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Do the Rich pay their “Fair Share”?

To explore this issue, I did three tax returns for the same young couple, John and Jane Doe (some very good friends of mine!) with two young children, and ran 4 scenarios.  In the first scenario, I assumed they made $60,000 a year in wages.  In the second scenario, I bumped their wages up to $120,000 a year.  In the third scenario, I assumed their wages were $600,000 per year.  In the last scenario, I assumed $6,000,000 a year.  In all the cases, I did not show any Income Tax Withheld, since I was only concerned with their net tax liability.  I also took the standard deduction on all returns.   I have attached copies of the returns to my website, in case anyone wanted to see the actual calculations.  Note:  I did NOT use their real Social Security numbers.  Or at least any correlation to their actual numbers is just by accident!

In the first scenario (making $60,000) John and Jane did not have any tax liability.  They were actually getting a $561 refund, due to the refundable portion of their child tax credits.

In the second scenario (making twice as much at $120,000), they went from owing nothing to owing $6,927.  Seven thousand is seven thousand, but it does not seem like a whole lot overall considering they make $120k.

In the third scenario (making $600,000), John and Jane owe $143,644, quite an increase.  This is five times the income as $120k, but over 20 times the tax.

In the last scenario (making $6,000,000), John and Jane owe over two million: $2,139,215, not exactly chump change.

According to the tax foundation https://taxfoundation.org/data/all/federal/latest-federal-income-tax-data-2024/ , the top 1% paid 25.9% of all income tax.  The top 5% paid nearly 45% of all income tax.  The bottom 50% of taxpayers paid only 3.3% of all income tax.  Just about any tax cuts help the rich more than lower classes, because the top 50% of the country pays close to 97% of all federal income tax.  For more information on historical tax rates, see my 2015 article on the history of taxation in the United States.

Now in truth, I’ve benefited from the tax structure through most of my adult life.  When Candy and I first got married, I was working as a minister and was paid $400 a week (we did have a parsonage with utilities paid by the church).  Later on, I got a raise and was making $450 per week.  We also had our four children between 1999 and 2006, so we benefitted from tax credits and Earned Income Credit, although they were lower then.  When I switched to accounting, I started out making $40,000 per year.   I did not make over $50,000 until after going out on my own, and of course it took a few years to build my practice.  This is NOT to complain.  I’m just saying, I know what it is to make less than the national average, especially for a family of six living on one income.  My only point is I’m not exempt from knowing what it is to have a family and try to pay bills, etc.  I’m also not saying what the tax rates should be for different groups.

I just hear these statements in political cycles that the rich need to pay their fair share.   My first question is: what is their fair share?

I decided to run one more scenario.  A couple making $60 million a year is paying about $22 million in federal income tax.  Maybe that is fair.  My only point is the federal income tax system is indeed progressive.  Not only do the rich pay most of the taxes.  They also pay a higher % of tax than most of the rest of us pay.

Another question I can see others asking might be about ways (loopholes) the rich can use to get around paying tax.  For instance, the couple making $60,000,000, could give $10 million to charity.  However, it would save them about $3.7 million in tax.  If they want to give that money to charity anyways, it is a good deal.  But spending $10 million to save $3.7 million in tax does not make a whole lot of sense otherwise.

Blog, Tax Topics

Tax Preparation Cost

Killeen - Harker Heights TX Tax Preparation Cost

What factors determine tax preparation cost?

Like any other business, one of the most common questions we get is about cost. Obviously, it varies by complexity of the return.

If you’re wondering what affects your tax preparation cost, watch this video:

Ways different tax preparers charge

  • Per hourly fee (sometimes the fee is different depending on services)
  • Fee per page (some franchises charge additional for each form). For instance, they will charge extra if you qualify for the Earned Income Credit – even though their software does all the work for them!
  • Up front pricing model – give you a quote when you come in based on what you have and stick to it (with certain exceptions).
  • Based on prior year – a lot of places are going to at least charge you what you’ve been paying

Problem with the Hourly Fee

The place I worked with the lowest hourly fee charged the highest prices.

  • The firm was incredibly inefficient when it came to getting returns in and out the door.
    • Charging an hourly fee does not necessarily encourage efficiency. If they take longer, they try to charge you more.
  • The place I worked with the highest hourly fee charged the lowest prices.
    • The firm was very streamlined and efficient.

Our model: Up Front Pricing for Tax Preparation Cost

  • We try to give a price or price range up front and stick to it.  Certain exceptions apply if you end up bringing in new information you didn’t include up front.
  • Obviously, we are basing it on how long we expect it to take to prepare the return and how complex it is.
  • This avoids unpleasant surprises later on
  • Our prices are often lower than our competitors
    • I’ve seen people get charged more from national tax franchises than what they could get from a CPA

We will contact you if something comes up. For instance, if you say you have three rental properties in California you forgot to mention.  Then, we will have to give you a new quote, before moving forward.   This is rare, but things like this do happen.

What can you do to lower your tax preparation cost?

Organize

I’ve had people come in with shoe boxes full of receipts.

If you can run totals and break things down by category, then it saves us time and you money.

For example, let’s say you have high medical bills

If you can total up out of pocket costs by category

  • Prescriptions $2,154
  • Hospital   $10,841
  • Doctors $2,538
  • Glasses $256

We don’t need the receipts.

Same thing with business, rentals, etc.

It you can total your income and list expenses by category it will save you money.

  • We can tell you how to lay it out in an initial consultation.
  • We will determine correct depreciation methods, enter items on appropriate forms, etc. In other words, we will prepare the tax return and give tax advice moving forwards.
  • We just give you the option to do things you can do yourself to save money.

