I did my Federal and state income taxes yesterday.
This post is a bit of a potpourri regarding filing taxes in the modern world.
1: Embracing full tax ignorance, or, you say it, I pay it.
Source: Calculated from U.S. Treasury, Monthly Treasury Statement.
Back when I ran my own small business, I understood my taxes because I did them in my own spreadsheet. That evolved from doing my business accounts in Excel. It just seemed easier to build a Form 1040 onto those than to figure out how to move all my business financial data into somebody else’s system.
As a side-effect, a) I knew where every number came from, b) I knew how the taxes were calculated. For example, I could calculate my true marginal tax rate (including income tax, self-employment tax, and Medicare tax, and so on) by jiggling the income number by a dollar and seeing how that affected the taxes owed.
This year, using Turbotax, I finally reached total tax ignorance. The Turbotax software talks to my financial institutions. This provides the dollar figures that populate various IRS forms (e.g., 1099-INT for interest earned.). Got a W2 this year? Chances are, Turbotax already has it in its database, so you don’t even have to type in the dollar amounts. Turbotax then chats with the IRS to tell them how much it thinks I owe. Assuming the IRS agrees, the IRS software talks to my bank and withdraws the agreed-upon amount from my account.
I’m starting to wonder why I’m involved in this process at all. I have no choice but to pay my taxes. At this point, I have no clue where the numbers come from or how the calculations work. I don’t even have to know any of the dollar amounts. The software just magically generates a number that it says I owe to Uncle Sam. And so long as it’s ballpark, who am I to argue with it, or with the IRS?
My fate is in the hands of Skynet.
Is this how most people go through life?
2: A potentially helpful note on handling last year’s Virginia state tax rebate.
Source: Pew charitable trusts.
Helpful note is in red, at the end of this section.
I, like most Virginians, got an IRS Form 1099-G from from the Commonwealth.
And, like most Virginians, I had no clue what I was supposed to do with it. I was completely flummoxed by the bafflegab that accompanied it.
Virginia told me “This is important tax information … a negligence penalty or other sanction may be imposed … “. But that’s it. On-line explanations were lacking. The instructions in Turbotax were unclear. All I knew is that once I entered the information, Turbotax showed that my tax forms were in error. But I didn’t know why.
Turns out, Virginia was not alone. A whole lot of states issued tax refunds for the 2022 tax year. And that’s not a coincidence. It is the flip side of the big Federal deficit that year. Because a big chunk of what the Feds did is ship money to the States, in various forms, mid-2021, in their attempt to keep the economy from tanking. That’s why, above, collectively, the “rainy day funds” (cumulative budget surpluses) of the states swelled in 2022. And those states then shipped money to their citizens in 2023, labeled as refund of 2022 taxes.
All of the tax guidance for dealing with this was ludicrously ambiguous. Even the guidance within Turbotax itself was not enough to lead me to the correct way to enter and deal with this.
Let me try to explain it, because it has two significant parts. But it all boils down doing proper cash accounting of your tax payments and refunds. You account for your state tax payments and refunds in the year that you receive them (cash accounting), and not by tax year (the tax year for which they were actually due.)
In the pre-Trump era, the rule for dealing with a state tax refund was simple and logical.
If you used the standard deduction in Year 1, just ignore any state tax refund in Year 2. State taxes paid in Year 1 didn’t affect your Federal return, so the refund doesn’t either.
But if you itemized your deductions in Year 1, and one of those itemized deductions was for state taxes paid in Year 1, then you have to balance your books in the event of a state tax refund. And it’s pretty obvious what you had to do. If you subtracted your state tax payments from taxable income in Year 1, then you have to add any refund to your taxable income in Year 2.
The logic is that, in the long run, you only get to deduct the net amount that you actually paid in state taxes. As a result, the tax instructions were an unambiguous if-then statement. If you itemized in Year 1 (and took off your state taxes as an itemized deduction), then you have to add any state tax refund to your taxable income in Year 2.
Post-Trump, there’s a $10K cap on the state and local tax deduction. And this is why the resulting tax advice is no longer obvious and clear. Then simple if-then gets replaced by a more complicated set of logic. Everything is conditional on hitting that $10K threshold.
