Pay Down the Public Debt

The Tax Foundation Tax Policy blog is one of those hard-core tax geek blogs that I love even if I often disagree with their conclusions. Today, they have a lighter item that fits well with this blog. "Pitching-In to Help Reduce Public Debt"

With the April 17th tax deadline looming, Americans are feeling the weight of their annual income tax burden. But there's a quirk of the federal tax code that may actually entice taxpayers to pay a little extra to Uncle Sam this year: the ability to write a special check to help pay down U.S. public debt.

Each year a handful of Americans take advantage of this oddity in the tax code, voluntarily sending debt-reduction checks to the IRS along with their regular tax return. It's no surprise few taxpayers take advantage of it, since it's not well advertised by the IRS. There's no line on the 1040 form for "public debt reduction." However, the IRS website offers detailed instructions for those inclined toward charitable gifts to Uncle Sam's debt-relief fund:

How do you make a gift to reduce debt held by the public?
If you wish to do so, make a check payable to “Bureau of the Public Debt.” You can send it to: Bureau of the Public Debt, Department G, P.O. Box 2188, Parkersburg, WV 26106-2188. Or you can enclose the check with your income tax return when you file.

Tip: You may be able to deduct this gift on your 2006 tax return.

According to the most recent IRS Data Book, last year 48 taxpayers mailed in contributions to reduce the public debt, for a total of exactly $21,179. That's $441 per gift. Since 1982, there have been a total of 16,122 voluntary contributions to reduce the debt, for a grand total of $9.8 million—or about 0.00012 percent of the nation's public debt of $8,367,661,575,868 as of March 29, 2006 according to the U.S. Treasury.

So if you are really scared of the national debt and have a little extra cash, send some the Treasury's way.

How to work the Web to find work

The CS Monitor Work and Money section has a good article on using the Web to find a job. Why is this important? Only 5% of new hires are found via newspaper classified ads these days. More than half are found as a direct result of a job being posted on the internet.

Most companies use software to match a resume to a job. Many even have simple surveys on their website that can disqualify you based on your answers. It's a natural response to the flood of resumes that companies now receive thanks to the internet. The article lists five tips for getting your resume read.

1. Keep resume formats simple.

This is the easiest way to get your resume tossed. A font that looks great on paper is unreadable on screen. Add to that some companies still print returns and use a scanner to pick keywords from resumes. Non-standard fonts will cause a scanner to kick out the resume and it will never be entered into the system.

2. Match your resume to the job.

See #1. Tailoring your resume will take all of ten minutes and very likely could be the difference between getting an interview or not. Take the requirements for the position and change your previous experience to highlight how you've met the requirements for the position you are seeking (but be honest). Try to match as many of the requirements listed in the job ad, the more you meet the more likely you are to get an interview.

3. Consider an end run - or not.

This is the big debate. Should you contact a human in order to try and gain an advantage? I would suggest not doing it unless you have a connection in some way. My profession is all about networking, and since I live in a city with a small pool of taxpeople I can usually find someone I know that a tax manager knows. In that case, trying to get a contact might work. If you randomly call a company and ask the receptionist for the hiring manager, you're just as likely to get the janitor as anyone that can actually make a decision.

4. It's still 'who you know.'

See #3.

5. Always be honest.

This is a good rule no matter what you do, but is moreso in job hunting. In more technical fields, you will be asked about certain requirements listed in the ad to make sure you actually have that knowledge/experience. Almost every has a "probation period" to make sure that you can handle the job once you get there. Getting fired during the probation period will be a red flag to other potential employers, so be careful.

Ex-KPMG partner pleads guilty in tax case

The first crack in the solid wall has appeared. One of the KPMG partners indicted for selling multiple tax shelters costing the US billions of dollars has pleaded guilty in order to receive a reduced sentence.

The ex-partners (they were indicted and thrown out of the practice in order for KPMG to escape indictment) had kept a united front that the shelters were not illegal at the time they were created and were just creative ways to generate losses using the tax code.

The agreement with the accounting firm was an attempt by the government to not bring down another of the gigantic global accounting firms. What was once known as the "Big 8" has been reduced to five with mergers and the implosion of Arthur Andersen. Losing KPMG would mean that four firms would control the vast majority of large corporate audits and tax planning. Global corporations rely on the Big 5 because they have offices wherever the companies do and can audit and advise on local taxes. Many governments have already commented on the lack of diversity in the firms and losing another major firm would have been a large blow to the profession.

