Why You Should Treat Your HSA Like an IRA

March 27, 2025

Would you raid your Roth IRA or 401(k) to pay for car repair bills? I suppose if you have no other choice, you might. But ordinarily, we want to use our tax-advantaged retirement accounts only as a last resort because we want that money to grow tax-free or tax-deferred for as long as possible. The HSA is the only account that allows us to make pre-tax contributions and withdraw them tax-free. Why then are we so willing to tap into our HSAs for medical expenses? Continue reading “Why You Should Treat Your HSA Like an IRA”

If You Aren’t Ready to Prepare Your Taxes, File an Extension

April 10, 2024

The deadline for most income tax filers falls on April 15th (or the next business day if April 15th falls on a Saturday, Sunday, or legal holiday). Therefore, you must complete returns postmarked by this date to avoid penalties.

However, if you cannot complete your return by April 15th, you can get an extension to give you more time to do so. Here’s what you need to know to file an extension.

ACTION ITEMS:

1. Obtain an automatic 6-month extension (until October 15), no reason needed.

  • File Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return
  • Estimate your full tax liability for the filing year using the information available to you
  • Enter your tax liability on line 4 of the form
  • File the form by the regular due date of your return

Tip: While Form 4868 gives you more time to file your return, it does NOT extend the time you have to pay taxes. If you do not pay the full amount of tax due on your return by the regular due date, you will also be subject to penalty and interest charges.

2. Understand the penalties associated with filing or paying late.

Paying late: If you fail to pay at least what you end up owing by the April deadline, even if you file for an extension, the late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the regular due date. The IRS will charge you for each month or part of a month the tax is unpaid. The maximum penalty is 25%. The IRS may not charge the late payment penalty if you can show “reasonable cause” for not paying on time.

Filing late: You’ll usually get a late filing penalty if you either failed to submit the form for extension and filed after April 15th or filed after October 15th, no matter what. The penalty is usually 5% of the tax due for each month or part of a month your return is late. Generally, the maximum penalty is 25%. If your return is more than 60 days late, the minimum penalty is $435, or the balance of the tax due on your return, whichever is smaller. You might not owe the penalty if you have a good reason for filing late, so be sure to attach a statement to your return (not to Form 4868) fully explaining the reason.

Here’s more from the IRS on how all this works.

Tackling Your Taxes

January 05, 2023

Let’s face it. Tax time is no fun. It can also be stressful. Perhaps this explains why 33% of Americans typically wait until the last minute to file their annual income taxes. However, tax season doesn’t have to be a dreadful, stressful time. So let’s look at how to make tackling tax time more manageable and (relatively) stress-free.

Stress Less

Financial issues have long been a source of stress for many people, and tax time makes this stress even more pronounced. Not only might you owe some additional money to the government, but there is also a clock ticking and some uncomfortable financial penalties if you are late. Use these tips to help reduce stress and anxiety the next time you have to file your taxes:

  • Break the tax filing job up into smaller tasks so you can complete your filing over time
  • Start early to avoid a stressful time crunch near the tax filing deadline
  • Use tax software to guide you and help keep you on track with helpful email reminders
  • Consider hiring a tax professional to handle your filing while you enjoy a fun, relaxing activity instead

Buy More Time

If the looming tax deadline is just too much to take, you can elect to file later and buy yourself more time. First, however, there are a couple of rules to follow:

Individual tax filers at any income level can request an extension until October 15 to file their federal income taxes. However, an extension to file does not give you an extension to pay. If you owe taxes, the IRS expects you to pay some or all of those taxes when you file. Requesting extra time is easy. You can file for an extension electronically using IRS Free File and following the online instructions. When you file an extension, you can pay taxes owed through the IRS website.

If you have time to file but need time to gather enough cash to pay your tax bill, the IRS also allows qualified taxpayers to pay over time. A setup fee may apply, and you must pay accrued interest and penalties. Still, this option will let you spread your tax payments over several months or even years. Apply online for a payment plan with the IRS to see if you qualify and to request a payment schedule.

