3-17-06
Bad Tax Ideas You Can Use
Let me start by explaining what sort of bad ideas I mean. I am not speaking of those that can be generally described as “fraud,” like leaving out chunks of income, or making up deductions, or getting your dog a Social Security number and claiming him as a dependent.
Neither are these bad ideas the Bush administration’s tax policies, if handing out random tax cuts for the rich and special deals for large businesses can be termed “policies.”
Rather, this is about two special tax provisions targeted at low-income people. What they have in common is a complete failure to solve the problems they supposedly addressed—if, indeed, that was the objective rather than merely generating good sound bites.
These bad ideas are still in the law, though, and useful for those who just did not have a very good year.
The Earned Income Credit
Back when we still had public aid in America, there was a belief in some quarters of the populace that people on welfare were shiftless and lazy, and didn’t really want to get off the dole. What was the point of working, when you could just sit back and wait for the government check to come?
Funny thing is, these smug racists (and it was racist) had half a point. Welfare benefits were reduced when a recipient began work. How much varied by state and over time, but typically the cut was 50 cents for each dollar earned. This meant that the recipient really only received half pay. If it was a minimum wage job, he might earn a huge 20 dollars a day, and even less after taking into account the cost of getting to work and a fast-food lunch.
The earned income credit was intended to solve this problem. Simply stated, it is a negative income tax: the government pays you to go to work, above and beyond what the employer does. When this was passed into law, elected officials proudly proclaimed that this program would soon have all welfare recipients hard at work building a greater America.
That was 1974. And as you may have noticed, that did not happen. The experts say that some people were, indeed, “inadequately incentivized,” but more were uneducated or truly unable to find work or mentally ill or drug-addicted or just out of prison or...the list of sociological or structural economic reasons goes on and on.
As it now stands after 30-plus years of Congressional fiddling, the maximum amount that a taxpayer with no children can receive is $399, and it phases out entirely for earned incomes above $11,750. Taxpayers with children get somewhat more: a maximum of $2,662 with one child, $4,400 with two or more, and they phase out completely at earned incomes of $35,250 and $37,250, respectively. That covers a lot of people.
There are, of course, restrictions. If you do not have children, you must be at least 24 years old (“mustn’t subsidize students”) and under 65 (“that’s why we have Social Security”), and you cannot be claimed as someone else’s dependent.
The other principal restriction disqualifies those who have more than $2,700 of unearned income: dividends, interest, rents, capital gains and so on. The idea (actually, a sensible one) is to disqualify those who live on capital rather than by the sweat of their brows.
Many working poor do miss out on the earned income credit because they simply do not file tax returns. Either they make less money than would be required to file a return (which is as much as $13,700 for someone with two children), or they just assume the withholding and their tax liability balance each other. Despite the best efforts of many advocacy groups, they don’t understand the underlying idea of a “negative tax,” that filing a return will get them money.
Actors do at least file tax returns (ok, most actors), and manage to use a professional preparer or software that will guide them through the process of claiming the credit.
Retirement Savings Credit
Traditional, defined benefit pension plans are becoming an endangered species. Even the surviving ones have become far less generous. Just ask any airline worker.
Replacing them has been a whole alphabet soup of defined contribution plans (including two flavors of IRAs, one of SEP-IRA, plus 401ks, 403bs, and 457s). Instead of the employer making a contribution to the plan for the workers, the workers must choose how much money to put away and make an active choice about how to invest it. All too often the chosen amount is zero.
The bad idea of a retirement savings credit popped up to try to deflect criticism of this sea change in pensions. Low income workers get a credit for putting money into a qualified retirement plan, ranging from 1 to 5 percent of the first $2,000 invested, or not more than $100. The credit phases out completely at an income of $25,000 for a single person, twice that for a married couple, and it is available to anyone who is not a student or dependent.
Whoopee. Like $100 is going to change the behavior of desperate people living paycheck to paycheck, and hoping it stretches. For those who have resources but not much income in a particular year—well, it’s found money.
The credit is available for only five tax years, 2002 through 2006. That suggests this bad idea was a cynical ploy to get credit for “doing something” that could then be left to wither.
Two Final Points
Some educated, bourgeois folks feel guilty about claiming these credits. They shouldn’t. The supply is not limited, so claiming the credit does not hurt some more deserving person.
And let me emphasize that both of these bad ideas were credits, not deductions. Credits are far more valuable, because they reduce your tax dollar-for-dollar.
Free Offer
Deductions are worthwhile, too, and my “Checklist of Potentially Deductible Items for Persons in the Arts” is free for the asking. Just write, call or e-mail me at my office.
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 call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He has also been known to produce theatre.