The Real Income Number That Matters When It Comes To Taxes

March 19, 2018

One of the things that is toughest to grasp about taxes for non-tax professionals is the difference between income (a.k.a. gross income), adjusted gross income (a.k.a. AGI), modified adjusted gross income (or MAGI) and taxable income (the amount that actually determines your marginal tax rate).

Gross income is actually (kind of) irrelevant

We all know that our gross income is really only just a number on paper. No one actually takes home the total amount of income they earn (at least no one complying with the tax laws in the U.S.), but understanding how that number translates into the amount of taxes they pay each year is a mystery that most leave to the tax geeks of the world like me and my fellow CPAs.

Unless figuring out the tax code intrigues you, there is no need to become an expert on how it all fits together, but I do think it’s important to have a general understanding of the different terms. Why? Because you’ll be able to make better financial decisions that ideally may lead to tax savings. Here are a few key concepts to better understand:

Adjusted Gross Income or “AGI”

Why it’s important:

Your AGI is the basis for several tax thresholds, including:

  • Determining whether you qualify for certain tax credits
  • Determining whether you can deduct medical expenses, all your itemized deductions and/or miscellaneous itemized expenses (at least for tax years 2017 and prior)

Your AGI is also the starting point for most states in figuring out your state income taxes.

How it’s calculated:

To put it simply, it’s all your income from working, investments, retirement accounts, rental property, etc. minus all the expenses considered “above the line” such as IRA contributions, student loan interest and HSA deposits. Here’s the full list from the 2021 Schedule 1, which is part of the Form 1040:

Modified Adjusted Gross Income (“MAGI”)

Why it’s important:

Your MAGI adds back some of the “above the line” deductions mentioned earlier, and determines things like your eligibility to: contribute to a Roth IRA, take a tuition and fees deduction (which was resurrected for tax years 2018 – 2020), and deduct contributions to a traditional IRA (when you have an employer-sponsored retirement savings plan, like a 401(k), available to you).

Why you should care

Here are just a few examples of reasons you should have a rough idea of what your AGI and MAGI is:

  • You rule out making Roth IRA contributions because your salary exceeds the income limits, not understanding that the limit is based on your MAGI for IRAs. If you make contributions to your 401(k) at work, deposit funds to your HSA or even pay alimony, your MAGI may fall below the limits and allow you to contribute.
  • You sold a stock holding that was gifted to you many years ago from a relative and the gain from the sale pushes you over the MAGI limit resulting in additional net investment income tax. If you’d known before, you could have taken steps to minimize that additional tax.
  • You are retired and decide to make a last-minute withdrawal from your IRA right before the end of the year, not realizing that the withdrawal increases your AGI, subjecting more of your Social Security income to taxation.

Avoiding these situations requires careful tax planning and the assistance of an expert. But these are just examples of why we should all try to be a little more knowledgeable about how the income tax system works so that we will know when to look further into certain financial moves before we make them.

After all, who wants to pay more taxes than they have to?

Disclaimer: The author of this post is not a practicing tax professional; the content of this post is for informational purposes only and should not be construed as tax advice. Taxpayers should always consult a tax professional for tax planning services and/or tax-related questions.

How To Avoid Penalties On Unpaid 401(k) Loans

March 01, 2018

One of the biggest risks to borrowing from your retirement through a 401(k) loan is the heightened likelihood of the loan becoming a taxable distribution if you leave your job (voluntarily or not) while still paying back a 401(k) loan. Because 401(k) loans are paid back via payroll deduction, when your paycheck goes away, so does the ability to repay it, so many employers require payment in full within 60 days of leaving.

New tax law provides relief

While some employers do allow you to continue to make loan payments if you leave your job, one provision of the new tax law that hasn’t gotten much attention can make a huge difference to people who find themselves in a bind with an outstanding loan and no more job. Basically if you “default” on your 401(k) loan, there is a way to still repay it, but the details matter.

What’s the big deal? 

Prior to January 1, 2018, employees generally had two options to prevent the loan balance from becoming a taxable distribution if they left their employer with an outstanding loan: 

  1. Pay the loan back in full. It is rare that an employee is able or willing to go this route. 
  2. Repay the loan balance via “rollover” by contributing the amount still owed to an IRA within 60 days of leaving your job.  

If you don’t pay back the loan, then any balance from a pre-tax 401(k) becomes taxable income, and if you are younger than 59 ½, you will also owe a 10% penalty for taking an early distribution from your retirement account. Since one of the advantages of taking a 401(k) loan is that it is not taxable if repaid, this can be a hard pill to swallow. 

What’s changed? 

The new law, which applies to distributions treated as being made after December 31, 2017, extends the rollover deadline from 60 days to the tax filing due date (including extensions) for the year in which the loan was considered defaulted. Let’s look at a couple of examples of how this works: 

  • Example 1: You leave your job in January of 2018. You could feasibly have 20½ months to pay back the balance of your loan by depositing the amount owed into a rollover IRA. Why so long? Because you have until the filing due date of your 2018 tax return, which can be extended all the way until October, 2019. If you file in April, the payments would be due by then, so this would be a reason to extend your return (keep in mind this does NOT extend time to pay any taxes due, including if you end up NOT completing the rollover).
  • Example 2: You leave your job in December of 2018. You still have 10½ months (until October of 2019) to pay back the loan via contributions to your rollover IRA, but you may have to stretch a bit more financially to make it happen.

Keep in mind that even if you can’t pay it all back by the deadline, you should still pay back as much as you can to avoid those taxes and penalties.

The logistics 

It’s important to note that you’ll have some paperwork to do in order for this to work. Here’s what I mean:

Let’s say you leave your job in June, while still owing $2,000 on a 401(k) loan. If you extend your tax return for that year until October, you’d have about 16 months to pay back your loan; that’s $125 per month. 

  • Because your old job has no way to know you are paying the loan back into your rollover IRA, they will issue a 1099-R for the $2,000, showing it as a distribution to you.
  • The company where you have your rollover IRA will then also send you a Form 5498 showing you made $2,000 in rollover contributions to the account (make sure the deposits are recorded as a rollover and not new contributions). 
  • If your plan is to pay the loan back via monthly deposits to your rollover IRA, it’s best to check with the IRA company first to make sure they are equipped to handle that while treating each payment as a rollover — it could be a real hassle if they code monthly deposits as new contributions, which WON’T satisfy the loan rollover rule. You may have to set up a separate savings account to collect your monthly payments, then make one lump sum rollover contribution to satisfy the loan rules.