Get Ready to Be Ready

Before the next tax season rolls around, there are some steps you can take to help make tax filing easier in the future.

  • Organize your records so you can easily find them. For example, many people scan or take photos of important tax documents as soon as they receive them and file them electronically using Dropbox or similar apps.
  • Run a W-4 withholding estimator to adjust your payroll withholdings and avoid future tax bill surprises at filing time.
  • Once tax season starts again, many accountants or services may be too busy to take on new clients. So, if you hire an accountant or tax preparer, conduct your search and decide well before next January.

Feel More Relaxed and Less Taxed

Although death and taxes are inevitable, according to an old saying, no one says that filing your taxes always has to be stressful and unpleasant. However, with a bit of pre-planning and some thoughtful organization, you can make your tax filing efforts simpler and much less hectic in the future. So take some time to review these tips, select a couple that works for you, and become better prepared to tackle your taxes.

How to Change Your W-4 and Increase Your Take-Home Pay

February 15, 2022

Are you looking for a quick way to increase your savings or find some extra money to pay down debt? If you are like millions of other taxpayers currently overpaying your income taxes to the IRS each year, you still have time make adjustments to how much you are sending Uncle Sam. The average refund was $2,827 in 2020 with over 125 million refunds issued. This is a substantial amount of money to be loaning out to the IRS at zero percent interest. Continue reading “How to Change Your W-4 and Increase Your Take-Home Pay”

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.

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 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.

 

How Getting Divorced Affects Your Taxes

April 12, 2017

One of the biggest questions people often ask as they’re going through a divorce is how it will affect their taxes. It’s a question worth considering, especially if the process of getting divorced spans multiple tax years where you’ll still be technically married but living apart. The IRS only cares what your marital status is on December 31st. For example, when I was going through a divorce, we had filed by year-end but the divorce was not finalized until late January. That meant that by the time we had to file our taxes for the prior year, we were no longer married, but in the eyes of the IRS, we were for that tax year.

If you’re separated from your spouse but haven’t filed for divorce yet, you may qualify to file as “head of household” if you and your spouse lived apart the last six months of the year and you paid more than half the cost of keeping up a home for your child who lives with you more than six months. This generally means you’ll pay less taxes than if you were to use “married filing separately.” This article goes more into the details of filing jointly versus filing separately. Just know that if you file jointly and then your estranged spouse bails on the tax bill, you’re fully on the hook. In my case, we filed jointly because we both ended up paying less taxes and I personally wasn’t concerned that my ex was committing tax fraud.

The decision could also depend on the rules of your state and how your expenses were paid. If you live in a community property state (AZ, CA, ID, LA, NV, NM, TX, MI or AK) and decide to file separately, you generally would each claim one-half of your expenses on your return. If you do not live in a community property state then each spouse only takes a deduction for expenses he or she actually paid. In other words, if you are making the mortgage payment without help from your spouse, you’ll want to figure out which status realizes the full value of the interest you paid.

Once your divorce is finalized, you’ll want to start from scratch in making sure you’re having enough withheld from your paycheck. Don’t have too much withheld either though. You can use the IRS Withholding Calculator to help figure out what changes you may need to make.

Finally, make sure you understand how maintenance (often called alimony) and child support work for tax purposes. Basically, you can deduct alimony paid but not child support. Likewise, if you’re receiving alimony, you have to claim it as income but not if you’re receiving child support. Who gets to claim the kids as dependents on their tax return is something that should be worked out in your divorce agreement and if you’re receiving a significant amount of alimony, you may need to file estimated taxes to avoid any under-payment penalty. For help with that, it’s best to consult a tax professional for customized guidance.

 

Quiz: Do You Get the Most Out of Your Benefits?

April 03, 2017

Today is Employee Benefits Day. How will you celebrate? Don’t worry. Celebrating Employee Benefits Day does not require you to make a special trip to the party store or spend a single dollar.

In fact, the best way to celebrate it is to recognize and appreciate the value of your employee benefits and to maximize them for your personal financial situation. Don’t know where to start? Take this quick quiz to test your benefits knowledge.

