Pick your deductions carefully

Okay, silly thing. It's tax time. Since becoming a contractor last year, I've been obsessed with my taxes. It's more the fact that I hate uncertainly. Unlike my mother's other son (who in matters like this, I prefer to refer to him as), I hate to find out at the end of the year either that I owe some huge amount (and they kill you if you have to pay a penalty!), or I get a huge refund back and I've essentially given the government a tax-free loan. (I will still say this mantra: a refund is just money you would have gotten back during the year before had you just increased your deductions! More on that later.)

Disclaimer: This isn't tax advice. Contact your accountant or tax adviser for more details.

That being said, now onto my findings.

Whether you have to pay in or get a refund, your tax bill is still the same. It just matters how much you've already had taken out of your check during the year that determines if you've paid too much or not enough.

At first, I had always gotten a refund. I had used it often towards paying things off, or perhaps contributing to my retirement account. Granted, if it's the only way you can save, there is that. But you could also increase your deductions and you would get a bigger paycheck, then sign up for an automatic savings plan to take out that amount. (Services like INGDirect will do this for you, and rates online are typically better because of lower overhead.) That way you're earning interest throughout the year, instead of the next year when you get your refund.

Then I heard, it's an interest-free loan to the government? Yup. As I said, owe or pay, your tax bill's the same.

So I said, well, I don't want to that. On the flip side, if you owe too much, you'll have a penalty. Well, how much is that? Generally, if you owe more than $1,000 and it's more than 10% of you total tax less some deductions. (See the 1040 instructions for details.) E.g., if your taxes are $20,000 and you owe $1,500 you probably won't owe a penalty. (More than $1,000 but less than 10%.) However, if your taxes are $5,000 and you owe $1,500, you probably will. (More than $1,000 and more than 10%.) If your taxes are $5,000 and you owe $800, you're probably fine. (More than 10% but less than $1,000.)

Also, if you've paid at least as much as the previous year, you're probably fine (unless your adjusted gross income is over $150,000, then it's at least 110% the previous year). That's helpful if your income (and thus your taxes) are rising, especially more than 10%.

Timing is also important. If you didn't pay on time (estimated taxes), you might owe a penalty even if you have a refund. Generally only those who have to pay estimated taxes have to worry about this, or those who don't have taxes taken out, such as the self-employed or those with unemployment payments.

Again, consult your adviser. These are just guidelines. Your results may vary.

So still with me? Okay, I don't want to give the government an interest-free loan and I don't want to pay a penalty, I've figured an amount I can pay in without paying a penalty. Now, I have to adjust my deductions.

So the whole reason I'm writing this is, how many deductions should I adjust my withholdings by?

For the longest time, I had never heard this answer. I had heard if you get a refund of more than $500, you should probably increase your deductions by the number of times $500 goes into your refund. But that's an estimate. I have the exact answer.

The what is the answer? For every additional deduction you take, your amount you owe will increase (or your refund will be reduced) by (drum roll please) the standard deduction times your marginal tax rate.

Again, your tax bill is still the same, it's just whether come April 15th you've paid too much or not enough.

The long answer is that the amount they take out of your check is that they estimate what your annualized income will be for that check minus deductibles they know about like 401k and health insurance premiums, and then subtract the number of deductions you've selected (to account for deductions they don't know about like state taxes and home loan interest) times the standard deduction, and then figure your taxes you'd owe on that amount. So if you increase by one the number of deductions, the amount they take out will decrease by the standard deduction times your marginal rate, de-annualized back by how often you're paid.

And at year end, that reduces your refund or increase the amount you owe by that amount.

Now, other things can affect your taxes (deductions, amount you make, etc.), and this is entirely an apples to apples comparison. It also assumes that you have the same amount of deductions for the entire year. Changing mid-year will result in a smaller change. And check-to-check changes affect it too. (A big check might have a bigger marginal rate, a smaller check might be smaller, etc.) So don't assume that the answer will be exact.

However, it is the most exact estimate I've never heard.

So for 2008, the standard deduction is $3500. Say, if your taxable income is between $32,550 and $78,850, your marginal tax rate is 25%. Increasing your deductions by one will reduces your refund or increase the amount you owe by $875. If your marginal rate is 28%, the amount is $980. 33%? $1155. You get the picture.

(What's my marginal rate? It's 10%, 15%, 25%, 28%, 33% or 35%. Check here. This is on taxable regular income, i.e. after deductions. Your taxable income is also line 43 on your 1040, but that's for the previous year, not what it will be next year.)