Because it is unclear what type of documentation the IRS will require, make sure to keep all forms and communication you receive and consult your tax professional to help you reflect this process on your tax return. Keep in mind that this process could take a few back-and-forth letters with the IRS, due to the timing of when the 1099-R and Form 5498 are mailed.

To avoid any issues, if you know you are planning on leaving your job, your best bet is to not take a 401(k) loan at all. However, if you find yourself unexpectedly moving on from your current job and have an outstanding 401(k) loan, keep these new rules in mind. Your future self will thank you when it comes time to retire and your present self will thank you for saving a lot of money on taxes and penalties! 

Should You Be Paying Off Your Home Equity Loan Sooner?

February 27, 2018

When it comes to the new tax law, by now you have most likely already heard that the income tax brackets were lowered, standard deductions increased, and there is a cap on state and local tax deductions. But there is another major change that could have an effect on your personal finances. The tax reform law alters the ability to deduct interest on home equity loans or home equity lines of credit.  

Changes to the mortgage interest deduction

The newly-enacted law places restrictions on home mortgages. The first restriction affects people who purchase a home between now and 2026 — basically you can only deduct interest paid on up to $750,000 in mortgage debt. The second part is that mortgages eligible for the itemized deduction must be used to purchase or improve it, including a home equity loan or HELOC (home equity line of credit). (Note that if you took out your mortgage on December 14, 2017 or earlier, you will still be able to deduct interest on up to $1 million in debt, but the home equity loan restriction affects all outstanding loans)

Can I still deduct my home equity loan interest? 

Because of the way the law is worded, it was initially assumed by many that if you have a home equity loan or line of credit with a balance, that the interest you pay would no longer be deductible as mortgage interest. However, this may not be true in all cases — according to recent IRS guidance, in many cases you can continue to deduct interest paid on home equity loans, as long as they were used to buy, build or substantially improve the home that secures the loan. 

Deductible versus non-deductible

For example, if you use a home equity loan to build an addition to your home or complete major renovations, the interest is likely deductible. But if you use a home equity loan to consolidate credit card debt or pay for your pet’s trip to the vet, you will not be able to claim the mortgage interest deduction. A loan is deductible if it is secured by your main home or second home (known as a qualified residence) and does not exceed the cost of the home and meets other requirements. 

When to re-prioritize debt paydowns

If you are no longer eligible for the home equity interest deduction, you may need to re-prioritize paying it down, but it’s important to look at the big picture. Since home equity loans and HELOCs often offer lower interest rates, you first need to consider your overall financial wellness before redirecting dollars to paying down home equity debt.

Focus on this first

In general, you should have a fully funded emergency fund, save enough to capture any matching contributions in an employer’s retirement plan, and eliminate higher interest debt such as credit cards or personal loans before paying down your home equity loan or line of credit (see Financial Priority Checklist).  

Making your money work hardest for you

If you already have your financial foundation in place your decision really comes down to where your money will work hardest for you. Financially speaking, your decision should be based on your after-tax cost of borrowing versus your after-tax return on your investments. If you are no longer able to deduct the interest on your home equity debt then your actual interest rate will become the main point of comparison.

However, if you have a variable interest rate you must also consider the significant likelihood of your interest rate creeping higher in the near future with the possibility of rising rates. There is also something to be said about the emotional aspect of eliminating debt. Paying off your home equity loan or HELOC ahead of schedule makes sense if it frees up cash flow to help you focus on future life goals such as paying for college or transitioning to retirement. 

As you can see, a lot has changed as a result of the recent tax law reform. One thing remains the same – you must constantly review your own financial plans to see how these changes will affect you. 

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Tax Reform Review: Should You Switch To Roth?

February 23, 2018

You’ve probably heard by now that Congress recently enacted a significant tax cut for most of the population. Beyond adjusting for lower withholding rates is there anything else you could consider? What about whether you should be saving into a pre-tax/traditional retirement account or a Roth/after-tax?

Get out your crystal ball

Making this decision is a bit of a prognostication game. If you make pre-tax contributions in order to save money on taxes now, you are locking in the need to pay taxes later. With a Roth 401k or IRA you are accepting the fact you are paying taxes now and electing to not have to pay taxes later. Essentially the decision comes down to when you think your tax rates will be higher.

One popular way to look at this question is to compare the amount of income you generate today vs what you think your income will be in your retirement years. If your income is higher now and rates remain the same then you may assume you can save more in taxes by making the pretax contribution. Conventional wisdom used to say that this was the case for most working Americans.

Things have changed

If you were assuming you would have a lower tax bracket in retirement you may need to rethink that. This most recent tax rate change actually has an expiration date — the new rules are set to sunset by 2026. That means that without a significant legislative move we will go back to the old higher rates. And considering the state of our national debt, social security and other fiscal matters of our nation, that’s very likely to happen.

Lower income may still equal higher tax rates

If the current tax rules can sunset this could mean that even if you have a 20% reduction in income at retirement you may be paying the same or higher tax rate in retirement than you would today. For example, if your income is $100,000 today your current top tax bracket is 24%. Let’s say you retire in 10 years and you anticipate your retirement income to be $80,000. If we go back to the old tax rates as planned, that would put you in the 25% bracket. Lower income could equal higher tax rates.

Roth might make more sense than ever … for now

It doesn’t sound like much, but consider for a moment the full power of Roth. Not only does the money you put in come out tax free, but also any growth on those dollars. Locking in the taxes you pay on that money at low rates could make great sense for people who expect to maintain similar income needs in retirement as they do today, and especially for savers with a long timeline for that money to grow.

For a mid-career person like me, this law change has made the landscape easier to plan for the next few years. It’s even prompted my colleague Kelley to change her retirement contributions from half pre-tax and half Roth to all Roth, despite being in what she considers peak earning years. However, once rates go back up, I imagine she’ll be looking at pre-tax again.

Who it might not make sense for

Despite the fact that tax rates are lower than ever, paying your taxes today on retirement income by using Roth may not make sense for everyone. For example, people in the highest tax brackets may still find their tax rates lower in retirement if they are socking away much of their earnings today and plan to retire at a much lower income in the 5-figure range. It’s best to consult a tax professional or a calculator for an answer specific to your situation.

