BY GREG MERMEL, C.P.A.
If you filed your federal 2000 income tax return on time, you should have already received the letter in which your elected officials announce to you the amount of your tax rebate. (And, if you’re lucky, you are not among the 500,000 Americans whose letters gave the wrong amount.) You may even have received the check by now, as they are being sent out in weekly waves through mid-September.
But what exactly is this payment? And where is the money coming from? The words used, and the way it has been presented, have left many people with the wrong impression. And that prestidigitator-like misdirection could cause much confusion and many erroneous tax filings next spring.
Rebates We Have Known and Loved
In the usual commercial transaction, a rebate involves a manufacturer sending money to the ultimate buyer of its product, effectively reducing the price. You go to Computers 'R’ Us, and buy a new hard disk. You send a coupon and proof of purchase to a post office box in El Paso, Texas or Young America, Minnesota, and eventually a check arrives. (Sometimes your name is spelled correctly on the check.) Or you purchase a new car, and instead of you laying out the cash and waiting for a check, you assign to the dealer the right to receive the manufacturer’s rebate on that model.
Either way, the idea is to induce you to buy a product that is not selling terribly well by cutting the price. The manufacturer could reduce the price it charges the retailer. Manufacturers, however, cannot legally set the retail price so there is no guarantee that the retailer would, in turn, cut the price it charges the consumer. The rebate ensures that the consumer both gets the price break and sees the price break.
So it was only natural for most people to see "tax rebate" and think it involves the most recently completed transaction, their 2000 taxes. Reinforcing that impression was the payment formula: The amount of the payment would be determined based on information in your 2000 income tax return. But guess what: it’s not about your 2000 taxes at all. This check is part of your 2001 tax refund.
Making Matters Unnecessarily Complicated
Among the tinkering with tax rates that was done in the recently-passed tax bill was the establishment of an additional bottom-tier tax bracket at 10 percent. Previously the lowest rate was 15 percent, and there still is a substantial 15 percent bracket. The first $6,000 of a single person’s taxable income is now taxed at 10 percent, and the next $21,050 at 15 percent; for a married couple filing jointly, the amounts are $12,000 at 10 percent and $32,500 at 15 percent.
These changes are effective for 2001 and later years. They have nothing to do with your 2000 taxes. So why do people think otherwise?
Your elected officials wanted to get the money into circulation immediately to stimulate the economy. It says so, right in the Congressional Committee Report, so you can ignore that ugly public squabbling about which elected officials would get credit for the refund in the letters the Internal Revenue Service sent at a cost of $35,000,000. But they have no way of knowing how much each individual American’s taxes will be cut. They don’t know how much money you will make this year–you probably don’t know how much money you will make this year–so they estimated the benefit based on the information they do have. And that information is last year’s tax forms.
What they did was analyze last year’s data to determine how much your taxes would have been reduced if this tax bracket had existed in 2000. And they used that estimate as the basis for the checks.
But what these checks really are is an advance refund of your 2001 taxes. In fact, you’re probably going to pay much of it back to the IRS before year-end.
Huh??
That’s right, you are paying it back if you have a paycheck from which taxes are being withheld. There’s no 10 percent bracket in the withholding tables, and there will not be until January 1, 2002.
A Little Dose of Reality
When you do your taxes next spring (or a professional does them for you), the amount of your tax savings might be more than the amount of the check. Various credits and limitations mean that it might not just be five percent of $6,000 or $12,000, even if your income was well above that level. You get the rest of the tax reduction then. But you have to know how much the "rebate" check was or you can’t complete the calculation. Hold on to that letter (and make sure the check agrees) or make a photocopy of the check before you go stimulate the economy.
Of course, the check you receive could be for more than your tax reduction if you have little or no income this year. (That does occasionally happen to actors.) You will pleased to know that your elected officials are not stupid enough to think there is a snowball’s chance in hell of getting that excess back, and are not requiring the IRS to try. Once you have the money, it is yours.
Some of you won’t receive a "rebate" check. If you filed your tax return after April 15 (or haven’t filed it at all), you’ll have to wait until you file your 2001 tax return and get a higher refund. And if you have such ugliness out there as unpaid back taxes, or a defaulted student loan, your check will be sucked up by that, just like any other tax refund.
And here’s the worst part: You could receive a check for $300 or $600 now, and owe that much or more when you calculate your 2001 taxes. Will you really feel OK writing that check then, knowing that you had the money now? Or will you think, "what tax cut?" and curse your elected officials?
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or 773/525-1778 (888/525-1778 outside the Chicago area).
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.