The Labor Department released inflation data yesterday and the Wall Street Journal had three tax experts estimate how all the inflation-pegged tax figures would change based on those numbers. Many tax numbers, like the brackets, exemptions, standard deductions, etc., are pegged to inflation so knowing the Labor Department figures can give you huge insight into how those numbers will move. The three experts are George Jones, senior federal tax analyst at CCH; William Massey, senior tax analyst for the tax & accounting business of Thomson Reuters; and Prof. James C. Young, professor of accountancy at Northern Illinois University. The Wall Street Journal does this every year and, for as long as I can remember, they’re often it pretty spot on. Based on their calculations, a bunch of inflation-pegged tax numbers are going up.

All these figures are merely estimates, the government can always go back and adjust inflation figures so these numbers may change.

2009 Federal Income Tax Brackets (Projected)

Here’s what they projected for the income tax brackets for 2009, compared to 2008 figures:

Some other changes:

• Standard deduction increases: The standard deduction for married filling jointly is expected to increase to $11,400 from $10,900, a $500 increase. Singles and those married filling separately will get a standard deduction of $5,700, a $250 increase from $5,450 in 2008.
• Personal exemption increases: The personal exemption amount will increase $150 to $3,650.
• $13,000 gift tax exclusion: Professor Young believes that that gift tax exclusion amount will increase from $12,000 to $13,000. Right now, if you give more than $12,000 a year to someone as a gift, you have to pay a gift tax on it (yes, the giver of the gift pays the tax). Professor Young believes that number will increase to $13,000.

More insight and explanation can be found at the Wall Street Journal and here were their predictions on last year’s IRS tax brackets.

Reader Ann asked the following question on my post about the 2008 Federal Income Tax Brackets:

Jim ~

My husband has just been offered a salaried position of which he is excited yet somewhat reluctant about. The increase in salary would put us “over the edge,” so to speak, into the 25% tax bracket. His position probably doesn’t have much more room for increased income. We are not currently in a position to owe significantly more tax. In addition, we are quickly loosing our child deduction as they are becoming “independent.” Advice?

Here was my reply:

Hi Ann,
I think you may be misunderstanding how the tax brackets work, the listed rate only applies to dollars that exceed the low end of that tier. Your entire salary isn’t being taxed at the bracket rate. I think this is best explained using an example.

Let’s say for the sake of argument your husband earns $60,000 a year, which puts him in the 15% tax bracket at the moment. The new job has a salary of $66,000 a year, which is above the start of the 25% tax bracket of $65,100 (for married filing jointly). Only $900 of his new salary (the amount above $65,100) is taxed at 25%, not the whole $66,000.

In fact, if you were to take the standard deduction for married filing jointly of $10,900 then your income would be reduced to $55,100 and not a single dollar would be taxed at 25%. Further deductions could pull you further down the list on your marginal tax rate.

Unless I’m misunderstanding your question, I think you just had a mixup in thinking how the brackets worked.

This is a mistake many people often make when they learn about the progressive tax system. They think that “tax rate,” despite being called a marginal tax rate (thought marginal has a specific meaning not often used in conversational English), is applied to your entire income. That rate is only applied to your next dollar earned. For the 25% tax bracket, for single filers, starts at $32,550 and ends with $78,850 - you are only taxed 25% on the 32550th dollar you earn p to the 78849th dollar you earn.

In reality though, it’s even less than that because with deductions and credits, your effective tax rate is far far less. Right off the bat, single filers can claim a standard deduction that reduces their income by $5,450. If you work and contribute to a 401(k) plan, each dollar you contribute is deducted off your taxes. At the end of the year, you’ll find that your actual adjusted income is far lower than your salary, so your effective tax rate is much lower than even the aggregate of the tax brackets.

If you’ve bought yourself a new car and are looking to get rid of your old one, or simply want to get rid of a car, consider donating it to an organization that accepts car donations. Selling the car will almost always be better than donating from a financial standpoint, but donating offers benefits that may trump the money depending on your situation. After detailing five reasons why you should donate your car, I’ll give a few scenarios where donating is better than selling.

Here are five solid reasons why you should donate your car:

#1. Selling Is A Pain

Selling a car is a pain in the ass. First, you’ll need to advertise somewhere. You can put it on Craiglist or eBay and do the new school thing, or go classic and chalking up “For Sale” on the windshield and leaving it by the road. If you go with Craigslist, you have to deal with all the local flakes, crazies, and lowballers who are looking to snatch up a good deal. With eBay, well, you have to deal with the national flakes, crazies, and lowballers who may or may not rip you off. If you leave it by the road, it might get towed, it might get broken into, or you simply won’t get enough interest. It’s no secret that selling a car is a pain.