What if I make too much money for Roth

If you have access to a Roth 401(k) through work, then there’s no such thing as making too much, as income limits don’t apply to 401(k). However, it is true that Roth contributions are limited to taxpayers whose incomes are below the annual limits. There are ways to get around it, but beware potential pitfalls.

 

 

Should You Increase Your 401k Savings Due To Tax Reform?

February 22, 2018

Have you noticed a little boost in your paycheck recently? That’s probably because employers have just started updating their employees’ withholding based on the new tax law, which reduced tax brackets across the board. So what should you do with the extra money?

Should you contribute more?

It may seem like the responsible thing would be to contribute it to your 401(k). After all, if you’re like the average American, you may not be saving enough for retirement and this would be a painless way to get closer to that goal. (You can use this calculator to see how much you should be saving.) Here are a few questions you may want to ask yourself first:

Is the tax bill really saving you money?

While rates have come down, some deductions have also been reduced or eliminated, including the state and local tax deduction. If you pay high state, local or property taxes, you may actually see your taxes go up. You don’t want to find that out at tax time next year and have to borrow from your 401(k) to pay the IRS. You can use a calculator like this to estimate your tax liability under the new law and compare it to what you owed previously.

Do you have adequate emergency savings?

Even if you are saving money, your 401(k) may not be the best place for those savings. Financial planners typically recommend having enough emergency savings to cover at least 3-6 months’ worth of necessary expenses. Otherwise, you may be forced to raid that 401(k) (with possible taxes and penalties) or borrow at high-interest rates in the event of an emergency.

If you can’t bear the thought of neglecting your retirement savings for even a short period of time, consider contributing to a Roth IRA. You can withdraw the sum of your contributions at any time and for any reason without tax or penalty so it can double as your emergency fund. (If you withdraw earnings before age 59 ½, they are subject to possible taxes and penalties but the contributions come out first.)

Just be sure to keep the Roth IRA money someplace safe like a savings account or money market fund until you have enough emergency savings somewhere else. At that point, you can invest the Roth IRA money more aggressively to grow tax-free for retirement.

Do you have high-interest debt?

It probably doesn’t make sense to contribute more to your 401(k) if you have a credit card balance at 19% interest. Those 401(k) contributions would have to earn 19% after-taxes just to break even. That’s something I certainly wouldn’t count on, especially with many financial experts forecasting future returns in the low to middle single digits due to historically low interest rates and high stock valuations. For that reason, my rule of thumb is to pay off any debt with interest rates above 4-6% before investing extra money (unless you haven’t maxed your employer’s match).

Are you planning to buy a home?

If so, consider stashing the extra money in savings. You’ll need cash for the down payment, closing costs, and any furnishings and renovations you want to add. This is on top of your emergency funds, which will be even more important when you can’t call a landlord anymore for home repairs.

If you’re saving money from the tax bill, have adequate emergency savings, no high-interest debt, and aren’t looking to buy a home anytime soon, your 401(k) can get be a great place for those extra savings. Go ahead and adjust your contributions before you start getting used to the bigger paychecks. After all, many said the tax law favors the rich so the quicker you can get there, the better!

 

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How To Make The Most Of Your Tax Refund

February 19, 2018

Ah yes, the annual tradition of gathering receipts and channeling our inner accountant! Tax Season is upon us. For millions of Americans, it also a time of great anticipation as we await the annual windfall that is our tax refund. Considering that in 2016, the average tax refund was a little over $3,000, it is easy to let our minds go to all the fun we can have with our tax refunds.

But before spending all your refund on a new TV or a car that will saddle you with high payments for the next 5-6 years, take a deep breath and think about how you can use that money to improve your current and future financial situation instead.

Option 1: Shoring up your financial foundation

If you’re still working on getting the 4 pieces of financial security in place, this can be one way to fast-track it.

  • Establish or strengthen your emergency fund – Most experts recommend having 3-6 months of expenses saved in an emergency fund to deal with unexpected expenses or even bigger events like job loss and illness/injury. Having one in place can allow you to stop using credit cards to deal with unexpected bills.
  • Pay down high interest debt – If you have credit cards or other high interest debt (north of 6% interest rate), using your refund to pay that down will save you a lot of money in interest. Once you pay off your cards, stop using them! Breaking the cycle of debt (see emergency fund above) will allow you to save for other goals and keep more of your hard-earned money.
  • Save for retirement – Using your refund to fund an IRA to help you prepare for retirement may not seem as fun as a trip to Vegas – but is a great way to get the most bang for your refund buck (and could even help you to increase your refund).

Option 2: Give your goals a boost

We all have financial goals that we are saving for, and a tax refund is a fantastic way to give those an extra boost! Here are some examples to consider:

  • Saving for college – Open or add money to the kiddos 529 plan.
  • Vacation – Set money aside for that next vacation rather than paying off the card after the fact.
  • New car fund

Option 3: A little bit of everything

It is ok to treat yourself with your tax refund, but be careful about spending all your refund on indulgences. Instead, think about splitting your refund to take care of past, present, and future you!

  • Past You – Pay off those lingering debts.
  • Present You – Treat yourself! Take 10-20% of your refund to get or do something for yourself.
  • Future You – Increase your savings for emergencies or other goals.

Making good choices with your tax refund can go a long way to improving your financial situation – now and in the future. Focusing on your priorities may not get you all the things you want right now, but it will help you get the things you want most in the long run! Happy Tax Refund Season!

 

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Why Tax Refund Anticipation Loans Are A Bad Deal

January 17, 2018

It might sound like a great deal to get your hands on your refund money today versus waiting until you’ve not only filed your taxes, but the IRS has issued the check, but it’s a bad deal all around. The storefront tax preparation companies that offer these deals are no longer allowed to charge the outrageous interest rates of prior years, but they still make a great deal of money off of these by charging fees that, when added up, can total a significant portion of your refund.

Back when we all mailed our returns in and had to wait for the IRS to send us a check, sometimes months later, these loans maybe made more sense for people. These days though, they are really just a way to make money off of less-informed people, which is what really gets my goat.

