The mirror image of the marriage tax penalty is the marriage tax bonus, that is when two spouses have disparate income or one spouse decides to stay at home, they pay less tax than they do if they don't marry.

I touched on the topic of marriage tax penalty in two previous posts:

• Tax Proposals in Obama's 2010 Budget Outline
• 2009 AMT Tax Brackets

It turns out that marriage tax penalty and marriage tax bonus have been studied extensively by economics professors. It's well known within the academic circles that three desirable objectives can't be satisfied at the same time:

1. Horizontal Equity: households with the same income pay the same tax
2. Progressivity: higher income pays a higher rate of tax
3. Marriage Neutrality: the tax system should stay neutral to the decision to marry

It's very similar to the time-cost-quality triangle: you can have any two but not all three.

A key concept is called the unit of taxation, in other words, whether taxes are levied on an individual person or on a family.

The current US tax system uses a family as the unit of taxation. It achieves objectives #1 and #2, but it fails in objective #3. Some people receive a tax incentive to marry while others are penalized for marrying.

Most other developed countries use the individual as the unit of taxation. The same person pay the same tax whether they are single or married. This system achieves objectives #2 and #3, but not #1. Under this system, a one-earner household pays a higher tax than a two-earner household with the same income.

Although it seems unfair under an individual unit of taxation system to tax a one-earner family more than a two-earner family with the same income, it's actually fair. When you recognize the value of the household work taken up by the stay-at-home spouse, the one-earner family produces more and therefore should be taxed more.

According to a research paper I read, Canada, UK, Japan all base their taxes on individuals. Only 9 countries in 30 OECD countries base their taxes on families. In the last 30 years, several countries also moved away from joint taxation like in the US to individual taxation.

The United States is once again in the minority relative to the rest of the world on this issue. Why am I not surprised?

Reference:

Alm, James, 2005. Thinking About The "Marriage Penalty", a PowerPoint presentation.

Alm, James and Mikhail I. Melnik, 2004. Taxing The "Family" In The Individual Income Tax, Public Finance and Management, Vol. 5, No. 1

Cleveland, Gordon and Michael Krashinsky, 1999. Tax Fairness for One-Earner and Two-Earner Families: An Examination of the Issues. CPRN Discussion Paper No. F07.

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In preparation for converting my non-deductible IRA contributions to Roth IRA in 2010, I'm rolling over the pre-tax portion of my traditional IRA to my solo 401k. I set up the solo 401k last year primarily for this purpose — to provide a harbor for my pre-tax IRA money so I won't get taxed proportionally on my Roth conversion. After the rollover, I should have only one small IRA, consisting of my non-deductible contributions plus or minus market fluctuations from now until I convert in January 2010.

I have my solo 401k with Fidelity. When I called them about the rollover procedures, to my surprise, the rep actually discouraged me from doing so. To his credit, he made valid points. He knew what he was talking about. Fidelity trained them well.

He said the 401k has more restrictive rules on withdrawals. Before I reach 59-1/2, I can withdraw from a traditional IRA for any reason. I just have to pay tax and the 10% early withdrawal penalty. Not that people should do that but that option is there. If I put the money into the solo 401k, I have to qualify for specific hardship events before I'm allowed to withdraw and pay the tax and the 10% penalty. Fidelity's solo 401k plan does not allow loans.

He also said rolling over money in an IRA to a solo 401k will get the solo 401k closer to an IRS reporting threshold. When a solo 401k plan's assets reach $250,000, the plan administrator will have to file a Form 5500-EZ with the IRS every year. I can avoid the extra paperwork for more years if I don't rollover IRA money into my solo 401k.

I would agree with him if I'm not preparing for the Roth conversion. I decided the benefits of low taxes on Roth conversion outweigh the restrictions on withdrawals and the extra paperwork.