#2. A Wonderful Tax Deduction

If you’re already a charitable person, consider donating your car rather than cash. While it is a bit more work for your charity, it’s still a win-win for both parties. Most charities that accept vehicle donations know what to do with them, so really there is minimal headache on your part. Most will be able to appraise your car or simply offer a receipt that lists the Kelley Blue Book, NADA or Edmunds private party value as long as it’s under $5,000. If it’s over $5,000, then you’ll need an independent appraiser but that’s usually not a big deal.

#3. It’s Done As-Is

If your car needs improvements, then the organization will make them and list the improvements on the tax receipts. You won’t have to fix up problems with your car beforehand. While you could sell your car as-is on the open market, chances are the number of interested parties is going to diminish tremendously. Prospective buyers will want to have a mechanic check it out, they’ll take it for a test drive, and they’ll otherwise need to go over the car with a fine toothed comb. You can’t fault them, if you were going to drop a few thousand dollars on anything, you’d go over it with a fine toothed comb too.

#4. It’s Fast

Want to donate? Call up the organization and let them know. They take care of it all from there. Think of all the time you’ll have saved by not having to show the car, not having to go on test drives, not having to meet prospective buyers in a random parking lot, not having to give out your private information to strangers, and not having to worry about whether you’ve missed anything (taxes? sales receipt? title?). The organization takes care of it all (many offer free towing too!).

#5. It’s A Good Thing(tm)

At the end of the day, you know that you’re doing something that helps an organization and its members. By selling, you don’t get as much for your car as you would by selling it (presumably). If your car is worth $5,000, you get a $5,000 charitable deduction off your income for the purposes of taxes. If you’re in the 25% tax bracket, then the deduction is worth $1,250 of cold hard cash. If you sell the car for $5,000, then you get $5,000 of cold hard cash. It’s a significant difference but ultimately you’re doing a tremendous service to that charitable organization.

When Donating Is Better $$$

If your car needs extensive repairs before you could sell it and you don’t have the funds to repair it, donating is going to be a better option for you. My wife’s car had a blown head gasket that pretty much killed the engine on her car. If she wanted to sell it, she’d have to overhaul the entire engine and that would’ve cost a significant amount of money. So instead, she donated the car to the local school so that the shop class could work on it. She received a sizable charitable donation receipt, the school received a car they could work on, and everyone was happy.

(Photo: orinrobertjohn)

Usually.

My friend just had their first child and began researching 529 plans. A 529 plan is an education savings plan run by a state or an educational institution, it’s named after Section 529 of the Internal Revenue Code. The plan offers tax benefits to individuals saving for future education. In his case, he was looking at a savings plan, rather than a prepaid plan*.

And now he had a choice: an in-state plan with a tax deduction or an out-of-state plan with potentially cheaper funds. Specifically, he wondered if he should open a Maryland 529, which offers a tax deduction to Maryland residents, or a state plan offering Vanguard funds, which is known for lower mutual fund fees. The state plan he found was Nevada’s, which is run by Upromise but offers Vanguard funds. (Plan data provided by Saving For College, run by Bankrate)

College Investment Plan (Maryland)

• Program Manager: T. Rowe Price Associates, Inc.
• Residency Requirement: No.
• Maximum Contributions: No annual limit until account balance for beneficiary reaches $320,000.
• Account Maintenance Fee: $25 / yr, waived with automatic investments or balance greater than $25,000.
• Management Fees: 0.28% manager fee, 0.25% once program assets reach $2 billion.
• Tax Deductions: $2,500 per beneficiary per year by account owner is deductible with a 10 year carryforward on excess contributions.

The Vanguard 529 Savings Plan (Nevada)

• Program Manager: Upromise Investments, Inc. and Vanguard Group, Inc.
• Residency Requirement: No.
• Maximum Contributions: No annual limit until account balance for beneficiary reaches $310,000.
• Account Maintenance Fee: $20 / yr, waived if account owner or beneficiary is a Nevada resident or assets in account exceed $3,000.
• Management Fees: 0.65% manager fee, include underlying fund expenses.
• Tax Deductions: None.

Comparing just the Nevada plan against the Maryland plan, it appears that the Maryland plan is superior. What you’re trading off is the tax deduction versus the mutual fund fees, but the tax deduction is only available the year you contribute. In Maryland, the $2,500 deduction is worth $125 (5% state income tax) making it nearly a wash between the slightly higher account fees in Nevada.

It’s really a choice between T. Rowe funds vs. Vanguard funds. If you’re an index fund type of investor, the T. Rowe Price Equity Index 500 (PREIX) has an expense ratio of 0.35%. Vanguard’s 500 Index (VFINX) expense ratio is 0.15%, meaning T. Rowe’s ratio is more expensive by 0.20%. On a balance of $10,000, that’s a difference of $20 being whisked out of the account each year for nothing. While $20 doesn’t seem like much, that’s a fee taken out each year and one that will erode your investment’s growing potential.

