Thinking outside the (tax) box

Q: This will be my first year filing taxes as a married man and I’m confused about how I should file—married filing jointly or separately.  I completely trust my wife, and know her financial liabilities/health.  My question is based more in the military venue.  I am currently stationed in Iraq, and therefore my income is tax free.  My wife is working as a server (waitress).  Her taxable income (approx $40k) will be quite a bit more than mine.  Would it make more financial sense to file jointly, or separately?

-Joshua, in-the-box

A: Congratulations on your marriage and thanks for all you are doing over there in the sand, wind, cold and heat.  In most cases, filing jointly makes the most sense…and dollars!  Since you’re a couple now, the goal is likely to pay as little in taxes as possible. 

To illustrate your scenario, I’m going to assume that you have no children, do not itemize, you were in a tax-free combat zone throughout the entire year and that you and your wife did have adjusted gross income of $40,000 (including dividends, interest, and her wages).  In this scenario, if you file jointly, your total federal income tax would be around $2,300 (that takes into consideration the standard deduction and personal exemption).  On the other hand, if you both filed separately you would have zero tax, but she would owe around $4,300.  So, if you want to keep momma happy and do what makes the most sense for you both it appears filing jointly probably is the way to go.  There are a few instances when it makes sense to file separately.  One example would be if one of you had extreme health expenses that exceeded 7.5% of that person’s income.  As with all things tax-oriented, seek advice from a tax advisor or CPA.  He or she can prepare your returns both ways and see what makes the most sense based on the specifics of your situation.  Thanks for a great question!

The preceding discussion is not tax advice. Consult with your tax professional regarding your specific situation.

Tax-friendly retirement destinations

Q:  Hi June. I’m looking to retire in the next 14 months and was wondering what states along the east coast are most military pension friendly when it comes to taxes.

Thanks,
--Danny, Eldersburg, MD

A:  You’re smart to think about taxes as they relate to your military retirement! What really matters to retirees is their “take-home” pay.  Less paid in taxes equals more to cover expenses and to spend in retirement.  According to retirementliving.com,there are 26 states that don’t tax retired military pay. Of those, only Massachusetts, New Jersey, New York and North Carolina fit in your parameters. The list expands as many more states exempt disability retired pay.  Although there are many other factors to consider when choosing your retirement destination, strictly in terms of taxation North Carolina may be your best right coast bet as they don’t tax social security benefits either.  Not a small point, because you'll likley have to pay federal taxes on social security. In 2009, married filing jointly taxpayers will be hit up with federal taxes on social security starting at about $32,000 in income.  Yes, in the view of the IRS, military pensions do count as income.  

Thanks for asking such a smart question. And congratulations and thank you for your service.

Social Security Disability and Taxes

Q:  I thank you for reading this.  Is Social Security Disability taxable or is it exempt?  Thanks.

-- Ralph

 

 

A:  Good question.  How about “maybe” as a definitive answer?  Two types of government benefits include SSDI (social security disability insurance) and SSI (supplemental security income).  SSDI provides income for the disabled while SSI may provide additional income for the disabled or elderly folks who demonstrate financial need.  SSI is not taxable, but SSDI is taxable under the same rules as social security retirement.  Check out IRS Publication 915 for more information. 

 

So in a nutshell, if you don’t have any other income, your SSDI should not be taxable.  However, if you do have income from other sources, such as investments, military retirement, part-time work, etc., taxes could be due.  Basically, if half of your social security plus all of your other income is more than $25,000 (single) or $32,000 (married filing jointly), a portion of your benefits will be taxable.

 

 

Investing in a down market

Q:  We have been contributing to the government's TSP program for the past few years and are now concerned about the current economic crisis. Should we stop our contributions into TSP? Or should we ride out the crisis and take advantage of buying lower-priced stocks with our contributions? My husband is 40 and I am 36; we have no debt and a sizeable emergency fund.

--Cassandra, Naples, Italy

A:  Oh contraire!  You guys sound as if you’re building a great foundation: no debt, big emergency fund, and the capacity to save.  (And you’re living in Italy, too – my favorite country outside the United States!)  A financial planner considers that the dream scenario!  Based on your age, I think you have about 10 to 20 years until you retire and begin to use your retirement savings to supplement lifestyle expenses.  In the investment arena, we call that a long time horizon.  That means you have sufficient time for the market to go through its ups and downs and arounds. 

In fact, because of your long time horizon, the current markets may be offering you a tremendous opportunity to buy at cheaper prices.  Warren Buffett, arguably the world’s greatest investor said in a recent NY Times opinion piece, “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.” 