Rather than using a refund anticipation loan charged by a preparer, try one of these options:

  • File online for yourself. If you make less than $66,000, you qualify for free online filing and should take advantage rather than paying a storefront to do it for you. Planning point: if you qualify for the Earned Income Credit, the IRS is required to hold your refund until mid-February. This is not a reason to take out a loan though — just don’t count on that money yet!
  • Have your refund direct deposited. Rather than waiting for a check to come in the mail then having to take it to the bank, have the IRS deposit the money straight into your bank account. This will really speed up your refund – the IRS says that most people should have their direct deposit within 3 weeks or less of filing. Plus, no more worrying about your check being stolen or lost.
  • Consider same as cash deals, with caution. If you’re planning to use your refund to make a big purchase such as an appliance or furniture, check to see if the store is offering any type of “same as cash” deal, where you have a certain period of time to make payments interest free, usually 90 days or more. The key to this working is that you actually pay the store credit off with your refund before the interest-free period expires. Otherwise, it can be just as bad of a deal as a refund anticipation loan.

The bottom line is that paying any type of fee or interest to a bank or business in order to get part of your tax refund early is almost always a bad deal. Before you sign up for one, make sure you fully understand what it’s costing you and consider waiting to just get the money from the IRS if at all possible.

 

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How To Make The Most Of Your Tax Refund

January 16, 2018

I was hanging out with a friend last week when I noticed that she had an unusual amount of magazines and sales ads around her. Knowing that she is one receipt away from being a shopaholic, I asked her what was going on.

She told me that in anticipation of her the tax refund she thought she was going to get, she had started creating a list of the things she was going to buy. I mentioned her New Year’s Resolution to save more money and pay off debt and reminded her that the refund can serve a greater purpose than buying stilettos. Maybe she needed to put the catalogs away, but let’s not go to extremes.

There are ways to use your tax refund to achieve your goals while also having some fun. Here’s what I suggested to her:

  1. Give yourself permission to spend (with limits). I told her to give herself permission to spend a percentage of her tax refund. Because she had practically nothing in savings, I suggested limiting her spending to only 10% of her refund.
  2. Save some. I know it may seem counter-intuitive to someone paying off debt, but put some of the money in savings. When I talk to people who cannot seem to get out of the cycle of debt, I find this is the stumbling block. If you do not have at least $1,000 in emergency savings, you are just one unexpected financial need away from getting kicked back into debt.
  3. Pay off debt. Finally, yes, you should use some of it to jettison debt a little faster. What’s the best way to pay off debt? The best answer I have to offer is the method that you will stick to until you are debt free. If you feel defeated and need quick wins to stay motivated, pay off the lowest balance first (an exception to this is taxes – always pay past due taxes first). If you want to save the most money on interest, pay off the highest interest rate first. Use a Debt Repayment Calculator to come up with a debt repayment game plan.

Taking a balanced approach to spending an anticipated refund gives you some wiggle room to enjoy the refund, but still gives you the ability to meet your other financial goals.

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7 Steps You Can Take To Adapt To The New Tax Law

January 08, 2018

Tax laws have just changed, and that is likely to affect you. Whether your see a net benefit in your paycheck (which I hope you do) or end up paying more is a function of personal factors like your mix of income sources, your overall income, what you currently deduct, how many children you have and where you live. Here are some steps you can take now to adapt to the new law:

Step One: Run a tax projection

How will the new tax legislation affect you? Will your taxes go up or down? The only way to know for sure is to run a tax projection – an estimate of what your tax return will look like for 2018. Several sites have tax projection calculators up now which incorporate proposed major changes, including CalcXML, CNN, and MarketWatch.

If you’ve got a complex situation and you think you may owe more or need to make estimated tax payments, consider asking your accountant to run a “pro-forma” tax projection early in 2018 to gauge your tax liability for the remainder of the year.

Step Two: Update your tax withholding

You may need to withhold more or less going forward. Unfortunately, it’s going to take some time for payroll departments – and the IRS – to put out new forms and rules. If you think you may owe less in taxes, keep your withholding allowances the same for now until the withholding guidelines are updated. You may not need to make any changes to see more in your paycheck once your payroll department has implemented the new standards.

If you think you may owe more, consider reducing your withholding allowances. Remember, it’s better to overpay and get a refund than underpay and get penalized. When updated for the new law, use the IRS withholding calculator to estimate how many withholding allowances you should claim for the remainder of the year. Contact your payroll department to change your elections (Form W4) if needed.

Step Three: Losing employer-subsidized commuter benefits? Increase your own contribution to your commuter account

The GOP tax plan eliminates the tax incentive for private employers that subsidize their employees’ transportation, parking and bicycle commuting expenses. If you’re using this benefit and your company has been paying for all or some of it, make sure you increase your contribution to your commuter account. Your contributions will still be pre-tax. The max is $255 per month.

Step Four: Consider the impact on buying or selling a home

The deduction limit for mortgage interest drops to $750,000 of debt on your primary residence. If you have a larger mortgage and are planning to stay in your home, no worries. It remains $1 million for homes purchased before Dec. 15 of 2017.

However, if you are buying a new home, a jumbo mortgage is not as financially attractive. Thinking about a vacation property or second home? Your mortgage interest will not be deductible over the limit of $750,000, including your primary residence.

If you are selling your primary residence, you can still exclude up to $500,000 for joint filers or $250,000 for single filers of capital gains if you have lived in the residence for two of the past five years. Moving for work? You may no longer deduct your moving expenses.

Step Five: Review the Roth/pre-tax decision

Generally, the lower your income tax rate and the further away you are from needing your savings in retirement, the more sense it makes to contribute to a Roth 401(k) and/or a Roth IRA.  However, if you’re losing itemized deductions with the new $10,000 cap on deducting state and local taxes (SALT), run some numbers to see if a pre-tax 401(k) contribution can help lower your tax rate. Conversely, if you don’t itemize and the standard deduction exceeds what you could take in previous years, it may make more sense to change from pre-tax to Roth. Compare your two options with this calculator once the new rates are incorporated.

Step Six: Rethink home equity loans

The deduction of interest on home equity loans has been suspended through 2025 unless the loan is used to substantially improve your home. This can make home equity loans more expensive. You may want to think twice before taking out a home equity loan and perhaps give higher priority to paying off existing ones.