1) You have decided it’s time to prepare a will. Where might you most likely find links to basic estate planning tools?

a. The public library

b. Your employee assistance program (EAP)

c. Your retirement plan provider

d. The HR department

2) Next year you plan to get laser eye surgery to correct your vision. Where is the best place to save extra money pre-tax to pay for it?

a. A health savings account (HSA)

b. An employee stock purchase plan (ESPP)

c. A flexible spending account  (FSA)

d. A deferred compensation plan

3) Where you can save and invest for retirement so that the income after age 59 ½ will be tax-free?

a. Non-qualified stock options (NSOs)

b. Nowhere – there’s no such thing as tax-free retirement income

c. A cafeteria plan

d. A Roth 401(k)

4) During this year’s open enrollment, you choose a high deductible health plan (HDHP) because of the lower premiums. You have the option to save money pre-tax in an HSA to cover the deductible and a portion of out-of-pocket expenses. You should:

a. Skip the HSA. The point of choosing your health insurance was to save money.

b. Contribute no more than $1,000.

c. Contribute the maximum ($3,400 for an individual and $6,750 for a family in 2017). If you don’t need to use the money, you can roll it forward to future years.

d. Contribute no more than $1,500.

5) Taylor takes the train to work every day, Max drives and parks in the public garage and Jenna rides her bike. Who can use a pre-tax commuter benefits account offered by their employer?

a. Only Taylor. The point of pre-tax commuter benefits is to encourage employees to take public transportation.

b. Taylor and Max can contribute up to $255 per month in 2017, but not Jenna. There are no employer-sponsored bicycle benefits.

c. Everyone but contributions are from the employer only.

d. Taylor and Max can contribute up to $255 per month in 2017. Jenna can’t contribute pre-tax, but she can participate in her employer’s bicycle reimbursement program, for up to $20 per month in eligible expenses.

6) According to our recent financial wellness research, the single most important tool an employer can offer to boost employee retirement preparedness is:

a. A “bank at work” program

b. A retirement calculator

c. Incentive stock options (ISOs)

d. A target date fund

7) Which benefit replaces your income if you have an injury or illness which is not work-related?

a. Disability insurance

b. Long term care insurance

c. Workers compensation

d. Unemployment insurance

8) According to the 2016 Milliman Medical Index, what is the typical total cost for family coverage in an average employer-sponsored group health plan?

a. $25,826 for a preferred provider organization (PPO) plan

b. $6,742 for a health maintenance organization

c. $43,350 for a high deductible health plan (HDHP)

d. $15,003 for preferred provider organization (PPO)

9) Your employer will reimburse you up to $3,000 for an undergraduate course, a graduate course or a professional certification. How will the reimbursement be taxed?

a. Reimbursement for a professional certification will be taxed  but not reimbursement for college/university courses

b. Reimbursement for college/university courses will be taxed  but not reimbursement for professional certification

c. Tuition reimbursements are generally included in the employee’s taxable income

d. Tuition reimbursements of less than $5,250 are generally not included in the employee’s taxable income

10) What type of pre-tax benefit can you use to pay for after-school care expenses for your children?

a. Health savings account

b. None – after school care is not eligible for reimbursement

c. Education savings account

d. Dependent care flexible spending account

See the answers in italics below. How did you do? If you scored a 9 or higher, congratulations! Chances are that you see your employee benefits as an integral part of your overall compensation.

If you scored an 8 or lower, you may be leaving money on the table by not taking full advantage of everything your employer offers. If you have access to financial coaching via your workplace financial wellness program, consider setting up a time to talk to a planner about how you can fully maximize the value of your employee benefits. In addition, check out the blog posts for the rest of this week, which will focus on various aspects of your benefits.

Answers:  1 – b, 2 – c, 3 – d, 4 – c, 5 – d , 6 – b, 7 – a, 8 – a, 9 – d, 10 – d

 

Do you have a question you’d like answered on the blog? Please email me at [email protected]. You can follow me on the blog by signing up here, and on Twitter @cynthiameyer_FF.

