What are the tax benefits of a 529 plan?

Today's question: "What are the tax benefits of a 529 college savings plan?"

Answer: An IRS section 529 college savings plan is a state-run investment program that allow folks to save money for higher education in an account. The earnings in this account grow free of federal income tax and, when used to pay for qualified higher education expenses, may be withdrawn without having to pay federal taxes. It is potentially an extremely valuable tool for saving for college for you or your children.

Click here to read more about the 529 plan itself.

As far as federal tax benefits go, it's important to remember that 529 contributions themselves are not deductable from your yearly federal tax bill. BUT, after you make your contribution with after-tax dollars, your earnings in the 529 plan grow tax-deferred. So long as these dollars are used for qualified higher education expenses under IRS Code Section 529.

Examples of qualified expenses include tuition, some mandatory fees and books. A student's dorm/boarding expenses are also covered if they are enrolled at least half-time. Please read the previous link to the IRS page for more details on qualified expenses.

The earnings on withdrawals not used for qualified expenses may be subject to federal, state and local income taxes and possibly a 10 percent penalty.

On a final note, I won't address all of the drawbacks to 529 savings plans, but I do suggest doing research on what happens to your 529 account if a child decides not to pursue higher education or if they receive scholarships that cover their tuition and expenses. This is worthy of consideration.

What types of earners have to pay estimated taxes to the IRS?

Today's user question: What types of earners have to pay estimated taxes to the IRS?

Answer: First, it's important to understand what estimated tax is. Simply put, estimated tax is what you use to pay your taxes if your income/earnings are not subject to withholding. This is a common practice among the self-employed and may also be used for a variety of other reasons such as dividends and interest earned on investments and savings, rental payments, prizes, alimony, etc. In some cases, if your employer is not withholding enough from your salary you may also need to pay estimated taxes.

Note that if you don't withhold or estimate enough in tax payments and make those payments by the due date each period, you may be penalized by the IRS (yes, I know this sounds unfair, and I agree that it is!).

You are required to pay estimated tax if you expect to owe the IRS at least $1000 in taxes for the current year and you believe that the withholding from your income subject to withholding tax, along with any credits, will be less than 90 percent of the tax to be shown on your current year's tax return or all of the tax shown on your previous year's tax return (whichever of the two is smaller).

The IRS has more information here.

What information should go on my W-4 form?

Today's reader submitted question: "What kinds of information should I include on a W-4 form at a new job?"

Answer: W-4s are a type of IRS form that you use to provide information to your employer so that they can withhold the proper amount of federal income tax from your wages/paycheck.

The W4 is completed by an employee based on his tax situation, number of exemptions, filing status and other factors.

You, as the employee, should state the number of exemptions you are claiming and note your withholding status as single, married or head of household.

Claiming one allowance is usually the norm for younger tax filers. If you prefer that the government withhold more of your money you could also claim zero allowances.

Depending on the state in which you live, a separate withholding statement should be completed.

The more allowances you claim, the less federal tax is withheld. If you withhold too little, it's possible you may owe more come tax day, depending on your income, filing status, etc. For this reason, you should always be truthful and accurate when claiming withholding allowances.

What will happen if I don't file my federal taxes?

Getting back to blogging after a very long break, I noticed a question from Mike from Los Angeles, Calif. that seems to be a very common one. His question was, "What will happen if I don't file my federal taxes?"

Mike and everyone else - individual taxpayers/earners must file a return and pay their taxes owed no later than April 15. This is the law. There is no way around it and if anyone tells you otherwise (about conspiracies, Constitutional loopholes, etc.) they are incorrect.

If your taxes aren't paid or a filing is submitted late, it is subject to late fees and tax penalties. Taxes that are severely delinquent are indeed subject to enforcement action by the IRS, including wage garnishment, a federal tax lien or levy on property until the taxes are paid. If you can't afford to pay all your taxes at once, the IRS will even consider setting you up on a payment plan that is more manageable (although you may be charged interest or other penalties).

Folks, just be sure to file a tax return each year. This is a sure way to remain on the good side of the law. I know this was a pretty obvious fact to most of us. But it's always good to remind folks who may be filing for the first time or are considering not filing for whatever reason.