If it were me, I think the Nevada plan is superior of the two because it offers access to cheaper Vanguard funds.

Five Best 529 Plans

Liz Pulliam Weston of MSN money recently looked at the 5 best college savings plans and listed Nevada as one of the top five. The other states included were Alaska, Nebraska, Rhode Island and Virginia. The Virginia plan offers access to some Vanguard funds too.

* A prepaid plan is an option where you “lock in” the price of an in-state public college education right now. You can always convert it to a private or out of state school later on based on some conversion tables.

(Photo: lednew)

A tax credit is not the same as a tax deduction.

Tax Deduction

A tax deduction, such as contributions to a Traditional IRA or 401(k), reduces your adjusted gross income. How much that deduction is worth to you depends on your marginal income tax rate (2008 Federal Tax Brackets).

If you are in the 25% tax bracket, a $1000 tax deduction means you will pay $250 less tax that year. If you are in the 10% bracket, a $1000 tax deduction means you’ll pay $100 less tax that year. If you have a simple tax situation, with little income outside of your regular job, this translates to a larger tax refund.

Common tax deductions are the two mentioned before, Traditional IRA and 401(k) contributions, as well as mortgage loan interest, student loan interest, and charitable donations.

Tax Credits

A tax credit is a dollar for dollar reduction in your income taxes. If you have a $1000 tax credit, you will pay $1000 less tax that year regardless of your tax bracket. A good example is the $1000 child tax credit. If your child applies and you don’t exceed the income limits, you get $1000 for each dependent child you claim on your tax return.

Common tax credits are the child tax credit, Hope Scholarship and Lifetime Learning Credits (education related), retirement savings credit, and the adoption tax credit.

Marriage is a beautiful and wonderful thing. I just joined the club several months ago and it’s not too bad so far. I’m not saying that you shouldn’t fall in love and spend the rest of your life with someone, I just think that the accounting details make it a raw deal. I’ve talked about how you shouldn’t get married in the past, but if you’ve already let the cat out of the bag and paid for the license, here are some more reasons why you should considering going back to the courthouse to get your money back (it’ll be pricey but think of the ROI!).

Tax Brackets & Marriage Penalty

The marriage penalty is the cute name given to the fact that the tax brackets for married filing jointly isn’t double that of single filers. That is to say, all things being equal, you will pay more as a couple than you would if you were just dating. This is a throwback to an age where one person worked, one person didn’t. In the case of only one income, doubling the brackets gave married couples a significant advantage tax-wise. Now, with two incomes, it’s become a liability.

Your Money, Your Choice

One of the great things about being single is that you are the master of your financial domain. If you wanted to spend $200 on a new purse or a pair of Nikes, you didn’t have to answer to anyone, you didn’t have the consult with anyone, you just did it. If you’re a saver and he/she is a spender, you had conflict. If you’re a spender and he/she is a saver, you had conflict. When it’s just you, there is no conflict. No one chastises you, you don’t chastise anyone, there’s no headache in a couple of one. You are the master of your financial domain.

Alimony Is Tax Deductible!

Did you know that alimony is tax deductible? That’s right, the government loves alimony so much that they will let you deduct it as an adjustment to your income whether you itemize or claim the standard deduction. You can’t deduct donations when you claim the standard deduction, but alimony is okay! First it’s the marriage penalty, then it’s alimony being tax deductible… if this isn’t a government incentive to get divorced, I don’t know what is!

I leave you with this:
A wise man once asked, “Do you know why divorce is so expensive?”
The answer? “Because it’s worth it!”

I was poking around Debt Hater this morning when I found her post about how she wasn’t deducting her charitable contributions to her church on the grounds that her donations (tithe) should be 10% gross, not net, and you shouldn’t be rewarded for doing it (the deduction). Here’s what she said:

My church provides every member with a receipt for the money they’ve given — in tithes and/or offerings — for tax purposes.

But I didn’t claim that on my taxes. It seems wrong to me. If you believe in tithing, you know that you tithe 10%. That’s gross, not net, because if you tithe net, then you’re paying the government before you’re paying God. So, if you get the money back through taxes, then you’ve gotten your blessing that way, and not God’s way, whatever way that may be.

The fundamental difference in thinking is probably with the perception of the deduction - DH sees it as the government giving you money (a reward) whereas I see it as you keeping your money. If you donate 10% of your gross income, you’ve actually lost 12.5% of your gross because 25% of that has gone towards the government. So if you’re paid $100, you donate $10, you’re actually down $12.50 because $2.50 of that $10 donated goes towards the government in taxes on income. The government has decided that donations are not considered income (in effect) so they let you deduct it, thus you get the keep the $2.50 because you gave away the $10 (the government is not rewarding you, you are merely paying less because you’ve in effect, out of your generosity, earned less).

