I Despise the USA Tax System SO Much

[FDC319]

The tax system rewards those who diligently study the rules. Since 1977, I have always prepared my own tax returns and have never had a problem.

It may be too late for some, but this post identifies many of the income limits and thresholds for 2020. You may find it helpful.

https://www.early-retirement.org/forums/f28/the-important-trigger-income-levels-2020-a-101090.html

Thanks to reading this post I have learned that I wasn't eligible to contribute to my Roth IRA in 2019. Taxes are already filed and 2020 Roth IRA is already maxed.

The "good" thing is I anticipate less income in 2020 and this won't be a problem as I'm retiring this year.

OOPS. Off to do some research to see how I can correct it with the least amount of account juggling and pain.

 

[clobber]

The AMT, for example, has been around since 1969. The AOTC has been around since 2009. The NIIT was enacted in 2010 and didn't take effect until 2013.

It is very valuable to be aware of the tax code and consider any tax consequences when making financial decisions, rather than just making decisions first and finding out about the tax consequences later.

OP here.

I think that this is exactly my point. I'm not even griping about "new" things that I did not know about. I have my own spreadsheets, I have 3rd party spreadsheets, I have Turbo Tax, and I'm fairly literate in the complexity of taxes. I knew that I would be paying my tax bracket rate on short-term gains and 15% on long-term gains etc. But for example, the NIIT caught me completely off guard. Maybe I've never even heard of it. If I had heard of it, I glossed over it because it never applied.

There is no defense of AMT, no matter how old it is.

Ohh - I dont think any one as commented on the use of AGI as a metric. I still don't understand why a person might be ineligible for a Roth, like @FDC319, just because they decided to sell some stocks. Or similar, If I decide to contribute to a tIra, I might be eligible to get the AOTC. But if I choose a Roth, I'm not. That should not matter.

I realize I'm asking for logic when there isnt any.

 

[scrabbler1]

The tax system rewards those who diligently study the rules. Since 1977, I have always prepared my own tax returns and have never had a problem.

I have to agree. I have been preparing my own tax returns since 1985, and have been preparing the tax returns of my ladyfriend and my best (male) friend since 2004. I have made a few fairly small, usually careless mistakes with these returns over the years, but not due to any misunderstanding of the tax code. Once I bought my first PC in 1995 and began creating spreadsheets to aid in my tax return preparation, it became easier to do them. With those spreadsheets came the ability to do what-if scenarios and predict how my taxes due would change based on income changes such as large cap gain distributions or ACA premium subsidy changes.

My ladyfriend's tax returns have become easier since 2013 because she no longer itemizes her deductions. I can do her returns in 10 minutes although the recent tax law changes added some forms because things previously shown on a single form got split up. My best (the snake-bit one) friend's returns are more complicated, since 2012, when an inheritance added a lot of investment income to his portfolio. We have since simplified his portfolio some.

Even without spreadsheets, I remember back in mid-1985 how I was able to figure out, armed with only a calculator and payroll withholding charts, how to increase my W4 withholding exemptions so that I would avoid getting a big refund in early 1986 and get that refund throughout the second half of 1985 in each higher paycheck when I began working at my first full-time job. Not having to file for that large refund meant I could afford to buy my first car in early 1986.

I tried TurboTax a few years ago as a check on my spreadsheets but found it to be totally useless. It gave me totally nonsense numbers so I threw it away and never considered it again. From my admittedly warped perspective, I can't figure out how it actually works correctly for anyone!

I will agree that there are some quirks and flaws in the tax code, and the tinkering over the years has only made things somewhat worse. But some of the tinkering has made things better even if it has become more complicated.

 

[eytonxav]

Talk about tax code being complex, take a look at the bills that get passed in congress that also drive desired behaviors and results while the drafters do not even realized the overall consequences.

 

[LOL!]

For more than 40% of US families that pay no federal income taxes, I think income taxes are not complex and are easy.