We will see if anyone else decides to flip now that one has. It's the classic prisoner's dilemma. Who do you trust?

What are your chances of being audited?

The IRS released it's latest data book which summarized the audit activity for fiscal year 2005 (ending September 30, 2005). 1.2 million returns were audited in FY 2005 out of 130.6 million filed, which works out to an audit percentage of 0.93%. So, you're chances are 1 in 100, right? Well, not exactly. It depends how much you made, what forms you filed, and how you filed.

If you made less than $25,000 and filed a 1040A, the audit percentage was 0.5%. If you filed the full 1040 (meaning you took itemized deductions), your chance of being audited tripled. Made over $100,000? Your chance of being audited acutally fell from 1.4% to 1.2% in FY 05. Are you a farmer? Congratulations! You had some of the lowest audit rates at less than 0.5% if you made under $100,000.

The highest percentage of audited returns were people that filed a Schedule C for an unincorporated business. As I've discussed before, the IRS is hitting these returns hard because of rampant fraud in claiming personal expenses as deductible business expenses. If you made less than $25,000 or more than $100,000, you had a 1 in 25 chance of being audited (still not a great chance). If you made between $25,000 and $100,000 your audit chance was 1 in 50.

All of this doesn't include computer matching audits (matching your income to filed W-2s from employers) and simple mathematical mistakes.

Now, if you're lucky enough to get selected for audit, what are your chances of making it through without an adjustment? Well, not very good. The IRS broke it down by who does your examining, but none of the subsets had more than a 1 in 5 chance in getting a "no adjustments" audit. If you get referred to a tax examiner, your chances are 1 in 20 of not getting at least one adjustment.

So, your chances of being selected are not very good (as long as you file a correct return) but if you get selected, the IRS will likely make changes to it. Remember though, that the IRS uses a computer scoring program to score you against the norms for your income group and uses a different program to match you to any 1099s and W-2s filed by others. So, even though your chance of being selected is low it still doesn't pay to cheat on your taxes.

Carefully research Target Date Funds

Earlier this week, I mentioned target retirement date mutual funds in a post about money managers. I mentioned that the funds are often too conservative, but I didn't go into great detail.

Luckily, the Washington Post saved me a long post by explaning this exact phenonoma in a recent article. The Vanguard funds are far too conservative. A portfolio aimed at a 45 year old, still 20 or more years from retirement, has only 57% of its assets in equities. A 45 year old should have more than 80% of their assets in stocks because they are far enough from retirement to ride out any short term ups and downs. During retirement, the Vanguard fund will drop to 30% stocks. Again, this is far too low to benefit from the long term trend of higher returns on stocks.

People will be using their retirement funds for 15 years on average and they may run out of money using such a conservative allocation. Fidelity does a little better job with 73% and 45% for their version of the same funds. T. Rowe Price does the best to take advantage of stock returns with 82% and 55% in their funds at the same timeframe.

T. Rowe Price has the highest cost, however, at 0.82% which still lower than most actively managed funds. And all of the funds are simply a "fund of funds" apporach that invests in other funds managed by the three companies, so you still need to look at the underlying funds to make sure that it fits in with your overall portfolio.

The IRS reminds taxpayers to do just that

The IRS has released 5 Revenue Rulings describing various tax scams that people should not expect any mercy from the IRS if they use them on their tax returns.

Revenue Ruling 2006-17 emphasizes to taxpayers, promoters and return preparers that inserting the phrase “nunc pro tunc” on a return or other document submitted to the Service has no legal effect and does not validate an invalid return, make a delinquent return timely, invalidate a signature, create a claim for refund of taxes previously paid, or reduce one’s federal tax liability.

Revenue Ruling 2006-18 emphasizes to taxpayers, promoters and return preparers that any argument that Forms W-2 only record and report payments made to federal employees, or that only federal employees or residents of the District of Columbia or federal territories and enclaves earn wages subject to tax, has no merit and is frivolous.

Revenue Ruling 2006-19 emphasizes that an individual cannot escape taxation by attributing income to a purported trust. The Service will take vigorous enforcement action against frivolous arguments relating to trusts.

Revenue Ruling 2006-20 emphasizes to taxpayers, promoters and return preparers that any argument that Forms W-2 only record and report payments made to federal employees, or that only federal employees or residents of the District of Columbia or federal territories and enclaves earn wages subject to tax, has no merit and is frivolous.

