agreement. No one likes to discuss the end before the start, but the reality is that divorce is costly. So, particularly if you have significant assets already or expect to accumulate or inherit significant assets, it’s worth considering such an agreement.

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From Ramit: If you’re interested in learning more about retirement accounts, read my previous post, The World’s Easiest Guide to Understanding Retirement Accounts

Part of the deal is also giving away 5 CCH CompleteTax passes for state/federal tax return prep and filing for random people who ask tax questions.

Today I’m giving away the last 3 passes for tax questions people asked. Congratulations to embarrassed (commenter #97), Andy (#105), and Sachin (#107) for getting CompleteTax passes.

David’s final tax answers, Part 3 of 3, will go up in a couple of hours.

See Part 1 here.

Are you ready to be rich? In the last post we discussed how paying taxes is a fact of life. Along with paying taxes comes the responsibility to regard almost every decision you make as relating to taxes.

The question of should I be self employed or should I be an employee has taxing implications. If you are self employed you are responsible for both halves of your FICA taxes not just the employee portion. If you accept a job offer because it pays more but does not include fringe benefits such as health insurance or retirement benefits, it may not be the wisest choice. You have the ability to deduct business expenses if self employed but not personal expenses, even though novices often believe that they can write off almost anything.

Whether self employed or an employee, if your goal is to accumulate wealth and prosperity, you must have a plan, specifically, a financial plan of what you are going to do to reach your goals. The choices you make allow you pay more or less in taxes. The general guidance is to defer recognizing income if you can and it is appropriate, and to accelerate expenses that reduce taxes. Everyone’s situation is different, but a good example of this: Joe buys land for investment purposes for $20,000 and its market value increases to $100,000. Should he sell it or should he exchange it? There is something called a 1031 exchange which allows him to defer recognizing the gain on this transaction. This is where I could go into detail on the pros and cons of both or I can ask you to become financially literate yourself by starting to seek out information about tax savings ideas. Another, even more common question is: Should I put money in to a CD and earn x% interest or should I put money into a tax-exempt investment where the principal accumulates tax free? There are reasons to do both.

“Are you ready to be rich” means that you have to take fiscal responsibly for your actions – not just work all year and then have someone do your taxes at the end of the year – when you are simply reacting to your situation rather than determining it . Build a plan, work the plan, save regularly and think taxes. People who accumulate wealth think and work on it every day.

Question 6. I own my own small business and work from an office in my home. Is it better to have my company pay me rent, or to take a home office deduction? Posted by Courtney at March 14th, 2007 at 4:08 pm
Answer. This is an interesting question and the answer is dependent on a number of things. If your business is a sole proprietorship you must file a Schedule C which is a part of your 1040. So if you pay yourself rent, which goes on your Schedule E and also a part of your 1040, you really don’t accomplish anything except maybe reducing your self-employment tax. The answers change as you put together a financial plan of where you want to be (as stated in the beginning of this column above). For example, if you want to write off rent and other expenses, it may be wise to incorporate your business and then pay yourself rent, which means rent is deducted from your corporate return and then picked up on your personal tax return. The only way for a CPA to give you the best advice is to sit down with him or her and detail your situation. The earlier in the year you do this, the better as it allows you to take full advantage of any tax savings strategies you decide upon.

Question 11. I run a small online business and I’d love to find out more about the kinds of deductions that I can make and any other ways of running or structuring my business to reduce the tax burden. Since I am self-employed I end up paying 7% more on my taxes than those that have a regular job. Are there any real tax advantages for a business?
Answer. There are real advantages to having a business and the legitimate deductions that go with it. In many instances you can establish a 401k plan and shelter your income. In some cases individuals travel for both business and pleasure and write off the entire airfare for business if the trip is primarily for business and not overseas. Different rules apply to overseas travel vs. domestic travel. These are just a few things to think about but it’s generally advisable for entrepreneurs to speak to a CPA or at the very least read books on how various types of income are reported and what types of expenses are deductible against your income. A good suggestion is to look at a tax guide on the web such as: http://www.completetax.com/taxguide/text/c60s15d165.asp).

Question 14. I’ve never payed taxes before and got a job this year as a consultant at a software engineering services company. Since I am not technically an employee, and am a consultant, I know my tax burden is higher. Is there anything I can do to lessen this?
Answer. This is another one of those questions that says you should research whether to be paid as a consultant or become an employee. A number of corporations are hiring independent contractors (consultants) to keep their costs down. If you are not an employee then you do have the added cost of paying both halves of your social security contributions, commonly called FICA. A self-employed individual, however, can deduct many business expenses that an employee would not be able to. For example, you might be able to deduct the health insurance you pay directly from your income rather than as an itemized deduction where you can only deduct an amount in excess of 7.5% of your adjusted gross income. Most likely you also will have an automobile expense deduction for mileage or depreciation and other items that are called “ordinary and necessary expenses paid and incurred in carrying out your trade or business” such as supplies, telephone, etc.

Question 32. How do I make an offer of a settlement on taxes I owe to the IRS? What are the requirements?
Answer. This is a very good question that can be answered by sending you to the IRS website at http://www.irs.gov/businesses/small/article/0,,id=104593,00.html which explains what an offer in compromise is and whether this is the best way for taxpayers to resolve their tax debt. I’d also suggest that you seek the advice of a CPA. While many individuals are adept at preparing their taxes themselves, if you’ve not been paying your taxes, trying to sort through this without an advocate may be extremely difficult, and may leave you with a settlement that is higher than it would be with representation.

Question 38. My question has to do with taxes for next year. I am expecting a return of about 1,000 dollars, and currently am claiming “1″ on my withholdings. Should I change my withholdings for next year? Is this a worthwhile change?
Answer. Raising this question is a good example of you taking control of your taxes – and keeping your money with you, where it belongs. If you are getting $1,000 back, that means that you essentially gave the IRS an interest-free loan over the year. Personally, I would rather have my money during the year than wait for a check at the end of the year. To determine how much you should change your withholding, you can go to http://www.completetax.com/calc.asp and find a number of free calculators that will help you. Once you’ve made the adjustment, I would suggest that you take the extra money that you will be receiving in each paycheck and invest it in something that will earn you a return on your investment or place it in a retirement fund for the future.

Question 50. I finished school in May and am now self employed as a contractor. My income stems from a 1099, and I’m told that I probably have to file quarterly. However, I’ve also heard that I can somehow save money by not filing quarterly, and just paying the penalty every year. Is that true, and under what circumstances?
Answer. I would advise you to pay the estimated taxes on a quarterly basis rather than pay penalties. It doesn’t make sense to ever pay a penalty when with proper tax planning you can minimize your tax liabilities.