Glossary of Tax Terms: Community Property

The term community property refers to property laws that apply to married couples in certain states. Those states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Married couples in those states who choose to file separate federal tax returns must apply community property laws to their tax returns, which means splitting many items of income 50/50 with their spouse.

Example

John and Mary are married and live in a community property state. John earns wages of $40,000 and Mary earns wages of $30,000. They decide to file separate tax returns. Both John and Mary will report $35,000 of wage income (50% of their own income and 50% of their spouse’s income).

The specific rules of income splitting differ from state-to-state. For example, income from interest and dividends is not always treated as community property.

Taxpayer Identity Theft — Part 19

IMAG0318The National Association of Tax Professionals picked up on Wendy Boka’s identity theft saga through my blog and asked me to condense my blog series into an article for their Spring 2014 Tax Pro Journal. The finished product is the cover story of the Journal, which is hitting tax pro mailboxes soon (mine arrived Thursday).

If you’re not a tax pro (or not a member of NATP) you can read my blog series — click here to find Part 1, and from there you should be able to find links to take you through the entire series.

Hold the Phone on the IRS E-file Outrage Machine

UPDATE 5/21/14: I was wrong. Don’t hold the phone on being outraged. We all should be outraged. See my updated blog post here.

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Earlier this week, the tax pro community — myself included — were outraged at apparent new IRS requirements for tax pros who e-file. Read Russ Fox’s posts here and here for further background.

This all stems from revisions the IRS made to the e-file handbook (Publication 1345). A quick glance at the revisions appeared to show the IRS saying:

  1. All tax pros who e-file must take copies of government-issued ID, and furthermore …
  2. Pull credit reports on their clients in order to verify the client’s identity

I was outraged when Russ broke this news on Monday. Here’s what Russ, Robert Flach and I had to say on Twitter that morning:

On Wednesday, I killed a tree and printed Publication 1345 so I could read through it with a highlighter in hand.

Here’s what I discovered: we may have jumped the gun on the outrage machine.

I don’t think Publication 1345 is saying ALL tax pros get photo ID and pull credit reports. The publication says we must do those things if the e-file authorization is signed electronically (meaning, not signed with paper and pen).

Electronic signatures are now allowed on e-file authorizations. This means, a client signs via their computer, or a saved signature dropped into a document (see Page 22 of Publication 1345 for a list of what constitutes an electronic signature). This is the situation where the pro would need to get a photo ID and maybe pull a credit report.

For those of us who have our clients sign with a regular old pen and then mail, scan or fax the authorization form back, I don’t think anything changes and these new requirements don’t apply to us.

This isn’t to say I think the IRS’s new requirements are good (I agree with the photo ID part but the credit report part seems over the top), but these new requirements make much more sense when one realizes that it applies only to limited situations involving electronic signatures only.

Tax Refunds and “Not Owing Tax”, Part 2

In Part 2 of this series, I want to explain more about the tax calculation and how getting a tax refund doesn’t necessarily mean you “didn’t owe taxes.”

In Part 1, I explained the tax calculation:

This is highly simplified but I think it covers the basics well enough. Here’s how the tax calculation works:

Income
Minus student loan interest, if any
Minus standard deduction or itemized deductions
Minus personal exemptions
Equals taxable income

Next, you calculate the amount of tax owed on your taxable income.

To clarify: you calculate your gross tax owed before any credits are taken into consideration.

Once you’ve calculated your gross tax, you subtract out non-refundable credits. These are things like:

  • The child tax credit
  • The credit for daycare expenses
  • The Lifetime Learning Credit
  • Part of the American Opportunity education credit
  • The credit for energy efficient windows and doors

Non-refundable credits cannot drop your tax liability below zero.

Next, you add any additional taxes, such as self-employment tax. This gets you to your “total tax.”

From your total tax, you subtract your refundable credits. These are things like:

  • Withholding from your paycheck
  • Estimated tax payments
  • The earned income credit
  • The refundable portion of the American Opportunity Credit
  • The refundable portion of the child tax credit

Refundable credits are how you end up with a refund.

So if you get a refund, it’s possible that you “didn’t owe taxes,” but only if your “total tax” before refundable credits equaled zero.

Example:

John’s total tax is $1,000. His refundable credits total $1,500. John will get a refund of $500, but it’s not accurate to say John “didn’t owe taxes.” He owed $1,000 of taxes for the year but because of his refundable credits, he got a $500 refund when he filed his return.

On Tax Refunds and “Not Owing Tax,” Part 1

Let’s talk about tax refunds.

No, I’m not going to opine on whether getting a tax refund is a good thing or a bad thing (though that’s a good idea for a future blog post).

Instead I want to explain how tax refunds work, and how it’s not always accurate to say you “didn’t owe taxes this year” just because you got a refund.

How the Tax Calculation Works

Time for a mathematical formula. (Try to contain your excitement!)

This is highly simplified but I think it covers the basics well enough. Here’s how the tax calculation works:

Income
Minus certain adjustments to income, such as student loan interest
Minus standard deduction or itemized deductions
Minus personal exemptions
Equals taxable income

Next, you calculate the amount of tax owed on your taxable income.

I know what you’re saying now:

“Wait a minute, ‘tax owed’? That can’t be right. I always get a refund when I file my return!”

Ah, that’s the rub. Just because you got a refund it doesn’t necessarily mean you didn’t owe taxes.

I’ll explain more in Part 2.