Revenue Ruling 2006-21 emphasizes that an individual cannot escape taxation by attributing income to a purported trust. The Service will take vigorous enforcement action against frivolous arguments relating to trusts.

Additionally, the IRS issued a Notice that explained these and even more common frivilous arguments (PDF link) and reminded taxpayers what the penalties for making frivilous arguments for delay of collection are (read: not fun).

I love reading tax protestor arguments and laughing. Again, if anyone tells you that you can avoid all taxation and they have the answer (for a large fee, naturally) run the other way. If you get a card, call the IRS; you may just be in for a reward.

H&R Block (yes, again)

Yes, another post bashing looking closely at H&R Block. Their current advertisements feature a guarantee that customers will get the largest possible refund from the IRS. They will refund their fees to you if you can find a way to get a bigger refund.

Sound familiar? Looking at the IRS Press Release on finding a tax preparer, the number one hint was:

Be careful with tax preparers who claim they can obtain larger refunds than other preparers.

While the IRS press release was primarily dealing with scam artists tax soothsayers that file zero tax due returns for people and then leave town, it is odd that H&R Block would have commercials that go against exactly what the IRS says to look for in a tax preparer.

Do money managers earn their keep?

CNN Money's "Ask the Expert" column takes on professional money managers.

The basic question is whether a science teacher should ditch his collection of mutual funds for a professional money manager that will take 2% of assets as his fee. The Expert says it's likely that he'll lose out since he'll be paying 1% more annually than he is paying now for a service he could do himself.

He does have a good point. The "lifestyle" funds that he mentions are a great tool for those that don't want to deal with rebalancing and tracking their own portfolio of mutual funds. These funds are far from perfect (and often way more conservative than they should be) but for a market-phobe it's a decent tradeoff of risk and return.

Another option would be to pick up either Kiplinger Personal Finance or Money when they do their annual Mutual Fund guides and use those model portfolios as guides for setting up your own portfolios.

Stay away from money managers unless you have enough money that you absolutely need to diversify into commodities, real estate, and the like. If you're asking yourself if you meet that test, you probably don't. Spending a few hours reading one of the publications above should give even the market novice a good head start.

If that still isn't an option, going to a fee-only personal financial advisor would work as well. They can guide you to a diversified portfolio without taking a percentage off of the top every single year.

U.S. Debt Limit Raised, Again

The US Senate passed the necessary, but politically senstive, bill to raise the debt of the United States to $8,985,000,000,000. The reckless spending of the US Congress has to come to an end soon as the debt is now nearly 3/4 of our annual GDP (according to the CIA Factbook) and has increased by 50% since President Bush took office.

Congress needs to follow the same rules as everybody else that runs up tons of long term debt to pay for short term items. Either get more income (raise taxes) or cut spending. If the Treasury is paying an average of 4.75% (based upon the current yield which may or may not reflect the true interest paid), the annual interest cost of carrying the current debt of $8.2 trillion is $392.8 billion. Every single year that's the amount going just to service the debt, not to pay any of it off.

The debt is unsustainable, but nothing will happen until the mood changes in Washington (or a fiscal catastrophe happens). Unfortunately, this debt glut trickles down to people who often joke that why should they balance their budgets when Congress can't? It's a good question.

Oops, they did it again

H&R Block is back in the news. This time, Eliot Spitzer is suing the company over what the company calls "Express IRAs".

These accounts were created to take advantage of their customers a 2002 tax law change that allowed low income taxpayers that contributed to a retirement account to take a tax credit for the amount they contributed. H&R Block set up these accounts so that their customers could deposit their tax refunds directly into the accounts and would, therefore, get a larger refund.

This seems like a great program that could actually benefit customers. People, especially lower income people, need to save for retirement. This allows them to use money that they never had to fund these accounts. But, the Devil is in the details.

According to Mr. Spitzer, 85% of accounts paid more in fees than they earned in interest. The median account balance of $323 earned $3 per year in interest but paid $10 per year in maintenance fees, $15 to set up the account, and a $15 “re-contribution” fee (whatever that is). Customers also paid $25 if they wanted to close the account. Customers could only invest in H&R Block’s money market account, so they could not get better returns even if they wanted to.

So, these accounts paid a return that was below inflation. That meant accounts were losing purchasing power every single year. On top of that, the median account was being charged around 7.75% in annual fees ($25/$323) in order to earn 1% ($3/$323) meaning the account was slowly being drained by H&R Block.