The actual rollover consists of two steps. Because I'd like to keep the assets in my IRA, I would transfer in-kind to a new Fidelity Rollover IRA as a bridge. After that's done, Fidelity needs a letter from me as the administrator of my solo 401k to accept the rollover from my Fidelity Rollover IRA. Then the bridge rollover IRA will be closed. Fidelity will not charge the usual $50 IRA closing fee.

I initiated the partial rollover online with Fidelity last Wednesday. I mailed the transfer of assets form on Thursday. By Tuesday, the rollover is completed. Four business days. Fidelity did a very good job.

With the rollover, I said goodbye to Vanguard Brokerage Service. Vanguard is a great mutual fund company, but its brokerage service is substandard. In order to avoid complications with the rollover, I wanted to change my dividend reinvestment election from automatically reinvest to taking the dividend in cash. I got this nice message when I tried to do so:

Vanguard Brokerage Service is saying their computers for processing dividend reinvestment elections go off their shift at 5 p.m. Eastern time. I honestly cannot think of any reason why computers work only a day shift.

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The government gives tax credits for buying a "green" car. If you are not buying a "green" car, you don't get a tax credit, but you still get a tax deduction for the sales tax. See previous post Tax Deductions: Above-the-Line, Standard, Itemized, and Miscellaneous for the difference between a tax credit and a tax deduction.

The tax credit is called Alternative Motor Vehicle Credit. It's been available for a few years now. There are four categories of vehicles under the program. For the average consumers, the two most relevant categories are basically hybrid and clean diesel cars. These cars must be purchased new. Leasing does not get you the credit.

For hybrid and clean diesel cars, once a manufacturer sells 60,000 units under the program, the credit starts to phase out. As a result, the popular Toyota and Honda hybrid cars no longer qualify. For cars that still qualify, the IRS has specific lists of makes and models and tax credit amounts:

• 2009 model year hybrid
• 2010 model year hybrid
• diesel models

To calculate and claim the credit, use IRS Form 8910. The bottom line on Form 8910 feeds to a line on Form 1040.

This tax credit is non-refundable, which means you must have enough tax liability to benefit from it. There is no upper income limit for the credit. It's not limited to one car either. However, if you are subject to AMT, you effectively don't get the credit. Unused credit cannot be carried over.

As far as I can tell, if you qualify, you can claim both this Alternative Motor Vehicle tax credit for buying a hybrid or diesel car and the tax deduction for the sales tax paid.

Reference:

• Form 8910 Instructions

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• Summertime Tax Tip 2009-03: Five Tax Facts about Summertime Child Care Expenses
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Certain employee benefits, like health care, are not taxable. Personal use of an employer provided BlackBerry or cell phone is not one of them. The IRS published Notice 2009-46 on June 8. It's on pages 13-15 in Internal Revenue Bulletin 2009-23. They are asking for public comments about the three methods it's considering.

1. Minimal Personal Use Method. There are two proposals under this method. Under the first proposal, if the employee can show to the employer that he/she carries another personal cell phone and uses that phone for personal matters, then the employee won't have to pay taxes on the company provided  BlackBerry or cell phone. Under the second proposal, there would be a threshold of say X minutes. If the employee can show he/she used the BlackBerry or cell phone for personal purpose for no more than X minutes or he/she used it only for certain exempted types of calls (emergency for example), the employee won't have to pay taxes for such personal use.

2. Safe Harbor Substantiation Method. Under this method, instead of getting proof from the employees or tracking how many minutes were used for personal purpose, the employer just uses an IRS-specified percentage for everybody, say 75% for business use and 25% for personal use. Employees will pay taxes on 25% of the fair market value of the service.

3. Statistical Sampling Method. Under this third method, the employer is supposed to take a sample and do some statistical analysis to figure out the percentage of personal use versus business use. Then the employer applies that percentage for everybody and adds the proportional value of the service to employees' pay, on which the employees will pay taxes.

