Top Ten Things To Do During Tax Season (Apologies to David Letterman)

10. Get your things organized and to your preparer as soon possible to avoid needing to file an extension.

9. If you owe a lot or are getting a big refund, adjust your withholdings or quarterly estimated payments now.

8. If you can deduct an IRA contribution and owe tax, consider making a contribution before April 15 and getting it on your 2010 tax return.

7. If you live in Colorado, have kids in college, and don’t have a Colorado 529 plan, set one up and put this year’s tuition in it now.

6. Start your file now for 2011 tax data.

5. If you’re going through a divorce…oh shoot, taxes are the least of your problems.

4. Start a mileage log with a section for charitable miles, medical miles, and business miles.

3. Keep track of all your out of pocket business expenses.

2. Keep organized on your other financial issues, not just taxes.

1. Reward your tax preparer with chocolate – especially if it’s me!


To Roth or Not To Roth

Congress lifted the income ceiling in 2010 for conversion of a traditional IRA to a Roth IRA. So lots of people are wondering if a conversion is a good idea.  The answer is – as it so often the case – that it depends. 

What’s the difference between the two types of IRAs?  Contributions to a traditional IRA might be partially or fully tax deductable, so this type of retirement account has some or all of the balance subject to tax when the money is withdrawn.  Also, with a traditional IRA, you are required to withdraw a portion of the account every year beginning when you turn 70½ and those withdrawals are taxable.  Contributions to a Roth IRA are never tax deductible, but withdrawals aren’t subject to tax.  Also, you are never required to withdraw the money from a Roth.  Both types of IRAs have a 10% penalty if you take money out prior to your age 59½, with a few exceptions. 

Converting from traditional IRA to Roth means that the taxes need to be paid on the taxable portion of the traditional IRA, which sometimes means the entire amount.  During 2010, that converted amount can be taxed partially in 2010 and partially in 2011.  But unless you know you’re going to drop into a lower bracket in 2011 due to a life event – retirement, quitting a job to go to school full time, taking a big pay cut – spreading the tax over two years probably doesn’t make sense.  We know the tax brackets in effect for 2010 and it’s likely that they’ll be higher in 2011.

It’s important to remember that you don’t have to convert your entire IRA.  You could decide to convert just part of it.  So if the top IRS tax bracket you are subject to is 28%, you could convert enough of your IRA to a Roth that you wouldn’t have income pushed into the next tax bracket and leave the rest in your traditional IRA in place.  That Roth balance will now be available in your retirement years to be withdrawn only if you want to withdraw it and will be tax free if you do use it. 

So who is a Roth conversion most appealing to?  If you are in a lower tax bracket this year than normal, you might want to consider it.  Maybe you just retired or you’ve been laid off or had a pay cut in your household.  If you are ten or more years away from retirement and don’t expect your tax bracket to go down much when you leave the workforce, that’s another favorable thing.  So if you’ll have a pension that will pay you when you stop working or your IRA is really large, you might want to look at a conversion.  Ironically, the people who haven’t been eligible this year – high income earners – often have the hardest time justifying a conversion.  I recommend doing a Roth conversion prior to age 59½ only if you have enough cash outside the IRA to pay the tax.  So paying between 28% to 35% to the IRS (on top of any state income tax) to move into a tax free instrument is a difficult pill to swallow at just about any time.  But to do it during a recession when it’s especially important to keep lots of funds liquid in case of a loss of income or another financial emergency is too aggressive for some of these folks.  For people already in retirement, a low stock market can be a good time to do the conversion.  If you account values are down, moving some money to the Roth will allow that money to grow tax free.  Assuming growth on the account of 8%, it takes about three to five years to get back what was paid in taxes.  From then on, all the growth I  the Roth puts you ahead in the tax game on your retirement funds. 

Still undecided?  Make an appointment with a financial planner to see if your particular situation could make sense for a conversion.  Your situation is unique and one of the factors that can’t be quantified is whether or not you’re comfortable with the transaction.

A Taxing Time

I live and work in Colorado and snow ski (not well).  Several years ago when we were in one of the ski outfitting stores getting the family fitted for skis, I turned to one of my kids and said, “Do you know what getting skis always makes me think of?”  Without waiting a nanosecond, she answered, “Taxes!”  She was right.  Sad, but true. 


So this time of year elicits different thoughts in different people.  For some, it’s like a second set of holidays.  They look forward to a juicy refund.  For others, it’s a nightmarish waiting game to know what “the damage” is.  For still others, it’s simply a time when they get all the right forms together and do what they need to to file and forget it.  No big deal!


While we can make wise financial decisions that may affect our tax situation, among other things, taxes are often a case of “It is what it is”.  Here are four concepts to bear in mind about taxes. 


         There’s a difference between tax avoidance and tax evasion.  Tax avoidance is taking advantage of completely legitimate tax savings that you’re entitled to.  There’s absolutely nothing wrong with that and you harm no one but yourself by paying more than your share of the national and state tax burden.  Tax evasion is cheating.  It’s taking deductions or credits that you shouldn’t or hiding income.  So unless you have a passion for wearing an orange jump suit in a very small living space, don’t be a tax evader.  Let’s not forget that what put Al Capone behind bars wasn’t murder, it was tax evasion.  So the government has no sense of humor about it.

         A little bit of organization throughout the year can save you from a purgatory of finding documents at the beginning of the year.  Start a few folders where you drop receipts that you’ll need.  If you use a computer program for your finances, make categories for some of the tax deductible items like checks to charity, out of pocket medical expenses, health insurance, child care, property taxes, and other things specific to your situation.  Keep a book in your car for mileage you can deduct.  Then you’re looking at one evening of organizing your file, printing your deduction report, and looking over last year’s return for anything you might have missed, instead of more paper cuts and frustration than anyone should endure. 

         Don’t let the tax tail wag the overall finance dog.  I’ve seen self employed people spend ridiculous amounts on items neither they nor their business need because “it’s deductible”.  Also, I’ve seen people hold on to investments that were terrible and not appropriate for them because they didn’t want to pay tax on capital gains if the investments were sold.  There are lots of tax strategies that can be pursued with very little effort.  Meeting your financial goals without paying more than you should is great.  But a primary financial goal shouldn’t be to avoid taxes. 

         Big refunds are not a good thing.  Would you like to invest during the year in something that pays you no interest and gets you back your money – without interest! – at a time the investment company determines?  That’s what you’re doing when you overpay your taxes and get the money back when you file a return.  Tax planning probably involves working with a financial professional to try to get to a zero sum game – not owing something you don’t expect and not getting your money back without interest – but if you’re getting a big refund every year, it’s worth the money to pay a professional to help you plan your withholdings.