Adventures in Tax Preparation, Part II

At my day job, people know I do taxes for H & R Block. The number one tax question they ask me? “How does that other guy we work with get such big tax refunds? He said he got over $7000, and he makes less than I do, even with my side job.”

The short answer to this question is that the other guy has kids, but it is actually a little more complicated than that. To try and explain it, I run out some numbers for people.

Let’s assume that the other guy (we’ll call him TOG for short) is married, with two small children. We will further assume that Mr. and Mrs. Tog have a combined income of $26,000 between them. We’ll enter that $26K onto the front page of their Form 1040. So far, so good.

Now we’ll turn the Form 1040 over to page two, which is where all the real action is. First, the Tog’s will probably take the married filing jointly standard deduction of $11,400. Then the two adults and two children generate four personal exemptions of $3650, or a total of $14,600. You subtract the standard deduction and personal exemptions from their gross income to arrive at the Tog’s taxable income, which is $0. The Tog’s do not owe any Federal income tax.

So now, let’s start calculating the size of their refund. Right off the top, they get back any withholding taken from paychecks throughout the year. For the purposes of this illustration, we will use a figure of $1700. It could be more, could be less, depending what they set up with their employer. Whatever they withheld, they’re getting 100% of it back. Remember, they owe no taxes.

Next, we add in to their refund the Making Work Pay credit. This was part of the Obama stimulus package for 2009 and 2010. The Tog’s are married, so even if only one held a job, they still get $800.

Now we’re to the part where the children really come into play. If they actually owed taxes, they would be eligible for the Child Tax Credit of $1000 per child, which would wipe out the first $2000 of taxes owed. Since the Tog’s don’t owe any taxes, they don’t get the Child Tax Credit. Instead, they get the refundable Additional Child Tax Credit of $2000.

But, as the infomercials say, wait, there’s more! The Togs are a low income couple, qualifying for the Earned Income Credit. The EIC is a phase-in, phase-out credit, increasing to a plateau as you earn more income, than gradually reducing to zero as you earn a higher income. At $26,000 of earned income (note, the EIC works on earned income, not taxable income) you get about $3000. Fully refundable, of course.

That just about does it. Let’s tote up the board, shall we?
Withholding: $1700
Making Work Pay Credit: $ 800
Add’l Child Tax Credit: $2000
Earned Income Credit: $3000
Total: $7500

See, it wasn’t that hard to figure out how the Tog’s got such a big refund after all. Processing the paperwork is a different matter, of course which is why there is a market for paid tax preparers.

The thing that jumps out at you is how much of that money wasn’t the Tog’s in the first place. Even with no withholding, they would have received $5800 from the Federal government, a 22% boost in their income. These are straight transfer payments, going from people who actually pay taxes into the pockets of people who do not. Classic redistribution of wealth.

There are those of us who are concerned that the US is going to turn into a socialist state. But from the point of view of someone who prepares taxes, it has already happened.