Step Seven: Rescue your 401(k) loan if you leave your job

Up until now, if you left – or lost – your job while you had a 401(k) loan outstanding, any unpaid loan balance would be taxable and penalized at an additional 10 percent. Under the new law, it appears that you have until the April filing deadline to basically contribute the unpaid balance to an IRA and call it a rollover.

For example, if you had a $2,000 loan balance outstanding when you left your job in June, you would have until the following April to contribute $2,000 to an IRA rollover in order to avoid the income taxes and additional 10 percent penalty. That’s a good deal if you can find the money

Keep reading. There’s more in the tax bill that will have implications for individual taxpayers. If your income is complex or you have questions about your personal situation, please consult a professional tax advisor.

This post was originally published on Forbes.

Is This The Year You Start A Charitable Giving Habit?

December 18, 2017

It’s the time of year for giving. In our home, as in many households, that giving includes charitable contributions. While we make some contributions during the year in response to events, we make our planned gifts during the holiday season. Here’s how we think about it:

Charitable giving is a financial habit

While I can’t prove this scientifically, I do believe that money has a “flow,” and that sharing some of the money I make with others shows gratitude for blessings in my life. In fact, giving away money can actually improve your budget by forcing you to manage your financial resources more mindfully. Making charitable gifts has always been something my husband, Steve, and I agreed upon in our relationship. In fact, when we got married we asked friends and family to make donations instead of sending presents.

How much to give

Personally, we aim to donate a set percentage of our income after taxes. We include charitable donations which are tax deductible, as well as contributions which aren’t (such as contributing to a GoFundMe campaign for a neighbor with unexpected medical bills). If you’re new to giving, start with a small percentage goal, like 1 to 2 percent of your take home pay, or 5 percent of your discretionary income.

Tax deductions

If you itemize your taxes, you may take a tax deduction for money or property donated to a qualified organization. According to IRS guidelines, you may generally deduct up to 50 percent of your adjusted gross income, but 20 percent and 30 percent limitations apply in some cases. Don’t forget to print out copies of the donation acknowledgements – you’ll need to save them in case your tax return is audited.

Where to give

Where you give is an entirely personal choice. If you’re new to charitable giving, consider asking yourself, “what problem do I most want to help solve?” as a starting point for your research. You may make more impact by making larger contributions to fewer organizations. Set some guidelines for yourself. For example, we focus our giving on education, international health and food security.

You’ve got plenty of charities to choose from. According to the non-profit directory Guidestar, there are 1.8 million IRS recognized non-profit organizations in the U.S., including 501c3 registered charities and other nonprofits. Some people give a set percentage to their religious organization. It’s a good idea to check out any organization on Guidestar or Charity Navigator to see how well they make use of donors’ contributions.

Giving stocks or mutual funds

Lucky enough to have bought Apple stock fifteen years ago? Give some shares of that instead! If you have stocks or mutual funds which have appreciated in value, donating shares instead of cash allows you to make the deductible donation without paying taxes on the capital gain. See IRS publication 526 for all the rules.

Check for matching donations

Chances are, if you work for a larger company, your employer will match employee charitable contributions, up to a certain dollar limit. Some employers have guidelines for what types of contributions they will match, so check your benefits website for more details.

When you can’t afford to give much – or anything

If you’re buried in student loans or credit card debt, or at a place in your life when you just don’t have any surplus income, please give yourself permission not to make donations. If you can swing it, give your time instead. Most of those 1.8 million non-profit organizations run on a combination of contributions of both money and volunteer effort. Don’t know where to start? Check out VolunteerMatch or Volunteer.gov.

The bottom line? Giving is habit worth developing.

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How Giving Your Money Away May Actually Improve Your Budget

November 28, 2017

You may think I’ve gone crazy or made a HUGE typo by suggesting that giving your money away could actually lead to more money, but I really mean it. Some people can actually help their ability to budget by being generous with their money. Here are several reasons to be generous this giving season:

Taxes

This may be obvious, but charitable giving can reduce your taxes, which may put more money in your pocket. If you itemize your deductions on your income tax return, then you can get a tax break for every dollar that you give to charity – as long as you have a receipt or proof of your donation.

That’s one thing to keep in mind when giving money away — by making bigger contributions by check or debit card where you get a receipt, you’ll get a bigger bang for your buck than by giving a couple of bucks in cash to several organizations here and there.

Just like anything else, the more you focus on the things important to you, the better results you will get. By finding causes that really resonate with you and supporting them to what you feel is a significant degree, you will get more tax benefit and more emotional satisfaction than randomly throwing money here and there.

Going big

Charitable giving to high levels, such as the Biblical principle of tithing or giving away 10% of one’s income, forces you to be accountable for every other penny you have because so much has already gone out the door. I’m not suggesting that your giving be restricted to religious organizations (nor am I promoting a religion), I’m just pointing out that the concept has been around for a long time.

If you are paying your taxes and then giving away another 10% to the charities of your choice, then you will have to prioritize the other dollars that you keep. Sometimes people find that by prioritizing the remaining 90%, they actually spend less and save more than when they have the full 100% available to them but don’t track where it’s going because they are always getting by. Here’s what I mean.

Scarcity often leads to better use of what we have

My wife recently completed graduate school to become a Nurse Practitioner. While she was in school, she continued to work full-time (3 days, 12 hours per day) while doing 2 days per week of shadowing in a medical practice, PLUS 1 day a week in class. Somehow through it all, she managed to continue being an amazing Mom to our kids and partner to me. We talked about her cutting back to part-time at one point, but she wasn’t sure it would help. When I asked her why, she said, “All that would mean is that I’d have a day to sit on my backside and watch TV. As crazy as this schedule is, I am so much more productive because I know that I have to be.” I think the same principle can often apply to our money.

Giving leads to gratitude which leads to greater performance

One other way that being charitable helps is that it makes us feel better about other people, ourselves and what we have. When we are focused on what we don’t have, are we really doing the best job we can for our current employer or do we have one foot out the door? If we are truly thankful for what we have and focused on doing the best job possible, that often translates into better job performance. While there are no guarantees, over time better performance usually leads to more pay and better earning opportunities.

So we’ve seen that there are tangible and possibly some intangible benefits to being generous with our money. If I’m right, then hopefully you will end up with a better bottom line even though you are starting with less. If I’m wrong, then you will have a little less money, but the world, and you, might be changed for the better. Is that a bad thing?