Summary about tax preparation cost:

  • Obviously we want a copy of any IRS forms (W-2’s, 1099’s, 1098’s, etc.)
  • Everything else, the more organized we get it the better (for reducing fees)
  • Again, if you don’t want to mess with it, that is fine. We can organize it for you. You can just save some additional fees by doing it yourself.
  • You do need to keep receipts in case you are ever audited, but we do not need them if you provide us with totals per category.

For more information about tax preparation cost, contact Derland Bahr CPA, Inc. at 254-432-5724.

Blog, Tax Topics

Tax Deductions for Rental Property

Tax deductions for rental property

What tax deductions for rental property can I take?

The video below shares a list of deductible items for Schedule E (Rental Property).

Generally, the largest tax deductions for rental property are:

•       Mortgage Interest

•       Real Estate Taxes

•       Homeowner’s Insurance

•       Cleaning and Maintenance

•       Repairs

•       Management Fees

•       Depreciation

Mortgage Interest

•       You cannot deduct mortgage payments (you must depreciate instead). However, you do get to deduct mortgage interest, real estate taxes, and homeowners insurance, which together normally make up a large part of the mortgage payments.

•       Mortgage Interest and Real Estate Taxes are normally found on Form 1098 sent out by the Mortgage company in January.  

•       Homeowner’s insurance is deductible for rental properties (unlike your personal residence).   Note: Sometimes, the mortgage company will include the cost of homeowners insurance paid on form 1098, but they are not required to.  If it is not included, you may have to check with your insurance company to find out the amount.

Depreciation

•       You depreciate the property rather than deducting principal payments

•       Residential rental property is depreciated over 27.5 years.  Some items, such as appliances, can be depreciated over a shorter time period.

•       Your cost basis is the full amount you paid for the property, plus any improvements you made to it prior to renting

•       Note: you should take allowable depreciation. When you sell, the IRS reduces the basis by the amount you could have taken, whether you take it or not!

Cleaning and Maintenance

•       Any maintenance fees paid by owner

•     Yard care, etc.

Repairs

  • As many have found out the hard way, this can be a huge rental expense.

If you use a management company and they take it out of your rent, they will normally include it on the year-end statement.

Cleaning and Maintenance

 

  • Many homeowners use a rental management company that charges monthly fees (often 10% of the rent)
  • These management fees are deductible

Limits on losses

  • You can generally deduct up to 25,000 in losses per year
  • MFJ taxpayers making over 100,000 have additional limits on what they can deduct.
  • MFJ taxpayers making over 150,000 cannot deduct losses in current year.
  • NOTE: You do not lose these losses. They carry over until you can deduct them! Either in a future year or the year you dispose of the property.

Other possible deductions:

  • Legal Fees
  • Mileage or Travel Expenses (Standard mileage rate is 67 cents per mile for 2024)
  • Supplies (if not included in repairs)
  • (Homeowner Association) HOA fees
  • Utilities – if paid by owner
  • Any other expenses paid by owner associated with rental property

For More Information

  • Contact Derland Bahr CPA at 254-432-5724 or visit DerlandBahrCPA.com to learn more about tax deductions for rental property.

Blog, Tax Topics

Difference Between Hobby and Business

Difference between hobby and business

What is the difference between hobby and business when it comes to taxes?

Many wonder, “Is My Business a Business or Hobby?” When it comes to filing your income tax return, you need to know the difference between hobby and business.

The video below shares some things to consider about the difference between hobby and business:

Hobby Loss Rules

Taxpayer View

Taxpayers want everything to be a business if it will help them reduce their taxes.

IRS View

They would rather categorize an entity as a hobby if it is losing money.

  • Hobby losses are limited
  • Expenses are limited to revenues
  • Reported on Sch. A subject to a 2% floor (currently does not apply under TCJA).

Example – Difference Between Hobby and Business for Photography

  • You get paid $2,000
  • Expenses are $4,000
  • You and your spouse’s AGI is $50,000
  • You show the $2,000 on your 1040 as other income.
  • You are limited to $2,000 in expenses. However, your 2% floor is $1,000 (50,000 x 2% = $1,000). Thus, you only get to deduct $1,000 ($2,000-$1,000 = $1,000).
  • And you only get to take that if you itemize!

If it were a business you would get to show a $2000 loss on Schedule C ($2,000 – $4,000 = $2,000 loss).

If it is a hobby, you still have to report the income. However, you might not get to deduct any expenses if you don’t itemize (currently cannot deduct under TCJA).  Even if you do, you only get to deduct $2,000 of the expenses.

Difference Between Hobby and Business

If you show a profit 3 out of 5 years, the basic presumption of the IRS is that you are a business.

This is not a hard and fast rule.

Some businesses show losses more than 2 out of 5 years

The basic idea is that if you have a profit motive, you will stop pursuing the business if it continues to show a loss and you do not have a plan to turn things around.

Note: Farms only have to show profits 2 out of 7 years

Profit Motive: The Real Key

It really comes down to do you have a profit motive or is it just a hobby.

Many small businesses do things they love. E.g., photography. But the bottom line is, are you trying to develop it into a successful business?

Other factors in the difference between hobby and business include:

  • Time involved
  • Are you trying to change your operations to increase profit?

Conclusions and Disclaimer:

Taxpayers generally want to avoid the “hobby” designation.

For a business that continues to show large losses, the IRS may want to re-categorize it as a hobby.

This is a somewhat superficial overview – talk to your tax preparer if you have specific questions or contact us to discuss your specific issues concerning difference between hobby and business.