Arizona’s New Withholding

Arizona has done it again.  Currently, anyone who is being paid in Arizona must select from several percentages on the A-4.  Arizona withholding is based on a percentage of federal withholding.  The percentage you pick will be multiplied times the federal withholding number on your paycheck to arrive at Arizona withholding.  If you selected 24.5%, and your federal withholding was $112, then your Arizona withholding would be .245×112 or $27.44.

This created a problem with all the federal withholding changes that have happened over the last 10 years.  Each time there was a withholding decrease, Arizona’s revenue decreased as well.  The Making Work Pay Credit last year decreased checks for everyone and was the last straw in the problem.  Arizona’s legislature had to increase the percentages on this form each time the federal government decreased withholding  just to keep withholding even. Finally, last year, the legislature directed the AZ Department of Revenue to develop a new withholding system to be put into place by July 1, 2010.

There are other glaring problems with this method.  Arizona’s tax rates are based on a formula.  By requiring employees to pick a flat percentage, they are forced to determine a marginal (or average) tax rate for their tax situation.  This can change based on events in a person’s life like marriage, divorce, new children, home purchase, a second job or a spouse begins working that didn’t before.  Any of these events change the marginal rate.  Most people never adjust their A-4.  This obviously causes frequent confusion.

Another problem is that many people simply have no federal tax liability.  With no federal withholding, there was no way to have any Arizona withholding and inevitably, these individuals would end up paying extra every year at tax time.

Yet another problem is those that move into the state mid-year.  As a Tax Preparing CPA, I found it very difficult to advise my clients when they move in mid- year which percentage to pick.  The problem still exists in the second year (first full year of residence) since they have no history to draw from in selecting their percentage.

So…..Arizona’s new method was recently announced and here is the form.  All employees must complete a new one of these by July 1, 2010.  Guess what? They solved none of the above mentioned problems and even made some new problems.  Now, the percentage you select is percent of gross pay.  This decouples the state from federal withholding changes but still does not give employees who are new a clue to which rate to select.  Now instead of new employees only being confused, any person working in the state gets to be confused and not just for half a year, but for next year as well.  There is still no basis in the actual tax rates with these percentages.

Instead of providing some rates that anyone can pick, there are still three lines for employees to select based on income level.  This should have been removed.  If you have very low tax liability but a higher than $15,000 income, you cannot select the lowest rate.  On the back of the new form, there is a worksheet provided.  Notice in line 10 of the worksheet that there is no provision in the instructions for selecting anything other than line 1 (front side) percentages.  What if the calculation result is lower than the percentages on the form?

Employees are not able to determine their “target” withholding without digging into last year’s tax return or contacting their tax preparer.  Again, changes in taxable life events make last year’s number irrelevant.  What are you supposed to choose? This value is difficult for those without a tax background to understand.

Supposedly, payroll “experts” were used to help develop this form.  Unfortunately, they chose to tweak the existing system enough to only make things more confusing.   I hope that the state will make some wholesale changes to this form to more closely match what other states are doing and what the Arizona tax system actually looks like.  It’s not bad to use withholding allowances and marital status.  We are forced to use that on the tax form.   Let’s get this right next time.

Stealing the Tax Base

Pardon the baseball analogy.  The season is almost over and I just couldn’t help myself. There is statistical evidence that taxpayers in high tax states are leaving those states and setting up residence elsewhere at the rate of 1100 per day.  By increasing taxes to cover shortfall, states and the federal government to an extent are actually creating a situation of obtaining less tax revenue.

Today’s post comes from some statistics I read in a CNN.com article.  47% of U.S. households pay no income tax.  That is a staggering figure when you think about it.  I see four different classes of U.S. households when thinking about that statistic

1. Households that have no income tax liability and still get a refund
2. Households that truly have no tax liability
3. Households that pay income tax
4. Households that pay income tax and are targeted by current tax policy

Case number one contains individuals that have the lowest earnings.  Government policy provides refundable credits for many things including the Child Tax Credit and the Earned Income Credit.  They actually get money back from the system without paying anything in.

In case number two, taxpayers have income that is taxable but through a combination of itemized deductions, student loan interest, small business/passive losses and refundable credits, actually end up with no or little liability.  This year has likely seen an increase in the number of individuals who fall into this category.

The number of households who fall into the third category has likely decreased this year with the number of job losses the economy has produced.  These individuals have tax liability that goes beyond their eligible itemized deductions.  Some of the deductions allowed in lower income levels of this class and in the second class are actually phased out as income increases thus increasing the tax liability of this class.

Class four is the group that politicians and folks in class 1 and 2 love to hate.  These are the successful folks who either have a successful job or have started a successful company and are now reaping the benefits or even those who have received an inheritance from a friend or family member.  Many singers, actors and sports figures fall into this category as well.  It is very difficult to reach this category.  Therefore, I find it strange that tax policy targets this group.  We hear statistics such as “incomes over $250,000″ per year to describe the level at which this group sits.  If federal tax rates (and many states for that matter) continue to climb, those in this category could see total tax rates in the range of 75%!!  It is important to keep in mind though that this class of people also own the majority of the assets in this country.  Many of them actually create the jobs our economy so desperately needs.

Good tax and financial planning requires that pay attention to what is going on the the arena of tax.  The environment in today’s government is very desperate.  It is important that you get involved in the political process and let your representatives know how you feel regarding legislation that is before them.  If Americans voted based on how well their representatives actually represent them, I think there would be a large number of changes in those holding political office.  The tax and spend policies of both parties would suddenly come under such scrutiny that something would undoubtedly change.

I welcome your feedback.

U.S. Taxing History

Today’s post will be a short discussion on the entity that everyone loves to hate, the Internal Revenue Service.  It is important to take note however that the IRS does not make the laws.  They enforce the laws made by representatives that we send to Washington DC on our behalf.  If you think a law needs to be changed or the tax system should be reformed, contact your senator and representative.

For a quick history of taxes in the United States, you can visit this page on the IRS website.  President Lincoln was the first president to impose an income tax.  The Supreme Court shot down the law as Unconstitutional shortly after it was implemented.   During the early 1900s, an amendment to the Constitution was created to allow Congress to levy taxes on individuals without regard to the population of a state.  Many tax protestors claim that this amendment was never properly ratified.  It’s not true, but makes for a fun story.  The 16th ammendment to our Consitutional was officially approved in 1913.  Originally, tax rates ranged up to 77%.  You can see a history of tax rate brackets here.

The newest inititatives are to get the entire country to file tax returns electronically.  Not only does the “green” the IRS, it saves millions of dollars per year in printing and mailing and handling costs.  By eliminating these extra costs, taxpayers can essentially remove yet another tax from the system.  Filing on paper is so fraught with potential errors.  There is simply no way see how all the forms interact to pay the smallest legal amount of taxes possible.

On a side note, please click the “Follow me on Twitter” link on the right side of this page.  I publish a daily tax thought which often end up as the inspiration for future blog posts.