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The Skinny On The Latest Tax Reform Package – Should You Worry?

November 03, 2017

You’re likely to see lots of headlines in the coming weeks about the tax reform package that Congress will be hashing out, which many are calling the biggest tax overhaul in 30 years. Time will tell if that’s true and should a new tax law be passed, chances are it will look much different from what has been put forth so far.

I personally tend not to worry too much about this stuff until it’s actually law, but I know not everyone works like that, so here are the highlights of what’s being proposed and whether or not you should worry about it.

Mortgage interest deduction

What’s being proposed: A limit on the amount of interest you can deduct.

Should you worry? The limit applies to interest paid on NEW mortgages bigger than $500,000, so if you currently have a mortgage that’s larger than $500k, you’re good. If you were to take out a mortgage in the future that is higher than $500k, you’ll still be able to deduct interest, the amount would just be capped at the interest on the first $500k.

FYI, the current law caps the deduction at $1 million worth of mortgage debt.

Student loan interest deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? If you currently have adjusted gross income over $80k ($160k if you’re married), then you already miss out on this deduction. If you’re just starting out in your career and paying down big loans, yes, this could affect your taxes. Depending on your tax bracket and total interest paid, this could cost you up to $625 in taxes. (keep reading though, this could be made up for with other changes)

Want to figure out more closely what it would cost you? Here’s how:

If you’re single and you make more than roughly $37k per year, then take the amount of student loan interest you actually paid (you can find this by logging into your loan service provider) and multiply it by .25. That’s about the amount you save on taxes with this deduction. Same process if you’re married and make more than about $75k combined.

If you make less than those thresholds, then just multiply your interest by .15 to get your number.

State and local tax deduction

What’s being proposed: A limit on the amount of state and local taxes you can deduct, including property taxes.

Should you worry? If you pay more than $10,000 per year in combined property and state income taxes, you could see your taxable income rise should this provision pass. The good news is that there are some powerful Republicans from states with the highest income tax rates who are likely to fight this on behalf of their over-taxed constituents. The fact that next year is an election year will play to your favor if this is an important deduction to you.

Alimony and moving expense deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? If you pay alimony or were counting on a tax deduction to help fund a work-related move, then yes, you should worry. If you receive alimony, this will actually help you because you would no longer have to claim it as income.

Medical expense deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? Most working people with decent insurance coverage aren’t able to deduct out of pocket medical expenses anyway, due to the law requiring that expenses must exceed 10% of your adjusted gross income before you can deduct it. Older Americans (who have a lower threshold and likely higher expenses), however, may suffer with this provision.

Is there any good news?

One of the goals of this package is to simplify the tax code, which is why a lot of deductions are going away. To make up for that, there are some positive changes proposed as well.

One thing that could help, especially for people who don’t itemize (and therefore don’t care about the mortgage and other tax deduction loss) is that the standard deduction is slated to practically double to $12,000 for individuals (currently $6,350) and $24,000 for families (currently $12,700). In other words, if you’re worried about losing your student loan interest deduction, the loss could more than be made up for by this larger deduction. The proposal also includes lower tax brackets for most of us, which is also good news.

One thing that wasn’t included, that many people thought was on the chopping block, are changes to the treatment of 401k contributions. Unless something gets slipped back into the final package, we can continue to contribute up to $18,000 in pre-tax money plus an additional $6,000 if you’re 50 or older. Even better news, that limit is getting bumped up to $18,500 for 2018.

“Worrying is like paying interest on a debt that never comes due”

The best thing you can do at this point to help your situation would be to let your congressional representatives know how you feel about these proposals. There will likely be organized efforts around some of these issues, so join in if it’s important to you.

There are obviously lots of other changes proposed in the proposed law that our representatives in Congress are working on, but those are the ones most likely to cause confusion and/or directly affect many of us “everyday” working folks. Time will tell what the final result will be. If I had to wager a guess, I’d say we probably won’t know much before Santa starts making his rounds.

 

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5 Tax Moves To Make Right Now

September 15, 2017

As we approach the end of summer and the beginning of fall, things are changing. Temperatures begin to cool, leaves start to turn color, and the kids start back at school. While we do not have much control over these changes, we do have the ability to make some changes to improve our financial well-being.

With about three quarters of the year in the books, now is a great time for tax planning. You should have a good idea of what your income (including bonuses) projects to be for the year, plus there is enough time to make some changes before the end of the year. Here are some ideas:

  1. Increase 401(k) Contributions. If your income projections show that you are on pace to creep into a higher tax bracket, consider decreasing your taxable income by increasing pretax contributions to your 401(k) plan. Most plans allow you to change your contribution amount at any time, as long as you stay within the IRS limits of $18,000/year, plus $6,000 more if you are 50 or older. Then, when the new year arrives, why not keep your 401(k) contribution rate at this higher level if it fits within your budget?
  2. Increase Health Saving Account (HSA) Contributions. Similar to 401(k) pretax contributions, HSA contributions can be used to keep you in a lower tax bracket, and can be changed at anytime through your payroll deduction. You can even write a check and have it deposited into your HSA up to April 15th of the following year. Since the unused balance in your HSA can be rolled over to subsequent years, and can be invested, view it as a supplemental retirement account as all qualified medical distributions will be tax free, regardless of your age.
  3. Use all the money in your Flexible Spending Account (FSA). Unlike the HSA, your FSA has a use it or lose it provision. So, look at your current balance and future contributions for the year, and match current year medical expense to at least meet this amount. If it looks like you’ll have unused funds, reschedule that minor procedure or visit to the doctor you were planning for this year instead of next so you can use the tax-free money (assuming, of course, rescheduling does not negatively affect your health). Load up on contact lenses or upgrade your glasses this year, rather than waiting until next year. For more ideas on eligible ways to spend extra money, check out this list for ideas.
  4. Offset capital gains with capital losses. If you sold some stock or other asset earlier this year that generated a capital gain, you can offset this gain with a capital loss. By using capital losses to offset capital gains you will lower your net investment income and tax liability. You can even use up to $3,000 of a net capital loss as a taxable income deduction.
  5. Hire a tax preparer. Don’t wait until you’re facing the April 15th deadline to figure out who you’re going to have prepare your taxes for the year. Interviewing and hiring during the fall gives you time to acquaint yourself with your preparer, which makes it more likely that he/she will be able to give you personalized tax planning ideas to actually help you save on your taxes. Waiting until mid-March or later not only limits this opportunity, but may also cost you a premium — some preparers charge more for people who submit their stuff after a certain date.