For more information, in case I misinterpreted something, please read Notice 2009-46 on Internal Revenue Bulletin 2009-23. If you have something to say to the IRS about these proposals, send your comments to them by mail or by e-mail. The addresses are on the last page in the notice. Be sure to include Notice 2009-46 in the subject of your comments.

What about company provided laptops or on-site fitness gym? I also wonder when the IRS will make employees account for soft drinks and snacks and team lunches.

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Bartering is apparently hot these days. The popular web site Consumerist recently quoted an Associated Press article Short on cash? Bartering making a comeback which said traffic to bartering web sites doubled in this weak economy.

Boise beautician Heather Wood has traded haircuts and pedicures for years of day care, kids' clothes, a paint job for her car, an oil change, a set of professional portraits for her family and dental cleaning.

"It's fun, and it builds a whole different kind of a relationship," said Wood, who has five children. "They're getting what they want and I'm getting what I want. I would much rather do that than make cash most of the time."

I also found this L.A. Times article from Google: Boom times for barter.

In this tough economy, Valerie Whitlock uses two forms of currency: money and barter. The 37-year-old actress and writer from Studio City holds down sporadic film and television gigs to cover her rent, utilities, car payments and insurance. For everything else — head shots and haircuts, clothing and cut reels — she trades her handcrafted jewelry.

What's wrong with charging money for your haircuts and pedicures or handcrafted jewelry? Whatever you can do with bartering, you can do with money. If it's an equal exchange, everybody is even after giving and receiving money. You give a pedicure for $50 and you pay $50 for day care. It has the same effect as bartering. But you can't do everything with bartering that you can do with money. You can't walk up to a gas station and offer haircuts for gas. So why go through the trouble with bartering?

I can't help wondering if it has something to do with taxes. I don't want to accuse beautician Heather Wood or jewelry maker Valerie Whitlock in those articles of anything because I have no evidence whatsoever whether taxes are a consideration. When you receive money for your products or services, you have to pay taxes. If you are self-employed, you have to pay income tax and both the employer's and the employee's shares of the payroll tax (15.3%). When you use the money received to buy stuff, you may have to pay sales tax. If the person on the other side of the trade is also self-employed, the other person will have to pay the same set of taxes too. If you do bartering, you are supposed to pay taxes the same way as when you charge money. The IRS says you have to record income for the fair market value of the bartered goods or services you receive. But it's a lot harder or perhaps impossible to track, because there is no money changing hands in bartering. There is opportunity to either not report them or report them at a much lower value. After all, the fair values of the bartered goods and services received in return are difficult to assess. Who says that paint job for your car has to be worth $600, not $200? The guy just gave you a good deal, you know?

The IRS must not be amused about all these bartering going on. They produced a video about bartering, telling people they must report their bartering income. Good luck with that.

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Married Filing Jointly	Single or Head of Household	AMT Income	QD & LTCG*
$0 – $70,950	$0 – $46,700	0%	0%/15%
$70,951 – $150,000	$46,701 – $112,500	26%	15%
$150,001 – $226,760	$112,501 – $199,860	32.5%	21.5%
$226,761 – $433,800	$199,861 – $299,300	35%	22%
$433,801 or more	$299,301 or more	28%	15%

* Qualified Dividends and Long Term Capital Gains

Compared to the 2008 AMT brackets, the amounts changed very little. The two rows in red are the phaseout zones. They are penalized for having a comfortable, but not rich, income. For more information on how these numbers are calculated, please read the previous post 2007 Tax Year AMT Brackets.

I repeat what I wrote before about my problems with the AMT:

First notice the marriage penalty. If each spouse earns $80,000, a married couple is in the 32.5% bracket. If they were single, they are in the 26% bracket. That’s a big difference in tax rate. Throw in the state income tax and Social Security and Medicare tax, the couple’s combined marginal tax rate can reach close to 50%. $80k per spouse is also about the point where eligibility for Roth IRA starts to go away, whereas they have more breathing room if they were single. Do we want gender pay equity and stable family or not? We want our skilled workforce to earn good money. That makes education worthwhile. $80,000 is a good income, but by no means "rich." I don't know why we want to tax them at 50% for each additional dollar they earn.

