Personalized tax answers for iwillteachyoutoberich readers — Part 1

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Last week, I wrote about CPA David Bergstein’s offer to give advice to iwillteachyoutoberich readers’ questions. There are now over 100 questions on that post.

Below is something pretty incredible. We have real questions from iwillteachyoutoberich readers, and then a professional tax analyst/CPA who’s providing his expertise to answer blog readers. Can you imagine this happening a few years ago? This is a special deal for iwillteachyoutoberich readers only, and I’m grateful to them for offering their software and expertise to you.

As a sidenote, David is with CCH CompleteTax, which has generously offered to give away 5 pieces of their tax software and waive the filing fees. I’ll be giving them away to people who have asked questions on these posts.

Now, on to David’s advice. Remember, although David is a professional tax analyst and CPA (among many other things), you should seriously consider what he says and talk to a professional about your own situation. Neither he nor I assumes any liability for what you do. Be smart.

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Taxes are fact of life; you want to minimize what you owe.

Post 1 of 3 by David Bergstein

The name of the game in planning to be rich is to minimize your taxes legally where you can. Evading taxes is illegal but minimizing them is an American pastime. Many readers have come up with some great questions, and one topic that is coming up frequently concerns multi-state income – where you live in one state and work in another or where you work in multiple states.

For some, multi-state taxes become an issue even before they get their first full-time job. For example, if you are going to school out of state and working part-time while there and then working summers in your resident state, you generally have to file state income tax returns for both states. For your non-resident state, you would file a part-year or non-resident state income tax to report your earnings and withholdings that your out-of-state employer has taken out of your pay. You also generally will have to file an income return for your resident state, reporting your income for both states. But never fear: you can take a credit for taxes you paid to the non-resident state so you are not being double taxed.

Did you ever ask yourself why so many wealthy people choose to take residence in certain states? One credible answer is to minimize their tax liabilities or reduce what they have to pay out in inheritance taxes when they die. Tiger Woods lives in Florida – one of seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) that do not tax any personal income – so he does not have to pay state taxes on tournaments he earns money in while in the state of Florida. When he goes to Georgia and plays in the Masters and wins money, then Georgia wants its share of taxes for what he earned while he worked there. Likewise, superstars such as Madonna may have an affection for other countries like the United Kingdom, which may only get stronger with the understanding they can avoid a portion of the U.S. federal income tax as well as some state and local taxes.

If you are about to graduate college or change jobs check out the facts before you move to a particular location. Choosing options based on the largest paycheck may not be the smartest move given state and local tax rates (income, property and sales taxes). Also, make sure you move wisely by taking advantage of the Moving Expense deduction, which may allow you to deduct part of your expenses, lowering your taxable income. The expense can be deducted whether the move is for a first job or just a job change, but time and distance generally govern whether you can expense your move. You can read up on details of this at http://www.completetax.com/taxguide/text/c60s10d129.asp.

Question 8. I live in CA but worked over the summer in TX and was not taxed on income while there. I still claim residency in CA so I’m wondering if I need to pay taxes on the income earned while in TX… thanks.

Answer: The answer may not be one you want to hear but California determines whether you file a return or not based on your worldwide income and their instructions for the Form 540 resident return states that you should “Enter the total amount of your state wages from all states from each of your Forms (w-2)….” This is one of those cases where you do not receive a credit for taxes paid to another state because Texas has no personal income tax.

Question 21. I worked in NY state during the school year and California during the summer, but I was never a legal resident of California – in fact, the address I gave my California employer was my NY state home address. How will this affect my filing? I’ve never filed in two states before, so I’m a bit nervous about it.

Answer: Similar to the description earlier in this column, as a non-resident of California, you do need to file a California state tax return detailing your income from California. And, as a resident of New York, you need to file a New York state tax return detailing your income from both New York and California. However, you should be allowed to take a credit for taxes you pay to California on your New York return. So, don’t be nervous just be happy that you are earning money and now responsible for paying taxes to multiple states. As you make money you should start to think of how to minimize your taxes by taking advantage of 401k’s, IRA’s or other tax-reducing ideas.

Question 17. Money from Renters in your Primary residence: I am a home owner. I rent out a bedroom to someone, and I charge him a fixed rent, plus a portion of the utilities. Should I report this money as income? Or does it fall under ‘shared living expenses’, as I’ve heard people claim?