Asses your overall tax situation now, and put a plan in place to avoid “scramble mode” at the end of the year.

 

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What U.S. Citizens Need To Know About Taxes & Working Abroad

July 10, 2017

Are you a U.S. citizen or resident alien (green card holder) planning on working abroad? We’ve got some experience with this in my family: my husband and I were expats for 5 ½ years. Living in a different country can be an amazing experience! Before you relocate (or return to your citizenship country if you’re a resident alien), make sure you know the tax basics for U.S. taxpayers living overseas.

You’ll file a U.S. tax return every year

As long as you’re a citizen or resident alien, you can look forward to filing U.S. tax returns every year, regardless of where in the world you live and regardless of your income sources. The IRS has a long reach: your worldwide income — not just your U.S. income — is subject to U.S. income tax. See the IRS guidelines for taxpayers living abroad.

Whether you owe taxes and how much will be a function of your individual tax situation, but in general, if you have any U.S. income, such as salary, business income, investment income, rental income, Social Security or retirement account distributions, you should expect to pay some U.S. taxes.

If all your income is foreign sourced, remember that income from abroad is still taxable, and you must report all your sources of income, but you should usually be able to take a credit or a deduction for foreign taxes paid. Practically speaking, what this means is that if you live in a country that does not have an income tax, or has a very low income tax, you’re not off the hook — you’ll still be paying Uncle Sam.

You may also need to file a state tax return

If you still meet the legal definition of being a resident of a state, such as maintaining your voter registration, driver’s license, owning a home or earning income in that state, you may need to file a state tax return as well. Check with your state to be sure and obtain a tax professional’s advice to be sure.

You’ll need to report any non-U.S. bank and securities accounts

If you open up bank or investment accounts abroad, you’ll also need to report those once a year, even if you are just a signatory. This includes bank accounts, brokerage accounts and mutual funds, as well as any other financial accounts, even if they don’t produce income. Penalties for not reporting are significant. See more details about Report of Foreign Bank and Financial Accounts (FBAR) here.

Other tips to keep in mind

You may be eligible for the Foreign Earned Income Exclusion  While working abroad, you may qualify to exclude a certain amount of  foreign earned income from your income taxes. That’s what my husband did, as he worked for a foreign company located outside the U.S. A qualifying individual may also claim the exclusion on foreign-sourced self-employment income. If both spouses have foreign earned income, they can both claim the exclusion (up to $102,100 each in 2017).

To claim the exclusion, you must either pass the Bona Fide Residence Test or the Physical Presence test. In a nutshell, you need to actually live in the foreign country, not just travel there for an extended period.

You may be able to claim a foreign housing exclusion or deduction My husband received a housing allowance as part of his compensation, and we could exclude some of our housing expenses, subject to certain limits. Keep in mind you still need to meet one of the tests described above. See the IRS overview here.

You’ll probably pay foreign taxes where you live Any time you work in a foreign country and earn income there, you will also be subject to that country’s tax laws. Keep in mind that there are exclusions, deductions and credits for your U.S. tax return that soften the impact. Use this quiz to see if you qualify for the foreign income exclusion or housing deduction.

The opportunity to work abroad, even if just for a temporary assignment, can be exciting and life-changing. Just make sure you mind your U.S. taxes while you’re seeing the world.

 

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What to Do If You Missed the Tax Deadline

May 04, 2017

April what? I’ve written before about why not to procrastinate filing your taxes, but sometimes life just gets in the way. We recently received a question about what to do if you missed the tax filing deadline. Here are some steps to take:

  1. Don’t panic. Assuming you’re not found guilty of egregious tax fraud, you’re not going to jail. In fact, if you don’t owe anything, you won’t even have a penalty. I once filed late one year and my only punishment was having my refund delayed.
  1. Decide whether to do your taxes yourself or use a professional tax preparer. Here are some things to consider. Keep in mind that if your income is below $64k, you may now qualify to use name-brand tax software for free. (If your income is above $64k, you can still use the IRS’s fillable forms for free, but they don’t offer any real guidance so I wouldn’t recommend this unless your taxes are really simple and/or you really know a lot about tax preparation, in which case you probably wouldn’t be reading this.) The good news is that if you decide to hire a tax preparer, you may have an easier time finding one now that the busy tax season is over.
  1. Get your taxes done ASAP. If you do owe taxes, you’ll want to get the payment made as soon as possible to minimize interest and penalties. (Here are some things you can do if you can’t afford the payment.) If you’re owed a refund, my guess is that you can think of better uses of the money than continuing to loan it to federal government tax-free (although they could really use the money right now). Either way, you’ll be relieved to get it off your mind.
  1. Prepare for next time. Check out these tips to prepare for the next tax season. If you think you’ll need extra time, you can file for an automatic extension until October. However, you’ll still owe interest and penalties for any payments made past the filing deadline. To be on the safe side, you may want to adjust your W-4 to have more money withheld from your paychecks so that you don’t owe next year.

Don’t worry. You’re not the first person in America to miss the filing deadline. That being said, next time the consequences could be worse so try not to make the same mistake again.

 

How to Invest in Your Employer’s Retirement Plan

April 27, 2017

Last week, I wrote about how to invest in a Roth IRA but how about your employer’s retirement plan like a 401(k) or 403(b)? After all, that’s where most people have the bulk of their retirement savings. Here are some options:

Keep it simple…real simple. If you have a target date retirement fund in your plan, this is the simplest option. In fact, it’s probably the default so you may not need to do anything at all.

The idea is to pick the fund with the target date closes to when you think you’ll retire. Each fund is fully-diversified to be a one-stop shop that automatically becomes more conservative as you get closer to retirement so you can set it and forget it. It doesn’t get much easier than that.

There are a couple of downsides though. First, you may not even have this option in your plan. Second, your plan’s target date funds may have high fees. Finally, you don’t have the ability to customize the mix of investments to match your particular risk tolerance (although you can pick an earlier date if you want to be more conservative or a later date if you want to be more aggressive) or to complement any outside investments you may have.