For the others, I will just ask: Have you ever read IRS Publication 17? If not, then you don't have a leg to stand on. That means if you are relying on Intuit Turbo Tax to help you, then you have been suckered by a business into treating you like a baby.

 

[HawkeyeNFO]

I LIKE THE FEDERAL TAX SYSTEM. Despite a much higher than average income, there are so many deductions and credits, that I have managed to not pay any federal taxes for most of the past 10 or 15 years.

When I was in the military, as a FL resident, there were no state income taxes either. However, because of where I now live, I have to pay thousands to the commonwealth of Virginia, and many many thousands to the county for property tax.

 

[clobber]

Even without spreadsheets, I remember back in mid-1985 how I was able to figure out, armed with only a calculator and payroll withholding charts, how to increase my W4 withholding exemptions so that I would avoid getting a big refund in early 1986 and get that refund throughout the second half of 1985 in each higher paycheck when I began working at my first full-time job.

I'm not saying certain things can't be done, but that does not make them needlessly complicated. The old way of w4 withholding allowances (equal to exemptions) was CRAZY. "I plan on selling some stock next year, so this year i better tell the IRS that I have less kids for next year."

A colleague of mine as 3 children. To get his yearly taxes about right he had to claim 12 W4 allowances. "Hey IRS, I plan to give some money away that you and the law say is deductible. Therefore, consider me to have 9 more kids than I really do."

 

[Spock]

We were "introduced" to how to file a tax return in a class in highschool. Jr High we were taught how to run a checkbook.
I've done my own taxes every year except one year I pharted with a rental property and the depreciation forms where nuts.

As a lean FIRE, I'm playing with the very bottom rungs of the tax brackets so things are extremely simple... it only gets complex when you're in the upper brackets trying to wiggle through every "loop hole" (they're intentional, so not really loop holes).

While I think the tax code as a whole should be trashed and greatly simplified (if it exists at all... I'm also a closet libertarian... "TAXATION IS THEFT!" my only personal complaint is the lack of certainty in planning for future taxes. Every legislators whim is a stroke of a pen from becoming reality in the next "must pass" bill that floats across their desk.
Its like getting a degree in college... when you start a degree the required course catalog for you is frozen... course requirement changes after that only effect new students. Same should apply for tax code changes.

 

[RunningBum]

I'm not saying certain things can't be done, but that does not make them needlessly complicated. The old way of w4 withholding allowances (equal to exemptions) was CRAZY. "I plan on selling some stock next year, so this year i better tell the IRS that I have less kids for next year."

A colleague of mine as 3 children. To get his yearly taxes about right he had to claim 12 W4 allowances. "Hey IRS, I plan to give some money away that you and the law say is deductible. Therefore, consider me to have 9 more kids than I really do."

Last time I did a W4, admittedly a long time ago, I could put down the correct marital status and # of kids, and add an extra withholding amount in $ for the extra income. Or one could make quarterly estimated tax payments for online very easily. This seems like a case where you are the one making things needlessly complicated.

 

[clobber]

Last time I did a W4, admittedly a long time ago, I could put down the correct marital status and # of kids, and add an extra withholding amount in $ for the extra income. Or one could make quarterly estimated tax payments for online very easily. This seems like a case where you are the one making things needlessly complicated.

The only way to do that was to then tell the IRS that you had no kids (no allowances) and then withhold extra. Of course, when tax time rolled around you would still claim exemptions.

 

[scrabbler1]

I'm not saying certain things can't be done, but that does not make them needlessly complicated. The old way of w4 withholding allowances (equal to exemptions) was CRAZY. "I plan on selling some stock next year, so this year i better tell the IRS that I have less kids for next year."

A colleague of mine as 3 children. To get his yearly taxes about right he had to claim 12 W4 allowances. "Hey IRS, I plan to give some money away that you and the law say is deductible. Therefore, consider me to have 9 more kids than I really do."