Brilliant! H&R Block figured out how to capture customers total refunds (albeit slowly) on top of their fees! Throw in funding via Refund Anticipation Loan and these appear to be a blockbuster (for H&R Block at least).

So, in the past few weeks we’ve learned that H&R Block charges outrageous interest rates on “loans” it pushes, cheats on its own taxes, sells your tax data, and now sets up IRAs for its customers that do nothing but enrich itself.

People may say that I'm anti-H&R Block. Really, I'm anti anyone that has a fiduciary duty that repeatedly uses that duty to enrich itself at the expense of people that they know do not know any better, which is apparently what H&R Block is doing over and over again.

Friends don't let friends use H&R Block.

5 Audit Red Flags

CNN Money has a list of 5 tax items that may red flag your return for audit by the IRS. Keep in mind that the IRS keeps what actually goes into the decision very secret, so this is just a guess. It's a pretty good guess based upon experience, but it can change at any time.

1. Overkill on Charitable Contributions

Aah, the prototypical "fudge" number on people's tax returns. These have been abused so long (and now in lots of more ways) that the IRS will look at any return that has a much higher percentage of charitable contributions than other taxpayers in their income bracket.

2. Self-Employed Expenses

Another oldie but goodie. People have been writing off all kinds of items as "business deductions" for so long that taking any sort of S/E expenses (especially if you have a full time job elsewhere) might as well be printed on bright red paper and have flashing lights on it. I would add abuse of the hobby loss rules to this as well.

3. Above Average Deductions

The IRS uses a computer matching program that scores your return against others in your tax bracket in various ways such as deductions, credits, and exclusions. If your score is too high, you'll get flagged for audit. Does that mean you should tailor your return to score low? No, you should take every deduction and credit you are entitled to. Just make sure that you are entitled to it and that you keep documentation so that it can withstand an audit.

4. Making Six Figures

IRS audit records have shown for years that you are much more likely to get selected for audit if you make $200,000 than if you make $20,000,000. The simple fact is that the more money you make the more likely you are to use a professional that is legally bound to file a correct return. People making low six figures can still file their own returns and may be tempted to stretch deductions (see #1 and #2) to lower their tax bite.

5. Careless Omissions

If you don't attach a W-2, or worse yet don't include it income, you'll be flagged immediately as part of the IRS push to match documents like W-2s and 1099s to tax returns. So, report everything!

Your Tax Records for Sale?

Previously, I had blogged about H&R Block's use of customers tax data to sell them stuff. I suggested that wasn't such a good idea and may be illegal. Well, it seems like they were just ahead of the curve.

Currently, companies can give your tax return information to affiliates if they bury it in a disclosure that you have to sign. The IRS has decided it just might be a good idea to allow companies to sell your tax return data to unaffiliated companies if they get permission. The IRS says this will empower consumers to use their tax return data how they see fit. I say it's a scam and many people will have no idea that their tax return data is being marketed to the highest bidder.

It also seems to be a bright shiny beacon to identity thieves. Here! Buy people's most sensitive data! You don't even have to fake out ChoicePoint anymore!

Bad, bad, bad idea. I really hope the IRS wises up and quick.

Investimist in Carnival of Personal Finance

I am participating in the Carnival of Personal Finance this week. Go check out the Investimist post as well as all the other excellent posts. I will likely be posting on several in the upcoming week.

For anyone checking out the Investimist for the first time, welcome and get comfortable. I can be reached by leaving a comment (I will always try to respond). I welcome comments (and even the occasional criticism).

Too Few Youngsters Saving Now

USA Today has an article on how my generation is not saving enough for retirement. While you could truthfully strike "my generation" from the above sentence, it's particularly an issue because we have time to know and shouldn't be having this problem.

Nearly 80% cite daily living expenses as a barrier to saving. While I know this can be a legitimate issue, there are ways to cut living expenses to the point where you can save. I, personally, just began putting money into my 401(k) again after buying a house and the birth of my daughter put a crimp in our budget (my wife is a teacher with a pension, so she was automatically saving). But we made every attempt to get back to putting into my 401(k) as fast as possible once my employer began offering a match.

61% cite "lifestyle purchases" as reasons not to save. This would be buying a nicer car, a big freaking tv, the latest iPod, etc... Why is this important? Compounding!

Here's an example from Choose to Save, a public education program. Suppose you want to save $100,000. If you have 20 years, you can reach your goal by saving $3,272 a year and earning a 4% annual return. Shorten your time frame to 10 years, and you'll have to save $6,559 a year and earn 8% annually to achieve the same goal.