If you itemized deductions in Year 1, and the state tax deduction mattered in Year 1, then you have to deal with the state tax refund, in some fashion, in Year 2. This boils down to having the state and local taxes line, on last year’s tax return, at or near that $10K threshold.
If you were below the $10K threshold last year, and you itemized, then the logic is the same as in the pre-Trump era. Yep, you’re going to owe taxes on your state tax refund paid in 2023. One way or the other.
If you exceeded the $10K threshold last year, by more than your state tax refund, then your state tax refund will not affect this year’s taxes. That’s because your actual payments, net of the refund, would still have exceeded the maximum allowable $10K.
The only tricky part is that Turbotax wouldn’t let me just skate by, because, apparently there’s some further twist to the law that allows you to spread the state tax refund over several years of tax reporting, if that’s to your advantage. In any case, after several attempts at fussing with the state and local tax worksheet in Turbotax, I finally clicked the right box that said, just reduce my state and local taxes paid this year by the full amount of the state tax refund I received this year. And that finally cleared the error.
It was weirdly complicated, in that, no matter what box I checked, my Federal taxes remained the same. And the default under Turbotax was to spread the Virginia $400 tax rebate over several years. But in fact, I could net out the full $400 this year, and be done with it, without paying any more tax. So a) Turbotax flagged this as an error under its defaults, and b) I had to override the default manually, to clear that, even though c) I owed the same amount of taxes this year, regardless. The Turbotax default minimized current-year taxes for all taxpayers. But it did not minimize future-year taxes for all taxpayers. If you’re well above the $10K threshold, check the box that tells Turbotax to subtract the full value of the rebate from this year’s state and local taxes paid.
Or do what I did, which was to keep checking and unchecking boxes on the state and local tax worksheet until the error message went away. Then figure out why it went away, after-the-fact.
Don’t forget to thank an economist if you still have a job.
Source: Federal Reserve Bank of St. Louis.
If you listen to nothing but right-wing media, you’re supposed to recall — and be incredibly angry about — the big Federal budget deficit that occurred during the pandemic. But you’re supposed to forget — right down the old memory hole — that much of that deficit was incurred because Uncle Sam sent big checks to (nearly) every taxpayer. (It goes without saying that you’re supposed to forget which budget was passed under which President.)
It was, arguably, the last truly egalitarian act that you’re ever likely to see from your Federal government. Anyone who had managed to file a tax return in the prior year, and was still breathing, got the same fat check(s). The only exception was for the well-to-do, who got squat, at least for some of the rounds of rebates. It was the sole exception you’re ever likely to see, in your lifetime, to the rule that the rich get richer.
As a side note, that policy demonstrates what every economist knows, but nobody is willing to acknowledge these days. The rich have an exceptionally low marginal propensity to consume out of current income. Or, in plain language, if you want to prop up spending in the economy, the last thing you want to do is give more money to the wealthy. That’s because they won’t spend it, they’ll save it. If you want to boost current spending, give money to the middle and lower classes.
The other thing you’re supposed to forget about that deficit is what it accomplished. When the pandemic hit, people panicked, and (God forbid!) stopped spending every penny they earned. This resulted in the unprecedented spike in the U.S. savings rate in 2000 (above), which, as night follows day, immediately began to tip the economy into a recession. Because money you save is money you don’t spend, and one person’s spending is another person’s income. The next Great Depression was avoided by the expedient of just mailing out money. Repeatedly. Until people started spending it.
Source: McKinsey.
Sure, it seems crude and expensive. Unless you are smart enough to compare it to the alternative, which was the total collapse of the economy. And it worked. The same scenario played out in more-or-less every civilized nation on earth. U.S. pandemic emergency fiscal policy was middle-of-the-road, in terms of overall size. The result was a short, sharp recession followed by immediate recover.
Next time you see an economist, thank them. Or, in the words of the patron saint of reactionary economics, Saint Milton, “We are all Keynesians now”. As evidenced by the near-universal adoption of strong stimulus measures in response to the pandemic-induced decrease in spending.