Target a particular risk level. If you don’t have a target date fund or want something more tailored to your particular risk tolerance, see if your plan has a target risk fund or an advice program. A target risk fund is fully diversified to be a one-stop shop, but it stays at a particular risk level so you may want to switch to something more conservative as you get closer to retirement.

An online advice program can recommend a particular mix of investments based on your risk tolerance. Many programs will even use the lowest cost options in your plan and/or factor in any outside assets you may have. For example, if you have a lot of stocks in a Roth IRA, the program may reduce your stock holdings in your plan accordingly. However, it will need to be periodically updated as your situation changes and some programs charge additional fees.

Create your own mix. If the above options aren’t available to you or if you prefer to have more control, you may have to create your own mix of investments. You can take a risk tolerance quiz like this one and use the suggested allocations as guidelines.

Just be sure to look for low cost fund options to implement your portfolio. You may want to use your plan for those assets in which you have low cost fund options and use outside accounts for the rest. (That’s why I invest mine all in a low cost S&P 500 index fund.) Don’t forget that taxes are another cost. If you have investments in taxable accounts, you may want to prioritize the most tax-inefficient investments like taxable bonds, commodities, real estate investment trusts, and funds with high dividends and turnover for your tax-sheltered retirement account since more of their earnings will otherwise be lost to Uncle Sam.

Consider a small amount in company stock. If company stock is an option, you might want to keep a small amount there to benefit from potentially lower taxes on the gains when you eventually withdraw it from the plan. Just don’t have more than 10-15% there because having too much in any one stock is too risky, no matter how great the company is. This is especially true with employer stock because if something happens to your company, you could be out of a job at the same time as your portfolio is decimated.

Not sure what to do? Don’t let analysis paralysis prevent you from investing at all. You can start with a simple option like a target date or target risk fund for now and adjust later. You don’t want to make the perfect investment plan the enemy of the good.

 

How to Find a Good Tax Preparer

April 26, 2017

As a CPA who used to actually prepare taxes for other people, many are often surprised to learn that I no longer even prepare my own income taxes. The first year my husband and I were married, I spent the better part of a spring Saturday inputting all of our stuff into online software and resolved after that to outsource that task to a real pro going forward. When I was single and had just a W-2, student loan interest and a deposit to my IRA, my taxes were simple and it took me less than an hour to get them filed. But our taxes are much more extensive these days.

My husband is an independent contractor so he’s considered self-employed. We make several trips to Goodwill each year to drop stuff off, which requires an entry for each and every trip, and I have income from my moonlight gig as a fitness instructor and writing the “Weekly Savings Tip” for Feed the Pig. Not to mention that my husband has a brokerage account where he likes to play the market a little bit (with money we can afford to lose), which some years means a dozen or more entries for capital gains and losses. If time is money, then the money we pay our accountant to prepare and file our taxes is money well spent. If you’re in the same boat or find yourself with a new tax complexity that isn’t as easily handled by the tax software available to “common folk,” here are some best practices for finding the best person to help you:

Decide if you want a tax preparer, an EA or a CPA.

What’s the difference? I bet you didn’t know that pretty much anyone can call themselves a tax preparer, although the IRS has started to regulate that by requiring people who accept payment for preparing taxes to have a PTIN (paid preparer tax identification number).

An EA (enrolled agent) is someone who has passed the IRS’s test for tax preparation and is allowed to represent taxpayers in front of the IRS. Most EAs are going to be pretty well-versed in the more common tax issues like what you can deduct, self-employment income and what credits you might qualify for.

A CPA (certified public accountant) is someone who has a degree, studied accounting, and passed the Uniform CPA exam, which is no joke. Just because someone is a CPA doesn’t mean they do taxes, but if a tax person is a CPA, you can bet that they have a decent depth of knowledge. If they are a CPA/PFS (like me!) then they have also passed an additional test demonstrating deep knowledge of personal finance issues like retirement planning, budgeting and investing.

If your situation is pretty simple, but you just don’t want to spend the time on preparation, then you may be satisfied with a tax preparer through one of the large chains like H&R Block or Jackson Hewitt. Just know that since these companies guarantee accuracy and your lowest taxable income, they’re likely to go a little overboard in requiring you to document things that ultimately may not matter, like casualty losses and medical expenses (which must exceed 10% of your adjusted gross income to count).

If you have a little more complexity like self-employment income, income in multiple states or rental properties, then you may want to look at either an EA or a CPA. The biggest difference here is probably going to be cost, although not always.

How to find an EA or CPA to help with your taxes.

EA: National Association of Enrolled Agents

CPA: Look to your state’s society of CPAs by searching “Illinois (or whatever state you live in) CPA society.” That’s the best way to find a database of those in your area since CPAs are registered through their state rather than nationally.

CPA/PFS: www.findacpa-pfs.com

When performing your search, make sure you limit results to specialties that apply to you. If the database has a category for “individuals,” always check that and then also look for other complexities you may have such as multi-state or small business. Your search is likely to turn up multiple results, so you’ll want to filter out anyone who works for a large firm because they’re less likely to actually work with “everyday” people and instead specialize in very wealthy individuals.

I tend to look for people who work in a small office or even on their own. They’re more likely to want to work with everyday people at an affordable rate. After that, it may come down to convenience. Whose office is easiest for you to get to in order to drop information off, sign documents or stop by mid-year for a tax planning session?

This brings me to another criteria. Do you want someone to just prepare and file your taxes or do you want someone to help you save money on taxes going forward? Our accountant is a straight-up tax preparer, at least for us. If you’re looking for more guidance on saving money going forward, then you’ll want to ask a potential preparer if they do tax planning and you may want to look for the CPA/PFS credential.

The sad fact is that there aren’t a lot of CPAs out there that actually want to do income taxes for regular families who just have jobs, kids, a house and a few charitable donations. The easiest way to find one that does is to just pick up the phone and start asking, “Do you accept individual tax clients and what is your minimum fee?” If the minimum is more than $500, I’d say move on.

 

Kelley Long is a resident financial planner with Financial Finesse, the leading provider of unbiased workplace financial wellness programs in the US. For more posts by Kelley or to sign up to have her weekly post delivered to your inbox each Wednesday, please visit the main blog page and sign up today.