The Tax Man Cometh

Question of the week:I'm debating this year about whether to do my taxes myself on my computer or hiring a tax return preparer. Which do you think is best? --Sarah S.

Dear Sarah,

The time alone required to complete a Form 1040 these days can be daunting, not to mention the amount of anxiety and stress that a lot of people go through when preparing their returns. So you're wise to think before choosing a tax preparation path.

When we asked members of the Armchair Millionaire community recently about the ups and downs of tax prep, we heard a range of responses:

Do it yourself. "I prepare my own taxes using TurboTax, which walks me through everything and then flags anything that might make the IRS audit. It's a lot easier than people think--you just have to focus and take the time to do it." --Kristi

Go with a pro. "It's a full time job trying to keep up with all the changes in tax law, so I've always turned to professionals." --Ryan

In general, I think it's a good idea for most people with relatively simple tax situations to prepare their own returns. It keeps them in touch with their situations, and with the range of tax prep software now available, it can be a snap.

For taxpayers with more complex situations--for example, anyone who is self-employed, going through a divorce, or facing the alternative minimum tax--I believe that a professional can be invaluable. If you chose this route, my checklist will help you get the most from it.

The Armchair Millionaire Checklist for Getting Professional Tax Help

• Choose the right type of preparer. There are many different kinds of preparers, each with a different level of expertise (and accompanying cost). These are the major types:
  • Return preparers at national chains or local outlets. While convenient and fairly inexpensive, the knowledge and experience from one preparer to the next may vary widely. I would recommend this option only if you have a fairly simple tax situation.
  • Enrolled agents. These folks must pass a rigorous IRS exam, pass a background check and complete continuing education requirements every year. If needed, an enrolled agent can represent you with the IRS if it questions your return.
  • Certified Public Accountants. CPAs must undergo rigorous training and licensing requirements and are highly skilled in accounting matters. However, not all handle tax matters, so be sure to ask. CPAs may also represent you before the IRS.
  • Tax attorneys. An attorney specializing in taxation may be appropriate if you have a highly complex or specific situation on which you need expert guidance in completing your return.

• Check them out. Before you work with any preparer, ask them about their training and qualifications, continuing education, experience dealing with your type of tax situation, and if they would represent you in case of an audit.

• Organize your stuff. Your preparer can do a better job (and will charge you less) if you don't dump a shoebox full of unorganized tax records on their desk. Provide copies of previous years' tax returns, but make sure you send copies, not originals. And don't wait until April 10 before making an appointment with your preparer.

• Check your return carefully. Don't sign your return without reading it through carefully to ensure you understand it and that there are no glaring inaccuracies or omissions.

THE BOTTOM LINE: The old cliché says, taxes are one of two things you can be certain to face. But you can certainly make them less painful by choosing the right path for your tax preparation needs.

Creating Order from Chaos

Question of the week:I'm constantly overwhelmed by the amount of financial paperwork there is to deal with. Any suggestions for a system for keeping everything organized? --W.N.W.

Dear W.N.W.,

When we posed your question to members of the Armchair Millionaire community, we found that nearly everyone fell into one of two groups: Those who are wedded to their filing cabinets, and those who are proponents of personal finance software. Here are two examples of the comments we received:

Go with paper. "I keep a file with folders sub-categorized for 'retirement,' 'monthly bills,' 'bank statements' and 'taxes.' It's nice, neat and ready for a quick review." --Wade

Go with software. "Using personal financial software is a must. It's the best way to control where your money is spent, to set up and control a budget, and to see your cash flows. This makes your whole financial life more fun." --Doug

But as important as it is to have a system for organizing all your paperwork-whether you do it with file folders or software-it's only the start. You need to get at the root of the problem by taking steps that will simplify and streamline your finances. My checklist has some suggestions.

The Armchair Millionaire Checklist for Simplifying Your Financial Life

• Consolidate. If you have accounts with six different investment companies (you'd be surprised at how many people do), consider consolidating with one fund family, or at least consolidating into one account with a discount brokerage company. You'll cut down on paperwork, and probably save on fees, too.

• Automate. Stamps are going the way of the dinosaurs for good reason. Nowadays, nearly any financial transaction you make on a regular basis-whether it's an investment (such as monthly deposit into your IRA), a loan payment (such as your mortgage), or a bill (such as your utilities or insurance payments)-can be automated. Take advantage of it in order to reduce the sheer volume of paperwork you handle.

• Reduce redundancy. You gain little (except a paperwork headache) from having multiple investments with similar objectives and holdings. For example, two different large company growth mutual funds will largely overlap in what they own, and deliver largely the same results.

• Go paperless. Most brokerage and fund companies will be happy to send you their account statements, prospectuses and reports via email. It saves them money, and saves you filing hassles.

• Only keep what you really need. Do you really need that electric bill from four years ago? Or that annual report from three years ago? Probably not. Don't automatically keep everything that arrives in your mailbox-decide what you really need to keep for the long-term, organize it, and toss the rest.

THE BOTTOM LINE: It's impossible to get a handle on your finances if you're swimming in paper. By simplifying your overall approach, you'll reduce your paperwork load and free yourself up to focus on your big financial picture.