 

5 Common Myths About Gifts

March 30, 2017

Whether I’m facilitating workshops and webcasts or talking to people individually, one of the areas that I’ve found the most confusion around is a topic that we all (hopefully) have some experience in and that’s gifts. Some of the misconceptions are harmless, while others can result in significant financial losses or missed opportunities. Here are some of the most common myths about gifts I hear:

To be a gift, you have to completely give something away. That’s how we generally think about a gift, but it’s not how the law looks at it. For example, if you add someone’s name to an account or a property deed, that’s considered a gift and subject to everything else in this blog post even though you yourself retain control over that asset. Assigning someone certain rights in a trust can be considered a gift as well.

Gifts are taxable to the recipient. Intuitively, this makes some sense. However, the income tax doesn’t consider gifts taxable income unless it’s a “gift” from your employer that could be considered part of your compensation. Also, the gift tax is actually a tax on the giver, which brings us to…

Being subject to the gift tax means you owe money to the IRS. First of all, let’s define “subject to the gift tax.” Gifts to charities and gifts in the form of payments directly to medical or educational institutions on behalf of someone else are not subject to the gift tax. The same is true for gifts of up to $14,000 per person per year. That means if you and your spouse have 5 kids, you can each give each of them $14,000 for a total of  $140,000 in 2017 without filing a gift tax return.

What if you give more than that? The good news is that you still likely won’t owe the IRS anything. That’s because any taxable gift reduces the total amount you can give tax-free over your life and death, which is currently $5.49 million. If Warren Buffett’s only taxable gift were to give $1,000,000 to you (above the $14,000 exemption), his $5.49 million exemption would be reduced to $4.49 million. Only after he’s given away another $5.49 million in taxable gifts would he have to pay the IRS.

A gift can save money from being spent down to qualify for Medicaid coverage of long term care. There is some truth to this one because giving away assets can indeed reduce the amount you have to spend down before being eligible for Medicaid. However, any gifts made within the last 5 years (formerly 3 years) still have to be spent down so you have to give the assets at least 5 years in advance. One option is to buy a 5 year long term care insurance policy so you can give assets away if you need care and then qualify for Medicaid after the insurance policy (and the 5 year time period) expires.

Giving assets away is more tax-advantageous than passing them on. If you give an asset away and the recipient sells it, they have to pay a capital gains tax on all the gain since you purchased it. However, if they inherit it, they only have to pay taxes on any gain from when they receive it. All the gain during your lifetime goes untaxed. That’s a pretty good reason/excuse to let your heirs inherit an asset rather than giving it to them now.

Hopefully, this will help you give and receive gifts with more confidence. For more complex questions, you might want to consult with a qualified tax professional. If you’d like to practice your new gifting skills but aren’t sure who to give assets to, feel free to send them my way…

 

Should You Follow Senator Elizabeth Warren’s Investment Advice?

March 23, 2017

Last week, I wrote about some of her money management tips as described in an article titled “You, Too, Can Invest Like Elizabeth Warren!” Overall, I found them a bit too simplistic. Now let’s take a look at the investing side:

1. Visualize. Specifically, “take a moment to savor your dream.” It’s hard to argue with this. If visualizing your retirement or other goals helps motivate you to save and invest, go for it. Just remember that the dream probably won’t become reality unless you wake up and take action, which brings us to…

2. Create a retirement fund. Warren suggests contributing 10% of your income to a 401(k) or IRA. This isn’t a bad idea on its face but lacks detail. Why just 10%? The consensus seems to be that the average American household needs to save about 15% of their income for retirement so 10% is probably too low.

Even better, you should run a retirement calculator to get a more personalized number. That’s because the percentage you should be saving depends on your age, your current retirement savings, how aggressively you invest, when you want to retire, how much retirement income you need, and how much you can expect to get from Social Security and other income sources. In other words, you may need to save a lot more or a lot less, depending on your particular goals and situation.

