The Monty Hall Problem

This is a probability problem which most people get wrong. Monty presents three doors. Behind two doors there are Goats. Behind the other there is a New Car.

You are instructed to choose one door. After you choose, Monty opens one of the remaining doors to show you a goat and then asks if you would like to trade the door you originally chose for the remaining door.

Most people believe that the probability of winning the car are the same whether they trade or not. Please give this some thought before you continue reading.

 

 

 

In actuality the odds are twice as good if you make the trade.

There have been lengthy discussions by many intelligent people. The problem finally being put to bed by running a computer simulation which show that trading is the correct choice.

My view on this is simple. This problem is a sleight of hand which confuses people. The sleight of hand is showing that there is a Goat behind one of the remaining doors. Here is why.

How many doors would you have to open to guarantee that you would find a Goat? There is only one car so if you open two doors there has to be a goat behind one of them. Therefor opening one of the two doors to show a goat is MEANINGLESS. It changes nothing in the problem. It is just the same as if Monty had said “behind one of these doors is a Goat”.

Since exposing the Goat is meaningless let’s dispense with it and revisit the problem.

This time you chose one door and Monty asks if you would like to trade your door for the remaining two doors. At this point nobody should have a problem reaching the correct decision. By choosing two doors out of three you are twice as likely to find the Car as you would with only one door.

 

Now you can all sleep at night.

Why do people owe the IRS? Identity Theft.

Identity Theft is a Big Deal with Billions of dollars per year being paid out in fraudulent refunds.

So you file your tax return and everything seems fine. What you don’t know is that someone already used your Social Security number and filed a tax return requesting a large refund. They fabricate the income and withholding amounts.

This is what happens next.The IRS compares the income that is reported to them (W-s & 1099) with what was reported on the tax return (The fraudulent tax return since it was filed first).

The IRS accepts ALL of the income claimed on the return but disallows the withholdings. Then they add all of the income and withholdings that were reported to it and send you a form CP-2000 pointing out the discrepancy and showing how much you would owe if the information is correct.

How much will you owe? Let’s assume that you had correct withholding and wouldn’t have owed any money. The CP-2000 will show you owe taxes on the fictitious income declared on the fraudulent tax return. Then you will owe the amount of the Refund. Then you will owe penalties for not having paid them amounts their records show you owed.

Why do people owe the IRS? Failure to file

What happens when you fail to file your tax returns?

Every year the IRS receives W-2s and 1099s representing wages and other incomes which you have received. The IRS can use these income amounts to prepare a Substitute for Return.

If you are single, receive a W-2, use a use a Standard Deduction and have no Capital Gains then the Substitute for Return might agree with the return you should have filed. However…

If you have kids, if you would itemize your deductions, if you have sold property or stocks, your return will show you owing substantially more than you should.

To explain…If you sold your home and don’t file your tax returns, the IRS will count the sales price as Net Income! There will be no cost basis or exemption.

Why do people owe the IRS? Under Withholding & Retirement Accounts

If your employer is withholding money for income taxes from your check how do you end up owing the IRS.

Your employer withholds based on the information you provide on your W-4. I have had clients who have claimed up to 99 exemptions on their W-4s. This means that not enough money is being withheld and so you owe the IRS.

Another big problem area is retirement accounts. Many people don’t understand that tax deferred accounts are taxed as regular income when the money is distributed. On top of that up to 85% of your Social Security benefit can be taxable depending on your other income.

Why do people owe the IRS? Self Employed part 2

So the Self Employed can owe the IRS because they didn’t make sufficient Estimated Tax payments.

The Self Employed use a Schedule C to declare their income. Users of Schedule C are more likely to be audited than people who are paid with a (W2).

When your Schedule C is audited the IRS wants documentation to prove your business expenses. If you haven’t kept good records then expenses will be disallowed and your net income and tax liability will go up.

This means the IRS will think you owe them money that you really don’t, but if you can’t prove it they will take steps to collect.

Why do people owe the IRS? Self Employed

I am an Enrolled Agent and have represented hundreds of people with Power of Attorney before the IRS. This had led me to think about why people owe. Today we’ll talk about the Self Employed, Self Employment Tax and Estimated Taxes

There are two types of self employed: Those that know they have a business and those who think they have a job but get paid with a 1099.

When you are employed (W2) your employer withholds money for income tax (W4) and they withhold 1/2 of your Social Security & Medicare. The contribute the other 1/2.

When you are Self Employed you must make your own Income Tax payments and since you are the employer and the employee and must pay both 1/2s  of your Social Security and Medicare (Known as Self Employment Tax this comes to 15.3% of your net income).

You make all of these payments as Estimated Taxes and the IRS expect them 4 times per year.

So one way people end up owing money is that they don’t even know that there are such things as Self Employment Tax or Estimated Taxes

Pocket Time Machine

When Summer ends Autumn comes and the weather turns cold. You go to your closet and get your coat or jacket.

Have you ever found money in the pocket? (I have). How did it make you feel? (It made me feel great)

This is how Saving works. You send money into the future. When you get there and find the money you feel great.

This is the whole philosophy: “A little and a little makes a lot”. Send good stuff into the future and you’ll be happy when you get there. If you send debt into the future it can be bleak.

Money in your pocket

When I was younger I would put my money in my pocket and then go about my day. After a bit my money would all be gone and I’d find myself wondering just where I had spent it all. I found that I could rarely account for it all and wondered if I hadn’t dropped some of it on the sidewalk.

This led me to think that if I couldn’t remember what I had spent it on I probably wouldn’t miss it if I set it aside up front and put it in the bank.

This is how I save money.

Retirement accounts

I’m always asking people if they are saving for retirement. Sometimes they say they’re invested in an IRA or 401k. Many of them think that those are investments and don’t realize they are just tax free vehicles(no tax consequences while the funds remain in the box).

Simply put there are two type of tax free vehicles: one where the money goes in before it is taxed and one where it goes in after it is taxed.

If the money went in before being taxed then it comes out  as regular income. If the money has already been taxed then it comes out tax free (unless they change the tax laws).

One idea is to have both tax deferred and after tax retirement accounts. This way you can take advantage of some tax savings up front and still keep you tax burden low during retirement since the regular income amount will be low.