I’ve been heard to say that your investment portfolio is kind of like a dress, you have to like it and it has to fit and make you feel good.  My recommendation would be to look at where the money is being invested; not wondering whether or not you should invest at all.  Choose an investment mix that suits your tolerance for risk and keep investing. 

In addition to what you’re currently doing, I recommend you look into investing in a Roth IRA. The IRS has income limits ($166,000 to $176,000), but if your modified adjusted gross income falls under that amount, you and your husband are afforded the opportunity to invest up to $5,000 each in the Roth ( for 2008 and 2009).  It works this way: you deposit after-tax money (I call it grocery money) into your IRA where it grows over time tax-deferred and then at age 59 and ½ and after you have held the account for at least 5 years, you can withdraw any earnings tax free!  It’s a wonderful way to have some control over your taxes in retirement.  I think your inclination of taking advantage of a down market is smart.  Keep up the good work and don’t lose the faith!

Debt settlement better than bankruptcy

Q:  Do debt settlement and/or debt negotiation work as an alternative to bankruptcy?

--Tom, Norristown, Pa.

A:  Debt settlement or debt negotiation may be a better alternative to reducing your debt load than is bankruptcy, but make no mistake about it: all can have a negative impact on your credit score for 7+ years.  But, you’re right, settlement will affect your credit score less. One major negative that’s often unknown or overlooked with settlements is that if $600 or more of a credit balance is “forgiven” then a Form 1099 will be sent to the IRS and taxes will be owed the following April 15th. 

According to the IRS, taxes on credit card debt may be forgiven under the Mortgage Forgiveness Debt Relief Act of 2007, if the “cancelled debt [was] used to buy, build or improve your principal residence or refinance debt incurred for those purposes qualifies for this exclusion.” 

A better alternative might be to contact a local agency that belongs to the National Foundation for Credit Counseling (www.nfcc.org).  This type of counseling can help you turn things around, prioritize your cash flow and make prudent financial decisions.  If your problems are serious, they will help you set up a Debt Management Plan to meet your obligations and right your financial ship. Best of luck.

Integrity First!

Q:  An ex-Marine portrays himself as paralyzed due to being shot in the back in Iraq. The truth is he was only slightly injured during basic training. The facade continues as he collects military disability directly from the government stating that he still in a wheelchair. He does not need assistance with walking, and is in fact very healthy. Is this a fraudulent claim? Should he still be receiving these benefits? Is there somewhere else I should go to gain more attention to this matter? Any assistance is appreciated. Thank you for your time.

--Name withheld

A:  If your story is true, it’s very upsetting to me too - both as a servicemember and a taxpayer.  I’ve served as an Internal Review officer at the division level and I’m sure they would be very interested in your story.  Also the division Inspector General or the Department of Veterans Affairs Inspector General might be able to help or point you in the right direction.  Contact them at 1-800-488-8244.  Fraud, waste and abuse are taken very seriously in the armed forces. As taxpayers, we all pay when this sort of stuff goes on!

Handy Military Website

Q:  I just finished boot camp and during the move, I misplaced my W2. How do I go about getting another? Is there a website I can go to?

-Christopher

A:  Visit the DFAS website myPay.dfas.mil to print out another W-2, or to view pay statements and lots of other good information.

Taxable Income: Social Security and VA Pension

Q: Are Social Security and VA pension considered income when filing my income tax return?
- Craig, Woodson Terrace, MO

A: Thanks for your question and your service! 

Unfortunately, it can be hard to escape the long arms of the taxman! A portion of your Social Security may be included as income when you file your tax return. Here is how it works: if your income, including one half of your social security and tax-exempt interest from bonds, is less than $25,000 ($32,000 if married filing jointly), your social security will not be included as income and taxed. If your income is between $25,000 ($32,000 MFJ) and $34,000 ($44,000 MFJ), 50% of your Social Security is included as income and taxed. Finally, if your income including half your Social Security is greater than $34,000 ($44,000 MFJ) 85% of your Social Security will be included in income. Whew!

On the other hand, disability or compensation received due to disability received from the Veteran's Administration is typically not included in income or taxed. I hope you find this information helpful. If you have additional questions, please visit www.irs.gov.

State and Federal Taxes

Q: Will my military retirement require me to pay federal taxes even if I live in Hawaii, which is a state that does not tax my retirement?
- Raymond, Kailau, HI

A: Retiring in Hawaii, you definitely need to find ways to save! Unfortunately, most of us have to work with two different income tax systems - state and federal. Although there are a number of states that do not require that you pay state income tax on your military retirement pay, the federal government does require that you pay federal income tax on your military retirement pay. You can not avoid federal tax on your military retirement, regardless of where you live. The only exception is if part or all of your military retirement is attributed to Military Disability Retirement Pay ? then it becomes federally tax-free. Thanks very much for your service. Aloha!