Now, let’s say you still aren’t convinced that you should deduct it. If you deduct it, you can donate $12.50 instead of just $10 - thus not only are you not keeping it, you’re making your gift that much larger. Of course, now you deduct $12.50 on your taxes instead of $10 and the never-ending math cycle continues, but you get the idea.

As for the question of “Are you doing it to provide something to your community or are you doing it to hide money from Uncle Sam?” I don’t see how donating money is hiding any money because you don’t get that money back later.

DH, I think you should take the deduction.

What do you all think?

I receive the following email the other day and I am posting it to see if anyone else has some advice for a fellow reader with regards to his situation:

From: Dave
Subject: Tax Breaks for Student Loan
Hi Jim,

I’ve got a question on a difficult situation.

My girlfriend’s brother exited an Indiana university early with a 4.0 GPA several years ago, and when he wanted to go back he didn’t have the resources to get started. My girlfriend got a $3k student loan for him, as well as a laptop she put on her Discover card, with the idea that he would buy books and give her the rest back to immediately pay back Discover. Long story short, he never paid her back, ended up running away to the Southwest, and pawned her laptop. There’s not much that the authorities can do, since she applied for the loan and essentially gave him a gift on her credit card, but I was wondering if there was anything that she could redeem from the student loan on her taxes. All police reports have been filed at present.

Any help, as you could imagine, would be an enormous help. We have a mortgage to pay and would like to afford to have a child. I just want to see some of that back, if at all possible.

My response:

Thanks for the email and that’s unfortunate what’s happened between your girlfriend and her brother, but sometimes that’s life. In general, student loan interest is deductible if you make under $50,000 (after adjustments) and I would think that since she is a cosigner on a student loan, she could claim the deduction as long as she’s not a dependent on someone else’s claim (her parents?). If she just got a regular loan from the bank (not a student loan), and lent it to him, she may not have any options in terms of deductibility.

Anyone have any thoughts?

Thanksgiving is over (even though the leftovers are still packed into the fridge), the Happy Holidays are just around the corner, now is the time to make those end of the year tax decisions before you get overcome with all the craziness of the holidays. So, I dove into the archives and saw that last year I wrote a whole bunch of posts related to year-end tax moves that still apply (most of them) to this year, so I thought I’d link to them so I’d know where they were:

• Offsetting Your Stock Gains With Loses & the Wash Rule
• Claiming the Energy Savings Tax Credit - This refers to the tax rebate you can get if you make certain home improvements that increase the energy efficiency of your home.
• Home Office Deduction for Businesses - Started a business this year? I researched everything I could find about home offices.
• Six Great Tax Breaks - Some of which no longer apply, but others do.
• 10 Common Tax Filing Mistakes - It’s a little early for this article but it’s nice to keep this in mind (here are 15 more mistakes to avoid).
• More Tax Deduction Talk - Charitable donations, refinancing points, and education related deductions.
• Deduction Donations - IRS Tax Rules - I take an untrained look at deductions for charitable donations.
• Retirement Savings Credit - If you earn under $25k, give this article a read.
• Understanding Capital Gains and Losses
• Understanding AMT
• Education Credits!

And, if you don’t like taxes, read this argument about how the tax system will collapse in ten years.

Like most folks out there, I don’t like owing anyone money. I don’t like owing the bank money on my first mortgage, I didn’t like owing the bank money on my second mortgage, and I don’t like owing the lender money on my student loans. Here is my dilemma… back in September I wrote a relatively straightforward article titled “Don’t Save, Pay Off Debt!” in which I said that you should list the interest rates of your cash and of your debts in descending order. If you happen to have any cash in an account listed lower than a debt, you should pay off the debt with that cash unless it’s earmarked for a specific purpose (down payment, emergency fund).

Many of us who have student loans probably locked them in at rates way under the 5% you can get any online bank. Personally, I have about $24,000 in student loans at 3.25% (currently in deferral because I’m taking classes) which would put the debt underneath the cash I have in the 5%. Logic, and math, would indicate I should just pay the minimum payment on the student loans and keep the rest of it in my HSBC Direct account (even if you factor in that I have to pay taxes on the 5% interest). In fact, since my first home mortgage is at 5.75% (fixed) I should actually be paying that debt off first before I even consider paying the student loans because it’s at a higher interest rate. And on the first mortgage, I have exactly zero chance of paying off my mortgage (over $200k) anytime soon.

I want to pay off the student loan because it’s satisfying to write a debt off the “books” but I have to keep reminding myself it’s not the smart thing to do.