So if you're getting back $700 now, you'd owe $175 if had one additional deduction. But your paycheck would also increase by a proportional amount. (If you get paid biweekly, if would increase $875 / 26 = $33.65 per check.) Put that savings and not only will you have $875 in the bank come April 15th, you'll have that plus interest.

Likewise, if you owe $1000 now and your reduced your deductions by one, you'd only owe $125. Your paycheck would be slightly reduced (by that $33.65), but it could make that payment on April 15th less painful too. And by all means, if it means you won't get penalized, do it!

(Again, apples to apples comparisons. Other things affect your taxes, taxes change year over year, check your adviser, your mileage may vary, offer void where prohibited, yada yada yada.)

It all works out in the end. It's just math. And that's exactly why people fail to understand it. (Don't feel bad. I almost majored in Math and this is the first I've understood it.) I hope this makes a little more sense to people, and either make their taxes a bit less painful, or get you your money back long before April 15th, instead of on it.

Not your father's rechargeables

I've long extolled the virtues of rechargeable batteries. In fact, I am the change I want to be, as I use them quite extensively, especially with a mobile lifestyle and the fact that traveling about in San Francisco (or stuck in economy for an 11 hour flight to Europe), I'm often no where near for a power source for extensive periods of time. I have to take my power with me.

However, I've only been moderately effective in convincing others to join my crusade. As it would seem, not everyone is as exhaustive of a battery user as I am. While I don't blame them, I do realize that rechargeable batteries are not without their shortcomings. Many such shortcomings have been overcome, such as capacity (many NiMH batteries have as much if not more capacity as their alkaline counterparts), environmental concerns (older Ni-Cad batteries had heavy elements that could be environmentally hazardous if not disposed of or recycled properly, although many alkalines have the same problem). But until recently there was a major shortcoming that was a problem even for me. That being the fact that, regardless of their capacity, rechargeable batteries didn't hold their charge for long.

While NiMH batteries were a huge step over NiCad batteries in capacity (great for those 11 hour flights or in digital cameras, although most newer ones use lithium ion batteries), they would still start to dissipate their charge about the second you took them off the charger. They'd have only about 60-80% their charge after a few weeks, and dead or near so within a few months. (It's even worse for AAAs, which my alarm remote uses.) So regardless of how much power you used, if you didn't use it in a certain period of time, you'd still be recharging the batteries after a month or two. Because of this, they were quite a bit more of a pain in devices that didn't have that strong of a draw, but still needed to change every 2-12 months. (I'm thinking like TV remotes here, or the alarm remote for my bike. Or that flashlight in your drawer for when the power goes out.) So while they were great for high drain devices, they were not suitable for what most people used them for.

Behold, the precharged rechargeable. I thought, how on earth do they do that? Rechargeables always come discharged, because who knew how long it was between the factory in China to the store and to when you actually picked them off the shelf and bought them. Apparently with some change in the chemistry, they now hold their ions longer. Much longer. Up to 80-85% of the charge is still intact after one year. So they charge them at the factory, and if you've bought them within a year, they still have at least 80% of their charge intact right off the shelf. As once you charge them again, they'll be good for another year. They can even be charged in most any standard NiMH charger, although of course the manufacturer will recommend you use theirs. So they work great for all those low drain devices that most people use.

You can find them at Radio Shack, Costco, Target, or most electronics stores, and they're now made by Sanyo, Duracell, Energizer and Kodak. Sanyo even has a version that comes with spacers that allows you to "upsize" a AA battery into a C or D "spacer" for use as a C or D battery. Great for that flashlight in your drawer! In addition, Duracell sells them now with their Mobile Charger, which not only charges the batteries from a car or wall outlet, but can use the four charged batteries to power its USB outlet to power or charge any USB device such as an iPod/iPhone or other cell phones with a USB cable.

The flip side is they don't have quite the capacity of traditional NiMH batteries (about 2000-2200 mAh for AAs, as opposed to 2000-3000 mAh for traditional NiMH AAs). But since they don't dissipate as fast as traditional NiMH batteries, they'll actually last longer than traditional NiMH batteries in most applications since they won't dissipate out before you'll actually need to use them. They also sometimes cost slightly more (but sometimes the same), but like traditional rechareables, the savings over using alkalines can still easily pay for itself. And I probably wouldn't use them in devices where the battery lasts over a year, like smoke detectors. Use a lithium primary battery for those. But for most of the applications people use and need alkalines for, they would work just perfectly.

And then I don't have to feel guilty about replacing my alarm remote with an alkaline every three months. Or at least having to recharge the AAA battery every couple weeks.