California taxpayers: How to benefit from your state IOU now

The basket case government of California, which has been unable to raise taxes and unwilling to cut spending, has come up with a bill-paying scheme that your fiscally irresponsible big brother probably used on you after filching money from your piggy bank when you were kids: I.O.U.'s

On July 2, the California State Controller began issuing I.O.U.'s for state obligations—including tax refunds. Most of California’s 12.8 million taxpayers are a trusting lot. This year, 65 percent of them let Sacramento withhold more in state income taxes than was necessary. The result: More than $6.6 billion in taxpayers’ money piled up in the state’s coffers. Of course, the state spent this money, rather than hold it for safekeeping. The average refund due is a not-unsubstantial $789.

The I.O.U.'s, known as “registered warrants” in financial circles, are supposed to be redeemable on October 2, “assuming there is adequate cash in the Treasury,” says Controller John Chiang. The California Bankers Association said in a press release, "We have learned that if sufficient cash is not available by the October 2, 2009 maturity date, registered warrants may be issued to cover those previously issued registered warrants.” 

California taxpayers, shouldn’t sit still for this. We advise you to turn your California I.O.U. into cash right now. Here are four ways to do it:

Buzzword: Automatic IRA

The Automatic Individual Retirement Account is a concept that’s been kicking around for a few years and may actually happen now that it’s included in both President Obama’s 2010 budget and the Treasury Department's Financial Regulatory Reform proposals released earlier this week. Basically, the Automatic IRA would make a mini 401(k)-like retirement plan available to millions of American workers who currently aren’t covered.

The law would apply to employers with 10 or more workers, that have been in business for at least two years, and that don't currently offer a retirement plan. They would be required to enroll their employees in an IRA and fund it through regular payroll deductions.

Employees would be allowed to opt out. But to lessen that possibility and encourage participation, the proposal would also modify the current saver’s credit for workers with modest incomes by making it “refundable.” That means participating workers could receive a credit, deposited into the automatic IRA, even if they owed less than that amount in taxes. We'll report on this in greater detail if it comes to pass. Meanwhile, more about the saver’s credit and how it currently works here. —Greg Daugherty

Greg writes the “Retirement Guy” column each month in the Consumer Reports Money Adviser newsletter.

Toward a better tax preparer...

Tax preparers, be prepared. The IRS today announced an initiative focused on tax preparers, with the twin goals of getting more people to pay what they owe and "ensuring uniform and high ethical standards of conduct for tax preparers." The process, which will include fact-finding and conversations with tax preparers and taxpayers, is designed to generate recommendations to the Treasury and the President that could include more regulation of tax preparers, more training, and more enforcement, the IRS says.

That can only be for the good for taxpayers, judging from the slew of tax practices the Justice Department prosecutes each year for fraud and other illegalities.

To make sure your tax preparer is both expert and ethical, check out our article on tax preparers. And if you regularly pay quarterly estimated income taxes, remember: June 15 is the deadline for your next payment!—Tobie Stanger

Needed: Protection from bad financial products

A bill recently was introduced in the Senate by Sen. Richard Durbin (D-Il), and co-sponsored by Sen. Charles Schumer (D-NY), and Sen. Edward Kennedy (D-Ma), to establish the Financial Product Safety Commission, a single federal agency to oversee the myriad financial products that bombard consumers.

"The Nation’s multiagency financial services regulatory structure has created a dispersion of regulatory responsibility, which in turn has led to an inadequate focus on protecting consumers from inappropriate consumer financial products and practices," the bill says.  "The absence of appropriate oversight has allowed excessively costly or predatory consumer financial products and practices to flourish."

Defend Your Dollars, a Web site sponsored by the advocacy arm of Consumers Union, offers an amazing gallery of people who've been victimized by financial fraud and chicanery. After reading some of them, you'll understand why CU and many other organizations support the establishment of such an agency. Click here for CU's fact sheet about the bill. And if you have faced or are facing foreclosure, share your story with us.—Tobie Stanger

New tax break for students

With college costs rising at almost twice the rate of inflation, it can be tough to make those tuition bills in any economy. But this economy has prompted some federal help to cut college costs with the American Opportunity Tax Credit. 