W4 withholding allowances, at least through 2008 when I last had to file that form, were never solely about how many kids you had. It was a means to get the total taxes withheld for the year to be close to what your total tax liability was going to be. When my investment income began to rise in the late 1990s, I reduced by 1 my W4 withholding exemptions to avoid underpayment penalties and to minimize or eliminate 4th quarter estimated tax payments. That's what I learned in 1985 but in the opposite direction - to avoid a big refund and to get that money as I earned it. In 1985, I put a "12" on my W4 because I was entitled to 12 exemptions, not because I had 12 kids. It makes perfect sense to me.

 

[clobber]

It makes perfect sense to me.

Again - I'm not saying the w4 issue could not be worked out. But you think it makes perfect sense that you had to figure out you needed 12 x $4300 (recent value of an allowance/exemption) for a total of $51600? And that you could then calculate that it meant your employer would withhold some progressive amount less equally in your paychecks?

Perfect sense = "Please withhold $573 from my checks"

 

[scrabbler1]

Again - I'm not saying the w4 issue could not be worked out. But you think it makes perfect sense that you had to figure out you needed 12 x $4300 (recent value of an allowance/exemption) for a total of $51600? And that you could then calculate that it meant your employer would withhold some progressive amount less equally in your paychecks?

Perfect sense = "Please withhold $573 from my checks"

You would need to have every payroll system in the country be changed to handle a feature most of us would rarely, if ever use. Most people are not going to be able to determine how much they need to reduce their annual income (AGI) in order to make their taxable income come out right. W4 exemptions are a simple currency to get there. The only time one needs to specify exact dollar amounts to withhold from pay is when putting a zero on the W4 exemptions doesn't withhold enough. Should we really want to offer W4 users a way to have zero taxes withheld via exemptions (i.e. putting a '99' in there, the way some people might have once done) then figuring out 1/26th or 1/12th or 1/24th or 1/52nd of their total estimated tax liability to include in its place? Yes, that would have been helpful to me in 1985 and a very few others over the years, but IMHO it would have been a needlessly confusing to anyone who didn't choose that option, or to anyone who chose it but calculated incorrectly. W4 exemptions are a simple currency to get there.

 

[Gumby]

I share clobber's desire for a way to indicate a specific dollar amount to be withheld, but that is mainly because at the beginning of the year I can figure what my taxes will be at the end, to within a few hundred dollars. But I realize I am unusual in that regard. The W-4 is designed for the vast majority of people who either cannot or will not make that calculation. It also ensures that people don't take all of the money now, spend it and leave nothing to pay the taxes when due next April. You know many people would do that if they could.

 

[SecondCor521]

OP here.

I think that this is exactly my point. I'm not even griping about "new" things that I did not know about. I have my own spreadsheets, I have 3rd party spreadsheets, I have Turbo Tax, and I'm fairly literate in the complexity of taxes. I knew that I would be paying my tax bracket rate on short-term gains and 15% on long-term gains etc. But for example, the NIIT caught me completely off guard. Maybe I've never even heard of it. If I had heard of it, I glossed over it because it never applied.

There is no defense of AMT, no matter how old it is.

Ohh - I dont think any one as commented on the use of AGI as a metric. I still don't understand why a person might be ineligible for a Roth, like @FDC319, just because they decided to sell some stocks. Or similar, If I decide to contribute to a tIra, I might be eligible to get the AOTC. But if I choose a Roth, I'm not. That should not matter.

I realize I'm asking for logic when there isnt any.

Ah, well, I see your point. I defend against the NIIT-style of surprise mostly by generally reading articles about tax topics, so even though the NIIT doesn't and hasn't yet applied to me, I know roughly where it starts coming into play. But for people who don't want to or don't like to or just were unlucky enough not to read the articles about NIIT, I think that's a valid criticism - the tax system has gotten so complex that it's quite unreasonable for people to try to read the whole thing every year and apply it to their situation.

The other defense I utilize against NIIT is that I complete my taxes based on what I know about my own financial situation and all the tax laws I happen to know. I try to read the "what's changed in taxes this year" articles and at the beginning of the IRS instructions and see if any of it applies. Beyond that, I don't go reading through everything every year looking for NIIT chestnuts that might bite me. If something falls through the cracks, then I will be reasonable when the IRS comes knocking, pay my additional taxes and interest and penalties, and hope to avoid jail time by demonstrating that I was reasonably diligent and honest.