Driving Down the Cost of Car Insurance

Question of the week:My car insurance premium has just gone up (again!), even though I have a perfect driving record. What can I do to get these auto insurance bills under control? --Kim T. Dear Kim, You're certainly not alone. According to the Insurance Information Institute, the cost of auto insurance premiums is expected to rise by about nine percent this year, which breaks out to about an additional $60 per vehicle. And as evidenced by recent comments from members of the Armchair Millionaire community, others are feeling the auto insurance premium pinch. This comment was typical: "I have a perfect driving record (not a single at-fault accident or moving violation), and yet I pay a ridiculous premium. Just because I am young and male and live in NJ (the worst possible combination in the US), I am penalized to the fullest. Just horrible..." --Alexander K. Reducing your coverage and increasing your deductible are obvious moves, but there are many other common sense steps you can take to ensure that your premiums don't spiral out of control. My checklist provides just a few. The Armchair Millionaire Checklist for Keeping a Lid on Car Insurance Costs Shop around. Prices do vary greatly from one company to another, so it pays to comparison shop. Keep in mind that insurance companies may sell their policies in one of three ways: through their own agents, through independent agents who offer insurance from several different companies, and directly to customers over the phone or Internet. It pays to get quote from each type. Also, check with your state's division of insurance--many offer free price comparison guides through their Web sites. Get every discount you can. Depending on what your insurance company offers, you may be eligible for a number of different discounts, including: Safe driver discount: If you have not had an accident or moving violation for a set period of time, or if you have recently taken a defensive driving class. Multiple car discount: If you are insuring more than one car with the same company. Car and homeowners: If you buy both auto and homeowners insurance from the same company. Discount for safety and anti-theft devices: For cars with specific safety devices (such as anti-lock breaks), or theft deterrent systems. Low mileage discount: If you drive the car fewer than a specified number of miles each year, typically 7,500. Other discounts may be available for long-time customers, students with good grades, college students away from home, and drivers over the age of 50 or 55. Be sure to ask. Check out the car before you buy. The cost of your car model, how much it costs to repair, its safety track record and its attractiveness to car thieves all affect your premium. Before you buy your next car, compare the insurance losses for different models you may be considering. This information is available from the Insurance Institute for Highway Safety on its Web site at www.hwysafety.org. Explore group policies. Some employers and associations (such as alumni and professional associations) offer group auto insurance policies at a discount to what you would otherwise pay. THE BOTTOM LINE: If you drive, common sense (not to mention your state law) demands that you have car insurance. But that doesn't mean that you have to be a victim of ever-rising premium costs. With a little hunting around, you can find the best possible coverage for the lowest possible rate.

Should You Be the Family Banker?

Question of the week:Our daughter has approached us about the possibility of borrowing $12,000 for a down payment on her first home. She's always been responsible with money, but we're still hesitant. What do you think about making loans to family? --G.L.

Dear G.L.,

You've hit upon an emotional topic that brings up strong opinions. We recently asked the Armchair Millionaire community about their experience with making loans to family members, and heard both the good and bad:

"I've loaned money to my parents and siblings and have borrowed from them as well over time. We have always treated these loans as serious financial obligations and have always paid interest at fair market rates, with no problems." --Ted C.

"In past years, I lent thousands of dollars to cash-strapped relatives and never was paid back one dime. Therefore, I have made it a strict policy to never lend money to relatives again." --Wendi H.

Most of us truly want to be able to help family members, but before you jump in, consider the consequences as rationally as possible. Ask yourself:

• Is the would-be borrower a good credit risk? Has he or she paid off debts on time in the past, or had a hard time keeping financial promises?
• Will the loan be used for something that will appreciate (such as a house) or return a value (such as a grad school education)? Or will it be used to pay off other debt or simply for living expenses?
• Can you afford it? If the only way you can lend money is to borrow it yourself--such as from a home equity loan or from your credit cards--then you can't afford to make the loan. I suggest that you lend the money only if you can afford to never see a single repayment.

If you're inclined to make the loan, go about it in a businesslike way. My checklist will help improve your odds for a positive outcome.

The Armchair Millionaire Checklist for Lending Money to Family Members

Treat it as a business transaction. Put everything in writing, including the loan amount, interest rate and payment schedule.

• Set a reasonable interest rate. You might set an interest rate somewhere between what you would receive if you kept the money in a money market account and the rate the borrower would have to pay if they were to borrow from a bank. In this way, you would both come out ahead. Keep in mind, however, that depending on the size of the loan, you may need to charge the applicable federal interest rate, which is set by the IRS.
• Decide in advance what to do about non-payment. You might charge a late fee, or require a token monthly payment as proof of continuing good faith. You might allow an occasional "grace period" where interest still accrues. Spell it out in your agreement and make sure the borrower understands what will happen if they miss payments.
• Get help from a professional. Depending on the nature of the loan, it could carry significant legal, tax and estate planning implications. I strongly recommend seeking the advice of an attorney or CPA before finalizing the loan.
• Keep everything in perspective. Remember that in the long run, your relationship is more important than the money. If the loan goes south, you may decide to cut your losses in order to preserve the relationship.

THE BOTTOM LINE: Mixing money and families is never easy, so weigh the situation carefully before shelling out your cash for a loan. If you decide to lend the money, go about it in a way that will keep you and the borrower on good terms.