The new tax cut, which was included in the stimulus package that passed earlier this year, actually beefs up an old college tax break, the Hope Scholarship Credit, says Eric Smith, spokesperson for the Internal Revenue Service. The new version increases the tax credit for higher education costs to $2,500 from $1,800 and can now be claimed for four years instead of two. Costs of books and course materials have been added to qualifying expenses. Income levels have also been raised so that more people can qualify—couples earning up to $160,000 and individuals earning up to $80,000 are eligible for the full credit. Those earning more—couples up to $180,000 and individuals up to $90,000—would get a partial credit. 

The stimulus package also has increased the Pell Grant by $500 to $5,350 for 2009 and $5,550 for 2010. 

For more college saving advice for these tough times, check out Consumer Reports Money Rebuild Your Finances special publication, available on newsstands or visit our online bookstore.—Cora Daniels

A last-minute tax move for young workers

The young don't usually have money, but they do have time. And when it comes to saving, that time can eventually earn them bundles.

The last thing many young workers want to do is take proceeds from a hard-earned, often low-income job and put it toward retirement. But in fact, a little bit of savings now pays off big-time in a few decades, even if investment returns aren't always rosy. Recently, an expert worked the numbers for Consumer Reports and found that $5,000 invested every year from age 22 to age 29 would grow to $1 million by age 66--without additional funding--based on an average annual interest rate of 8 percent. While 8 percent seems unrealistic right now, over a long time horizon, it' s not unreasonable.

Here is an option for young workers--and their parents and grandparents--to consider: 

The saver's credit helps you save on your taxes if you're a low-wage earner and contribute to a retirement account. For young workers in particular, it's a good enticement to save. Funding an IRA and triggering the saver's credit also can be a way for parents and grandparents to give their working kids a leg up on the future without a direct handout.

Here's how it works: If you contribute to an IRA, 401(k), 403(b) or other qualified retirement plan, you're entitled to a saver's credit that reduces your federal taxes. Depending on your income, you'll get a credit of between 10 and 50 percent of what you contributed. The maximum saver's credit is $1,000 per person per year. It's too late to contribute to an employer's retirement plan to get a tax benefit for 2008, but you can still contribute to an IRA by April 15.

You're eligible for the 2008 saver's credit if your adjusted gross income is $26,500 or less as a single filer, $39,750 as a single head of household, or $53,000 as joint filers. There are other requirements: You can't be full-time student, you can't be used for an exemption on someone else's return, and you must be at least age 18. For more, download the 2008 version of IRS Publication 590, Individual Retirement Arrangements (IRAs).  

The saver's credit, together with an IRA or retirement-plan contribution, can deal a triple blow to your tax bill. The IRA deduction reduces your taxable income. It may also drop you to the 10-percent bracket from the 15-percent bracket, cutting your tax bill further. The saver's credit, subtracted from your tax, reduces what you owe even more--perhaps to zero.

Mark Luscombe, principal analyst of the tax and accounting group at CCH, a provider of tax information and software, helped me work the numbers for a single person making $18,000. Let's say you contribute $2,000 to an IRA, reducing adjusted gross income to $16,000. Subtracting the standard deduction of $5,450 and exemption of $3,500 drops that figure to $7,050--and into the 10-percent bracket. The tax on that $7,050 is $708. Subtracting a $1,000 saver's credit from that reduces taxable income to zero. In contrast, you'd have paid $960 by doing nothing.

Of course, most folks earning $18,000 a year would find it hard to put away $2,000. That's where a parent or grandparent can step in. They can help fund the young person's IRA, which triggers the saver's credit and the tax savings. The gift remains relatively out of reach in a retirement account, growing for the long term. 

--Tobie Stanger

Taxes: Last, best money-saving options

It's too late to sell more shares of losing stock or make donations to charity for tax-year 2008. Yet many people, whether they itemize or take the standard deduction, still have a few good options for reducing their tax bills and holding on to a bit more money. 

•IRA contribution for 2008. Depending on your income, you can contribute up to $5,000 to a traditional for 2008 and get a full or partial tax deduction. (Folks age 50 and over can contribute up to $6,000.) The deadline for setting up or contributing to an existing account is the same as for filing your return: April 15. Details on who's eligible for a deduction are in IRS Publication 590, Individual Retirement Arrangements. Also check that publication for rules on SEP-IRAs, intended for the self-employed.