It also matters whether you choose a 401(k) or an IRA. While they can have similar tax benefits, you’ll want to contribute at least enough to your 401(k) to get your employer’s full match. After that, your choice depends on a variety of factors like the investment options in each account and whether you prefer the convenience and simplicity of having everything in your 401(k) or the freedom and flexibility of an IRA. Don’t forget that you can also do both.

3. Invest prudently in the stock market. Warren also recommends investing another 5% (or 10% if you’ve paid off your mortgage) in an indexed mutual fund. Her own non-retirement account portfolio is largely invested in fixed and variable annuities with some money in stock, real estate, and bond funds.

Again, why 5%? The amount you save should depend on how much you’re willing to put away to reach your goals. If your goal is retirement, you’ll probably want to max out your 401(k) and IRA before investing in a taxable account. If your goal is education funding, consider tax-advantaged education accounts like a Coverdell account or 529 plan.

The index fund recommendation makes sense since compared to actively managed funds, they generally have lower costs, outperform over the long run, and generate less in taxes since they don’t trade as much. However, Warren seems to be using deferred annuities instead to shield her personal money from taxes. There are a couple of downsides to this strategy. One is that variable annuities tend to have high fees. Another is that the earnings are withdrawn first and are taxed at ordinary income tax rates.

In addition, her heirs will also have to pay taxes on the earnings they inherit after she passes away. In contrast, long term (over one year) capital gains on stocks and funds are taxed at lower tax rates and won’t be taxed at all when passed on to heirs. Her real estate and bond funds also generate a lot of taxes.

A better strategy for Warren would be to prioritize the bonds and real estate investments in her 401(k) and IRA and use the taxable accounts for the remaining stock funds. This is because stocks are more tax-efficient and their higher volatility would allow her to use losses to offset other taxes. By sticking to index funds, she could save even more in taxes and other costs.

4. Oh, and avoid investing in these: gold, prepaid funerals, and collectibles. I’m not sure I’d call prepaid funerals an investment at all, but collectibles can be a fun way for someone to speculate as long as they’re not counting on them for anything. A small amount in gold is used by many investors as a hedge against rising inflation and other types of instability and can help diversify a portfolio since it typically moves differently than stocks and bonds.

As with her money management advice, you could do a lot worse than funding a retirement account, investing in an index fund, and avoiding speculative investments. But Warren’s investment advice is a bit too oversimplified as well. Instead, find out what retirement and investing strategy makes the most sense for your particular needs or work with an unbiased financial planner who can help you. After all, we don’t all have a senator’s pension to bail us out of any mistakes.

 

What Qualifies as Deductible Mortgage Interest? (The Answer Might Surprise You)

March 22, 2017

When it comes to being able to deduct the interest you pay on a mortgage, most people correctly assume that this applies to a home that you use as your primary residence. (There are some wonky rules around limits on the deductibility of certain types of mortgage interest from home equity loans or loans in excess of $1 million, which are best explained by Figure A on this page.) But many are surprised to learn that they may also be able to deduct interest paid on a second home and are even more surprised when they learn what the IRS considers a “qualified home.” Generally speaking, in order to be considered a home, a property must have sleeping, cooking and toilet facilities.

This means a boat, camper, or even a tricked out old ambulance could qualify as long as it has a bed, a stove and a toilet on board, and as long as any loan you took out to purchase the property is secured by the actual property. In other words, if you used a credit card to buy that fancy yacht, you can’t deduct the interest you pay on your card. But if there is a loan document that you signed that basically collateralizes the boat/home (aka if you don’t pay the loan back, the lender can repossess the property and sell it to satisfy the debt), it’s a mortgage and the interest is technically tax deductible. In most cases, the lender will send you a Form 1098 showing how much interest you paid. That’s one clue that you have an actual mortgage.

Another surprising aspect of the rule is that you don’t have to live there full time. In fact, you don’t even have to use it at all during the year as long as it’s not rented out. Note that if your second home is rented out, you may still qualify to deduct the interest. You just have to use it more than 14 days or more than 10% of the number of days it is rented, whichever is longer. If you don’t meet that qualification, you may still realize a tax benefit from interest paid, but it will be applied against the rental income you generate.