Also notice the significant penalty on qualified dividends and long term capital gains for people in the phaseout zones . Together with state income tax, the marginal tax rate on qualified dividends and long term capital gains can exceed 30%. That’s double the 15% number everybody talks about.

What do you do if you are affected by the AMT, or worse yet, if you are in the AMT exemption phaseout zones? Not much unless you are willing to move to a low/no tax state or not have kids. Know what your marginal tax rate really is. Maximize traditional 401k contributions to get your taxable income down. Make your taxable investments super tax efficient. Minimize even qualified dividends and long term capital gains.

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1. Make some tax cuts in the stimulus law permanent. These tax cuts are already in the stimulus law, but the stimulus law had them for only two years in 2009 and 2010. President Obama proposed to make them permanent.

• $400/$800 Making Work Pay Credit
• lower refundable threshold for Child Tax Credit
• American Opportunity Tax Credit for college education. Stimulus law increased the maximum benefit from $1,800 per year for two years to $2,500 per year for four years.

2. Do not extend some other tax cuts in the stimulus law. These other tax cuts are in the stimulus law for limited time, but President Obama did not ask for extending them. It's not clear if the President really meant not to extend them or he simply omitted them.

• $250 one-time payment to retired and disabled individuals. The stimulus law had it as one-time.
• $8,000 first-time homebuyer credit. The stimulus law had it ending on November 30, 2009.
• Tax deduction for buying a new car. The stimulus law had it ending on December 31, 2009.
• Increase in Earned Income Credit for families with three or more children. The stimulus law had it only for 2009 and 2010.
• $2,400 unemployment income excluded from taxable income. The stimulus law had it only for 2009.
• Increase in employer sponsored public transit benefits. The stimulus law had it only for 2009 and 2010.
• COBRA subsidy. The stimulus law had it only through December 31, 2009.

3. Raise taxes on upper-income taxpayers. President Obama proposed raising taxes from upper-income taxpayers in three ways starting in 2011 (page 129 in the budget outline PDF):

• Reinstate the 36 percent and 39.6 percent rates for those taxpayers earning over $250,000 (married) and $200,000 (single).
• Reinstate the personal exemption phaseout and limitation on itemized deductions for those taxpayers earning over $250,000 (married) and $200,000 (single).
• Impose 20 percent rate on capital gains and dividends for those taxpayers earning over $250,000 (married) and $200,000 (single).

I don't have a problem with having a progressive tax system in general. It's debatable whether our current tax rates are too progressive or not progressive enough. I'm not getting into that argument. However, I do have a problem with where the line is drawn and with the blatant marriage penalty in these tax hikes.

I can see how a single person earning $200k can be considered as rich. But a couple earning $125k each, especially in a high cost of living area, is not rich. I submit as evidence from the recent Fortune magazine's 100 Best Companies to Work For.

Yes, these are six-figure salaries, but they are also the average pay for the most common salaried job in these companies. We are not talking about executives or higher management. These jobs are performed by so-called knowledge workers. I believe they are crucial for American competitiveness in a global economy. The administration talks about top 1%. I fail to see how these engineers, toolpushers, and research assistants fall into the top 1%. Why single them out? If it's going to be $200k for single, why shouldn't it be $400k for a married couple? What's the incentive for two knowledge workers to marry each other if they are going to be penalized like that? Or is it the implicit message that women shouldn't pursue knowledge and career?

I'm also concerned whether these $250k/$200k numbers are going to be indexed for inflation. If not, we will have another problem down the road like we have today with AMT.

I'm writing to President Obama and my legislators about this.

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401(k) plans are offered primarily by private sector employers. Employees in public schools and tax-exempt organizations have 403(b) plans. State and local governments and tax-exempt organizations have 457 plans. Some employers offer both a 403(b) plan and a 457 plan. What is a 401(a) plan then?