Answer: This is an interesting question as it might go both ways depending on the facts and circumstances. In your case, if this is your primary residence and you are “renting” out part of it, then you should report the rental income and offset it with the rental expenses. For example, expenses you pay for the house such as insurance, repairs, maintenance, etc. can be allocated against the income. You also may be able to depreciate a portion of the residence related to the rental room via square feet of that room to the entire square footage of the house as a way of reducing the income. Ultimately, it would be difficult to categorize what you describe as “shared living expenses” because this is your home and not just a case of two individuals splitting rent you are benefiting from this arrangement as your equity is going up as you pay your mortgage from this rental income.

Question 48. I just bought a house and expect to have about $31,000 in mortgage interest paid out over 2007. I know I can deduct that on my taxes for next year, but what else can I deduct? Would the mortgage interest be a separate category from Standard Deductions? I’m just wondering if I can be overgenerous with my charitable contributions and lump that together with my mortgage interest deduction. Thanks!

Answer: Good question on whether to itemize or take the standard deduction. Once you own a house it generally pays to itemize instead of taking the standard deduction. The standard deduction for a single individual in 2006 is only $5,150. A homeowner can deduct the interest on the mortgage as well as real estate taxes paid during the year. Charitable contributions are also an itemized deduction taken separately on Schedule A of the 1040 tax form in addition to your mortgage interest and real estate taxes. You may want to take a look at a Schedule A (http://www.irs.gov/pub/irs-pdf/f1040sab.pdf) to see the various categories of itemized deductions.

[Update]: See Part 2 of this series here.

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14 Comments

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  1. [...] [Update, 3/21/07]: Part 1 of David’s answers are online now. [...]

  2. Minimizing your taxes is not only the smart thing to do, but also the responsible thing to do. Sure there are those that are unethical about it, but most people are honestly trying to use their money the best way possible.

    It’s socially responsible to provide a nice home for your family (the mortgage interest deduction).

    It’s also socially responsible to give to others less fortunate than ourselves (the charitable contribution deduction).

    Most people would agree that we know better what to do with our money than the government. My advice would be to look for professional advice on your taxes sooner rather than later.

    Your CPA isn’t there only to fill out your forms for you but also to provide tax planning strategies for your next financial moves. (No, I’m not a CPA).

    By the way, nice sit Ramit.

    -limeade

  3. From what I understand, California is notorious for trying to get into people’s pockets when they really have no business there. My CPA told me about a client of his who worked as an independent contractor (1099) in Texas. The product he sold was imported directly to his customers in Texas from China. He never even visited the state of CA.

    But, the company that he worked as an IC for was incorporated in CA and they were trying very hard to tax his income, even put a lien on his home. Dealing with CA is difficult: There’s a lot of money in the state for the taking, but they want their cut, whether they deserve it or not. (Most likely not…)

  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.

  5. [...] has published the first part of his series of personalized tax answers. Ramit has a CPA friend who has agreed to answer various tax-related questions from [...]

  6. Deborah Lucena Link to this comment

    I always owe Ca State Tax even though my Federal is minimal or refunded. What can I change on my W4 to withold more so that I don’t have to pay state taxes in April? Every year, I fall about $2200 short on state tax. I currently have 0 allowances and an extra $100 pulled from every paycheck because for many years my husband had a variable salary due to self employment. He is still semi self employed, but also has taxes pulled from his weekly salary.

  7. Thanks for the help on #17. I live in California and rent out one bedroom and bathroom from my primary residence, and I haven’t figured out how to report this. With regards to
    “expenses you pay for the house such as insurance, repairs, maintenance, etc. can be allocated against the income”, does this include half of each of the Homeowner’s Association fees, general utilities, appliance installation, plumbing repairs? Thanks.

  8. Please answer this question for me. I used to live in New Orleans, now I live in Texas. Due to the hurricane I lost all my tax records, and now the state is sending me threatening letters to pay state taxes I know I already paid. They Are threatening to seize property from me. Is this something they can do now that I live out of state? Since I’m no longer a resident, what’s the worse they can do to collect what they claim I owe? Please let me know As soon as possible please, thanks.

  9. I went from a sole-prioretorship to an LLC in June of 2007. Do I have to file both a 1040 and a 1065? Do I pick one of the two? Can I do a 1040 this year, as my books were not really set up for LLC in my quicken for 2007?

    Second, my husband and I both work at home. He works at home as a telecommuter for his company, and I run the business from home. We have separate offices in our home. Can we both deduct our office spaces-his for his personal income tax, and mine fo the LLC taxes?

  10. i have a large investment loss, can i slit it up over multipal years, or is there a limit per year to claim amount, or does it have to be claimed all in onr year?

  11. can i claim my girlfriend as a dependent? she was a student part of the year and i provided all financial support she had no income.please let me know i’m getting mixed answers