I don't care too much about AMT, but the argument for it was that high income people with lots of deductions should still pay some tax. (Aside, I wonder how Amazon avoids AMT. It is popularly claimed that they make a lot of money and still pay $0 in federal income taxes. Not sure if it's true, but if it is, it doesn't exactly square with the argument for AMT.)

In general, although I don't think it's explicitly stated, the reason for most AGI-related phaseouts are that it is popular for Congress to social engineer in favor of the low income and in disfavor of the higher income. Take, for example, the coronavirus stimulus payment. It has an AGI phaseout of 5% starting at $75K individual and IIRC $150K MFJ. The stated or implied reason is that lower income people need the money more. Also, the lower income people will spend more of it, and since it's purpose is to stimulate the economy, it's more effective.

I don't really have any problem with any of this. I've arranged my financial life - and happen to have low interest in spending money - so that I am able to have a low AGI, very low taxes, and generally be quite content.

I do think that Congress has gone a little too far in the sense that they have made so many things phase out, so that the progressiveness of the tax code is too extreme for middle income earners. I've commented before that for every dollar I add to my AGI, it has many different marginal rates applied simultaneously:

1. Federal income tax
2. State income tax
3. ACA subsidy phaseout, which acts like a tax (about 15%)
4. FAFSA EFC increase, which acts like a tax (about 5%)
5. Coronavirus stimulus phaseout, which acts like a tax (5%)

In addition to these four, I also have AOTC, retirement savings tax credit, and possibly others I haven't thought of.

The fact that the phaseouts are all at various AGI levels just makes the planning that much more fun. And by fun I mean difficult.

I'll reiterate the original point along with another poster from earlier: Because the tax system is so complex, there are opportunities for the diligent to save money. It would be better if this weren't the case, but it is, so we might as well take advantage as best we can.

 

[street]

IMO it's criminal how complex our tax codes are, thanks to politicians & special interests meddling. There is no reason it couldn't be a lot easier. It should be possible for the average citizen to understand and file their own taxes, but I doubt many can.

Exactly!

 

[SecondCor521]

Thanks to reading this post I have learned that I wasn't eligible to contribute to my Roth IRA in 2019. Taxes are already filed and 2020 Roth IRA is already maxed.

The "good" thing is I anticipate less income in 2020 and this won't be a problem as I'm retiring this year.

OOPS. Off to do some research to see how I can correct it with the least amount of account juggling and pain.

For 2019 I think you will find that you need to either remove the Roth IRA contribution plus earnings, or recharacterize your Roth IRA contribution plus earnings to a traditional IRA. If you elect to recharacterize, it is as though you made the contribution to your traditional IRA all along. Since you're probably not eligible to deduct the traditional IRA contribution, if I were in your shoes I would prefer to do the withdrawal. Otherwise you'd have an IRA with basis, which is a pain to track IMHO.

Since you've already made a 2020 Roth contribution, be sure to be clear with the custodian when you give them instructions that you're referring to your 2019 contribution, not your 2020 one.

After withdrawing or recharacterizing, you can amend your 2019 tax return as needed. If you recharacterize and are eligible for an IRA deduction, then you would amend to take that deduction. If you withdraw the money instead, then you wouldn't need to do anything with your 2019 tax return, but you will get a 1099-R from your IRA custodian in January 2021 which will essentially say that you owe taxes and possibly a 10% penalty on the earnings on your 2019 Roth contribution while the money was in your account.

If you're under the cutoff for 2020, you can leave the 2020 Roth contribution alone. (Or withdraw it or recharacterize it, of course.)

 

[scrabbler1]

(snip....)