It gets worse when you have 40 years to save before retirement but put it off until they are 50 and are unable to match the amount they would have earned. About.com has another example of this power.

So, Gen Yers. Save now. The more you save now the earlier you can stop working. There, that should be enough incentive.

4 Steps to Premium Dividends

I love the advice of the Motley Fool. They are usually spot on when talking up value stocks (though they thankfully abandoned growth stocks after the tech bubble). However, they sometimes forget they are talking to a lay audience.

The advice that they give is impeccable. However, not everyone has the ability, or time, to not only become an expert in one industry but to read through SEC filings. Abandoning Yahoo! Finance or other screeners just isn't an option for most people. So, what do they suggest? Buy their newsletter! (of course)

Instead, they should be telling you to rely on time-tested ideas like finding stocks with lower P/E ratios than return on capital ratio. Stick to companies you've heard of. Do a Google News search for any bad news out there. Look at news stories on Yahoo! or MSN Money to see if anything has come out that would knock the stock down.

Or, conversely, you could invest in mutual funds or ETFs that invest primarily in dividend stocks and let professionals do the work for you. That's my suggestion and that is what I do.

A Portrait of the Median American Family

The WaPo has an article on the median American family from a financial perspective. And it ain't pretty.

It has about $3,800 in the bank. No one has a retirement account, and the neighbors who do only have about $35,000 in theirs. Mutual funds? Stocks? Bonds? Nope. The house is worth $160,000, but the family owes $95,000 on it to the bank. The breadwinners make more than $43,000 a year but can't manage to pay off a $2,200 credit card balance.

How do financial advisors rate the median family? They would prescribe the typical cut expenses, save more mentality. We keep harping on it, but it really is the only way to build wealth. Less than 50% of Americans have a retirement account. While I don't think that includes pension accounts (the article doesn't say), that's still an astounding number given the shedding of pensions lately.

Case in point. We've replaced our furnace already this year. We just got word that our roof and siding will have to be replaced thanks to a freak February hailstorm. Luckily, we have insurance and have an Aon Home Warranty, so we'll only pay $1,100 of the total $15,000 cost. But how many families have $15,000 for emergencies? We'd use most of our savings to pay the bill but would likely have to take on little debt. How many would be so lucky? Certainly not the median family listed above.

Automatic IRAs -- a Quick Fix for Workers Without Pensions?

The WaPo has an article on the future of retirement benefits and the discussions now taking place.

One of the ideas floated includes an automatic IRA for employees that don't have pension benefits through their employers, either in the form of a true pension or even a 401(k) plan. The idea would be modeled on the Federal Employees Thrift Savings Plan and would allow employees to opt out if they do not want to participate. However, employees would initially be enrolled to take advantage of inertia of most employees.

There are several obstacles. If they make it truly automatic, it would work a lot like Social Security and would essentially tax the poor even more. However, it is the poor that need the help the most, which is why individual Social Security accounts are such a bad idea. If they don't make it truly automatic, many lower income employees would opt out so that they could pay for things like food and rent. Again, these are the exact employees these IRAs are supposed to target.

On the other side, the reason that employers don't provide 401(k)s are anti-discrimination rules to ensure that highly paid employees are not treated better than everyone else and the costs involved of paying a trustee for the plan. This idea would would require all employers offer automatic IRAs, but would allow a tax credit of $250 to offset start up costs. Also, since the plans are straight IRAs, there would be no regulations on highly compensated employees or contributions to be made.

All this might work, but it would really be better to not add to the confusing number of retirement options. One of the great ideas the GOP has had in the past few years was to combine the various retirement accounts into one option. I would love to see everything combined into a 401(k) account with the 401(k) limits. It would level the playing field and not handicap workers just because they work for an employer that doesn't offer a 401(k).

Consumer Spending Outpaces Personal Income

Consumers once again spent more than their incomes in January.

Personal incomes rose 0.7% in January, but spending rose 0.9% meaning consumers spent all of their raises and then some in January. That, in and of itself, isn't entirely bad. However, coupled with the fact that we were already at a negative savings rate, that means consumers were spending more of their savings in January.

This is not sustainable. The fact that it hasn't happened since the Great Depression should be the first indication of that. People need to save, otherwise they'll be sorry once their savings are depleted and they just can't have that plasma screen they NEED RIGHT NOW!