Strictly speaking a 401(a) plan is a bit of a misnomer because other kinds of plans including 401(k) plans must also qualify under tax code 401(a). In a loose context, a 401(a) plan is a retirement savings plan in which employees can't choose or change the amount contributed to the plan. It's also called a "money purchase plan."

In a 401(k) plan, employees make so-called "elective deferrals" which means that employees have a choice between (a) contribute to the plan and defer income tax on the contributions; and (b) receive the money in cash and pay the tax. In a 401(a) money purchase plan, either the employer contributes to the plan all by itself OR the employer makes it mandatory for all covered employees and deducts a set percentage from everybody's paycheck.

As a result, contributions to a 401(a) plan do not count toward the 401(k) "elective deferrals" limit ($16,500 in 2009). If someone has a both 401(a) plan and a 401(k) plan, he or she can still contribute up to $16,500 in 2009 to the 401(k) plan. Contributions to a 403(b) plan or a SIMPLE IRA also count toward the same 401(k) elective deferral limit, but contributions to a 457 plan do not (go figure).

I don't work in the employee benefits field any more. It still amazes me how many different types of retirement plans we have in the tax code and how they have similar but different rules. We've got this alphanumeric soup:

• 401(a) money purchase  plan
• 401(k) plan (with Traditional and Roth accounts)
• 403(b) plan (with Traditional and Roth accounts)
• 457 plan (no Roth yet, why?)
• SEP (no employee contributions allowed, why?)
• SIMPLE 401(k) (lower contribution limit than regular 401k, why?)
• SIMPLE IRA (no Roth, why?)

Why can't we just have one type of plan regardless where you work? The more you look at anything related to the tax code, the more you see it's a total mess.

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In a previous post Free E-File Is NOT Free, I said I'm going to try TaxACT this year because it's substantially cheaper than TurboTax and TaxCut. A couple weeks ago, I got TaxCut Standard for $1 at Dollar Tree. TurboTax also sent me a trial CD some time last year. With all three major tax prep software on hand, I was able to do a side-by-side comparison.

The tested versions are (all on Windows):

* Retail prices from Amazon.com on Feb. 19, 2009.

I tested with my real data. My moderately complex return includes:

• salary on W-2
• self-employment income and solo 401k contributions
• interests on 1099-INT, both taxable and tax-exempt
• dividends, both qualified and non-qualified
• short-term and long-term capital gains distributions from mutual funds and ETFs
• investment sales with both short-term and long-term gains and losses
• foreign tax credit
• capital loss carryover from last year
• restricted stock units (RSU) sales and ESPP non-qualified dispositions
• mortgage interests and property taxes
• charity donations
• IRA contributions
• Alternative Minimum Tax (AMT)

Installation: No major problems.

TurboTax installation took a lot longer because it requires a Microsoft component called .NET Framework 2.0 SP1.

Unlike last year, TaxCut didn't install the ad-supported pdf995 by default this time. From reading the reviews, I see it will install pdf995 only if you want to save your return in PDF. Because I already have the open-source software PDFCreator, I will not touch the "save as PDF" functionality in TaxCut.

TaxACT installation went very fast.

Update: Both TurboTax and TaxCut CD installations required updates, which went smoothly. Just follow the prompts. TaxACT download didn't require any update because they had the latest version up on their web site.

Launch: No problem launching either TurboTax or TaxACT under a limited user account in Windows XP. TaxCut still required running as an administrator.

They all show the software registration screen but you don’t really have to register. Just go File -> New Return and skip directly to a new return.

Import last year’s data: TurboTax imports last year's file in TurboTax, TaxCut and TaxACT formats. TaxCut imports last year's file in TurboTax and TaxCut formats. TaxACT does not import last year's return in any file format except its own.