I do think that Congress has gone a little too far in the sense that they have made so many things phase out, so that the progressiveness of the tax code is too extreme for middle income earners. I've commented before that for every dollar I add to my AGI, it has many different marginal rates applied simultaneously:

1. Federal income tax
2. State income tax
3. ACA subsidy phaseout, which acts like a tax (about 15%)
4. FAFSA EFC increase, which acts like a tax (about 5%)
5. Coronavirus stimulus phaseout, which acts like a tax (5%)

In addition to these four, I also have AOTC, retirement savings tax credit, and possibly others I haven't thought of.

The fact that the phaseouts are all at various AGI levels just makes the planning that much more fun. And by fun I mean difficult.

I'll reiterate the original point along with another poster from earlier: Because the tax system is so complex, there are opportunities for the diligent to save money. It would be better if this weren't the case, but it is, so we might as well take advantage as best we can.

The ACA subsidy is more of a cliff than a phaseout, a cliff which I and others here have discussed several times over the years. If your MAGI is one dollar over the max, the entire subsidy, no matter how small or big it is, disappears. It's not like the subsidy gradually decreases as your MAGI rises a little over the max.

 

[SecondCor521]

The ACA subsidy is more of a cliff than a phaseout, a cliff which I and others here have discussed several times over the years. If your MAGI is one dollar over the max, the entire subsidy, no matter how small or big it is, disappears. It's not like the subsidy gradually decreases as your MAGI rises a little over the max.

Well, as always, it depends on your AGI

For the RobbieB's of the world, yes, there is a cliff at 400% FPL.

Between 100% (*) and 400% FPL, there is indeed a phaseout which is implemented via the somewhat cryptically named "Applicable Figure" in Table 2 of the Form 8962 instructions. If one's AGI increases from, say, 150% to 300% of the FPL, then one's Applicable Figure increases, which results in a lower PTC, which is the equivalent of a marginal tax.

There can actually be a cliff at the bottom as well. I think those under 100% or 133%/138% (I never understood this stuff very well) may also lose their ACA subsidy in certain circumstances.

(*) or 133% or 138%, or whatever.

...

Also of note: Although it is disguised somewhat in the calculations, although the increased loss of PTC looks like about a 5% rate, it actually is much higher because the 5% loss rate on PTC is applied to all of AGI, not just the portion above some threshold value. This ACA PTC loss acts differently than the traditional tax brackets and other phaseouts. It depends on where your AGI falls in that 100% to 400% range, but for me the marginal tax rate works out to about 15%.

 

[FDC319]

For 2019 I think you will find that you need to either remove the Roth IRA contribution plus earnings, or recharacterize your Roth IRA contribution plus earnings to a traditional IRA. If you elect to recharacterize, it is as though you made the contribution to your traditional IRA all along. Since you're probably not eligible to deduct the traditional IRA contribution, if I were in your shoes I would prefer to do the withdrawal. Otherwise you'd have an IRA with basis, which is a pain to track IMHO.

Since you've already made a 2020 Roth contribution, be sure to be clear with the custodian when you give them instructions that you're referring to your 2019 contribution, not your 2020 one.

After withdrawing or recharacterizing, you can amend your 2019 tax return as needed. If you recharacterize and are eligible for an IRA deduction, then you would amend to take that deduction. If you withdraw the money instead, then you wouldn't need to do anything with your 2019 tax return, but you will get a 1099-R from your IRA custodian in January 2021 which will essentially say that you owe taxes and possibly a 10% penalty on the earnings on your 2019 Roth contribution while the money was in your account.

If you're under the cutoff for 2020, you can leave the 2020 Roth contribution alone. (Or withdraw it or recharacterize it, of course.)

Thanks for the detailed rundown. That is about what I was about to type up as a question to ensure I was seeing things mostly correct.

Originally I was hoping to leave it in the Roth with the potential of paying a one time penalty, but that does not look to be a possibility.

I am leaning towards asking for a recharacterization of my 2019 contribution From Roth IRA to Traditional. Execute that, and then amend the return. I appreciate the additional tip to carefully specify the 2019 contribution.

I'll give Vanguard a call tomorrow and see what they say.


*I apologize for hijacking the thread. If I have other questions, I start a new thread.