•Catch-up IRA contribution for military. Because  the IRS generally gives members of the military and support personnel  a filing deadline extension of 180 days after they leave the combat zone, they also have an extension of their IRA contribution deadline. And under the 2006 HERO Act, the time window is still open for members of the military who received tax-free combat pay in 2004 or 2005 and wish to make IRA contributions for those years. The deadline for making those special back-year contributions is May 28, 2009.

•First-time homebuyers credit. Through the economic stimulus package, first-time homebuyers are eligible for a tax credit worth up to $8,000. Taxpayers who buy a home before Dec. 1, 2009, can claim the credit on either their 2008 or 2009 tax returns. They do not have to repay the credit, provided the home remains their main home for 36 months after the purchase date. The credit begins to phase out as income rises. The IRS defines a first-time homebuyer as someone who hasn't owned a home for three years. For more details, click here. 

•Recovery rebate credit. This credit is last year's stimulus payment with a slightly different name. Most taxpayers who filed taxes last year already got their full payment--up to $1,200 per couple, $600 per individual, and $300 per child--but a few may not have. For example, if you had a baby in 2008, you can apply on your 2008 return for the $300 child credit, provided the child has a Social Security number. Folks who didn't earn enough in 2007 to qualify but earned more in 2008 might also be eligible. Check here for more details. 

 --Tobie Stanger

Get free face-to-face tax help tomorrow

It's officially springtime, which for most of us means tax season. 

If this season's income tax bill threatens to overwhelm you financially, tomorrow is a good day to work things out with the IRS. The agency will be holding unusual Saturday hours at its approximately 250 offices nationwide. Folks with tax issues, and those who think they won't be able to pay, are welcome to come in and talk face-to-face with IRS staffers. 

In addition, hundreds of free community tax-prep assistance locations, staffed with IRS-trained volunteers, will be open nationwide tomorrow to help folks who earn $42,000 or less annually prepare their taxes, free of charge. 

Once you've checked tax prep off your to-do list, your spring can really begin.

Pay your taxes by credit card? Here's why not...

It's tempting to pay your state and federal tax bill by credit card. The tactic lets you delay actual payment for a month or so, and maybe earn a few hundred or thousand reward points in the bargain. 

Here's what's wrong with that reasoning:

•If you file and pay your bill electronically, you'll owe more. The IRS authorizes just a few companies to process electronic credit- and debit-card payments. They're permitted to charge processing fees of up to 2.49 percent of your balance. On a $2,000 tax bill, that's an extra $50. Why should anyone get more of your money, especially now?

•If it turns out you can't pay that credit-card bill on time and in full, you're subject to credit-card annual interest rates currently averaging 10.75 percent, according to Bankrate.com. Folks with less-than stellar credit can pay an average of about 13 percent, says Cardtrak.com.

•If you're paying by credit card because you're short of cash now, the government offers an option that can cost far less. The IRS automatically accepts requests for payment installment plans (also called payment agreements) for up to $25,000 in combined taxes, penalties and interest. You'll pay interest as long as you owe, but the IRS's current interest rate--4 percent for the second quarter of 2009--is far less than the average credit-card rate, and isn't likely to jump up sharply over time like a credit-card teaser rate. (If you choose the installment plan, you still have to file the return on time on April 15 to avoid penalties; you just don't have to pay everything then.)

•The average credit-card reward is 1 percent of purchases; on a $2,000, that's worth $20. If you're late on a payment, you'll likely wipe out that reward with penalties and late fees. Why bother? 

IRS still wants your tax money, but won't outsource collection duties

The Internal Revenue Service is ending it's contracts with private debt collection companies and will hire as many as 1,000 federal workers to collect delinquent taxes, the agency announced today.

"I believe this work is best done by IRS employees, and I believe we have strong support from the Administration and the Congress for increased IRS enforcement resources going forward," IRS Commissioner Doug Shulman said in a statement, citing a study that showed it was more cost-effective for the IRS to do its own collections work.

The agency head also said that IRS personnel could do the job better than outside contractors because they have "more flexibility handling cases."

"In these challenging economic times, I have asked all IRS employees to go the extra mile to help financially distressed taxpayers," Shulman said. "IRS employees have more options available to them to resolve difficult collection cases."

The IRS hired outside companies to assist in collecting delinquent taxes in 2006 after Congress passed voted to permit the practice in 2004. The current one-year contracts expire today, according to the IRS.