I imported my TurboTax file from last year to both TurboTax and TaxCut. I had to enter my personal info in TaxACT. If I'm going to use TaxACT next year, it's a one-time deal I'm willing to endure. I'll be able to import next year.

Import W-2 and 1099: TurboTax offered to import my W-2 and 1099s from payroll providers and financial institutions. TaxCut does not import W-2 or 1099 from anywhere. TaxACT can import from W-2 eXpress by TALX (I've never heard of this payroll provider before).

I didn’t use this import feature due to privacy and data security concerns. Importing probably will save some time if it’s done accurately. However, it can also cause problems if you don't know what were imported and what were not. You have to check each import to make sure it got everything correctly. I've seen other people report problems because some fields were defaulted to zero, which made the calculated tax much higher than it should be.

I think importing W-2 and 1099 is more trouble than it's worth. It's a lot harder to fix bad imports than entering data on your own. I don’t mind typing my numbers. It wasn’t too bad.

Import from Financial Software: TurboTax and TaxCut can import from Quicken, Microsoft Money, or TXF files generated by other software. TaxACT does not import these files.

Interview and Data Entry: Like in last year's versions, the interviews in TurboTax and TaxCut are similar. They are both easy to complete. TaxACT, however, uses the bottom half of the screen for the tax form view. It splits W-2 entries into multiple screens. If you have to make a correction, you have to page through the screens to find the right spot.

TaxACT also doesn't mark the required fields versus optional fields. For 1099s, it asks payer's address, which isn't used anywhere in the return. I ended up typing a bunch of things before I realized I could just leave them blank.

TurboTax seems to ask more obscure and sometimes confusing questions. Those questions are irrelevant to me but perhaps they are relevant to 0.1% of the users. TaxCut strikes a good balance for me.

All three software have a topic list. You can jump ahead or jump back. They all let you open a tax form directly (disabled in TurboTax trial until I pay).

TurboTax still requires splitting the 1099-INT into two if not 100% of the tax-exempt interest is also tax-exempt for the state. TaxCut and TaxACT both handle it more elegantly with an extra field in the interview.

Valuing Donated Items: As I mentioned in a previous post, valuing non-cash donations is not dependent on which tax preparation program you use. Therefore it's not a criterion for this comparison.

Built-in Help: I am familiar with the tax ramifications of my transactions. I didn’t really use or test much of the built-in help or online support.

Refund Calculation: All three programs produced the same bottom line.

TurboTax trial does not let me see the form or print the return unless I pay. The numbers from TaxCut and TaxACT are nearly identical for all lines on all forms, except for rounding a dollar here and a dollar there.

TaxCut rounds everything to the whole dollar as soon as you enter them in the interview. A reader pointed out to me this is technically illegal (26 USC 6102). You are supposed to keep everything in dollars and cents on the worksheets and only round the total when you enter it on the form.

Both TurboTax and TaxCut were able to calculate the maximum contribution I can make to my solo 401k plan. That's really helpful. The calculation matched what I got from my spreadsheet. TaxACT does not have this functionality (at least not in the Standard version), but it's OK because I can use my spreadsheet.

The bottom-line result being identical didn’t surprise me. That’s the way it should be. These software are like fancy calculators. Given the same inputs, the result should always be the same.

Conclusion: All three software did an adequate job for my return, although none is perfect.

TurboTax is much more expensive. It can be confusing with its irrelevant questions. Requiring splitting one 1099 into two is lame.

TaxCut requires running as an administrator. It's also technically illegal with its rounding method.

TaxACT should really work on importing TurboTax and TaxCut file formats and importing TXF files. The way it splits entering a tax form into multiple screens is not as convenient as having everything on one screen as in TurboTax and TaxCut. It should also mark the required fields for data entry.

After weighing the pros and cons, I decided to use TaxACT this year. Before I did this side-by-side comparison, I wasn't sure if it can handle my moderately complex return. It did the job well. Now that I know how it works, I can easily work around the features I don't like.

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