 

[Cobra9777]

Late in my Megacorp career, I was an expat for 3 years. The expat agreement included a tax equalization provision, which basically meant that Megacorp was responsible for all additional tax resulting from the assignment. In exchange, they received all benefit from the foreign tax credit on my US return, including any carry-forward balance after the assignment ended... which even included a couple years AFTER I had retired.

For those 3 years, plus 3 or 4 years afterward, Megacorp engaged one of the Big Four accounting firms to prepare our returns in both countries. This included the hypothetical stay-at-home return that I was financially responsible for, as well as all the reconciliations. That whole process was almost inconceivably complex.

I sort-of understood the hypothetical return and I had my usual Excel model to plan and keep track of our responsibility under the agreement. But the actual US tax return that they filed on our behalf was incomprehensible. There were deductions and adjustments for things I never understood even after lengthy email exchanges with the partner in charge.

One year, we had to send the return by paper due to an earlier fraudulent return using my SSN. They sent us the return for DW and I to sign and then mail. It was 95 pages long! The return for the foreign country where I was living and working was exactly one page every year... basically a percentage applied to my salary. Maybe not a fair comparison in that situation, but still... 95 pages.

Aside from that frustrating period, I've always done our taxes using TurboTax and Excel for planning and what-if's. I stay current on code changes and adjust accordingly. Forums like this keep me thinking creatively about tax reduction strategies like Roth conversions, tax-loss harvesting, HSAs, tax-efficient investing, etc. Now that I'm retired, this is sort-of fun and helps exercise the brain.

 

[Toocold]

If it makes you feel better, I had to file 3 state taxes this year because CA and NY require you to file taxes if you earned company equity either during the date that it was vested or exercised, and CA and NY had different calculations and different holding amounts. This meant that someone had to track multiple trips to CA 5-8 years ago and calculate what % of the total time I had been working to prorate the taxes owed to CA, and same for NY, and because these awards are vested over a 4 year period, you had to track staggered vesting schedules.

I'd vote for a flat tax.

 

[SevenUp]

I am leaning towards asking for a recharacterization of my 2019 contribution From Roth IRA to Traditional. Execute that, and then amend the return. I appreciate the additional tip to carefully specify the 2019 contribution.

Might not be any need to amend the return, but simply file form 8606 instead.

 

[Midpack]

From 2016. I’ve never used a tax service, but I was guessing the % would be higher. Way more people should be able to do them my manually IMO - I’d bet they could generations ago.

 

[SecondCor521]

Originally I was hoping to leave it in the Roth with the potential of paying a one time penalty, but that does not look to be a possibility.

I am leaning towards asking for a recharacterization of my 2019 contribution From Roth IRA to Traditional. Execute that, and then amend the return. I appreciate the additional tip to carefully specify the 2019 contribution.

You're right about the lack of a one time penalty. It used to be 6% of the excess contribution per year as long as it remained an excess contribution, which is usually enough of a penalty to cause people to remove it.

I think there is a way to carry it forward and treat it as though it was a 2021 Roth contribution, but that would probably involve the 6% excess penalty for 2019 and 2020, so probably not worth it.

If you recharacterize, the nice thing is you don't have to worry about the excess earnings. The drawback is if you're not entitled to the IRA deduction on your taxes, then you have basis in your traditional IRA. Having an IRA with basis is a multiyear record keeping issue that I choose to avoid. The other option is to do the recharacterization, take whatever tax deduction you can get, and forget about the basis. You'll pay slightly more taxes when you take money out of the traditional IRA many years from now, but you won't have to bother with the accounting.

Might not be any need to amend the return, but simply file form 8606 instead.

If FDC319 wanted to take the deduction for their 2019 traditional IRA contribution, Form 8606 would not be sufficient. This would also be true of the retirement savings contribution credit, although I suspect FDC319's income is probably too high for that.

I'm not sure if FDC319 would have to file an 8606 with the amended 2019 return - they may need to do so. FDC319, check the instructions for Form 8606.