You shouldn’t go out and buy a second home, boat or RV you can’t afford just for the tax deduction, but it is worth knowing, especially if you’re looking into buying a second home for your future retirement or just a place to vacation throughout the years. If you’re thinking of taking out a loan to buy a boat or RV, make sure you shop around to get the best rates. Dealers often offer financing deals, but it’s worth it to double check that your bank or credit union can’t offer you a better deal. You can use this mortgage loan comparison tool to compare up to 3 loans and see which is the best financial deal.

 

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.

 

3 Strategies To Help With Your Tax Fears

March 15, 2017

I’m going to go out on a limb and say that tax time is pretty much everyone’s least favorite time of year. Even for me, a CPA and former tax preparer – I dread the process of digging up all our information and organizing it in order to complete our taxes and I especially dread the verdict of how much we’ll owe. It’s no surprise that nearly 1/3rd of all tax returns were filed in the last two weeks of the 2015 tax deadline. Whether it’s due to fear, procrastination or waiting on that last bit of information, tax time is stressful. My colleague Teig Stanley offers the top 3 fears that we help people address and a strategy to overcome each of them:

Fear #1:  It’s Confusing/Overwhelming

Your strategy: Overcome this barrier by writing a short, step-by-step plan to file. Set a date and time well in advance of the deadline (April 18th this year) when you will start your tax filing and decide if you are going to use a tax preparer or do your taxes yourself.

Then, organize your documents. Use a tax preparation checklist or ask your tax preparer for one and start making an inventory of the documents you’ve saved. If you’re like most, almost all of your documents are in paper form, so make these files for them:

  • Income
  • Charitable contributions
  • Taxes paid
  • Receipts
  • Miscellaneous

Fear #2:  I Might Not Get a Refund

Your strategy: If you’re afraid you’ll owe, the sooner you know the better. Even if you file your taxes in February, that balance isn’t due until April 18th so go ahead and file as early as possible and use the extra time to make a plan to pay what you owe. If it’s more than you can afford, you can contact the IRS to arrange a payment plan or borrow from another source.  Just be sure to compare interest rates to get the lowest possible cost.

If you’ll be receiving a refund – great! Get those tax returns in quickly to receive the money sooner. Asking for direct deposit makes it even faster. If that refund is large, consider filing a new W-4 form with your payroll department to increase your exemptions and take more money home in your paycheck throughout the year.

Fear #3:  What If I Get Audited

Your strategy: Statistically, less than 1% of tax returns for those reporting under $200,000 in income (and more than $0) are chosen for an audit by the IRS each year. If you are concerned about an audit, work with a professional tax preparer who will agree in writing to provide audit support if one is requested.

The bottom line is that while tax time is no fun for anyone, it’s not something you should be fearing. If you haven’t already, get down to it and get it done. If you’re going it alone in preparing your own taxes and need help, contact your tax software provider or search for free tax prep help through local community organizations and national non-profits. You may even qualify for free preparation if you have a moderate to low income.

 

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.

 

How to Maximize the Benefits of Incentive Stock Options

March 02, 2017

If your employer is providing you incentive stock options (or ISOs) as part of your compensation, they’re giving you a stake in the success of the company (or at least the stock price). ISOs can be complicated though. To make sure you’re taking full advantage of the opportunity they offer, here are some questions to ask yourself:

Are you subject to AMT (the alternative minimum tax)? When you are granted the options and when they vest, there’s generally no tax (assuming they’re priced at the current fair market value of your employer’s stock). When you exercise the option, there’s also generally no tax (unlike with nonqualified stock options, which are subject to income and employment taxes when exercised).

However, there’s an exception that your gain when the option is exercised is considered income for purposes of calculating the AMT. For this reason, you may want to wait to exercise the option until a year when you’re not subject to the AMT. If you’re not sure when that might be, consult a tax professional for guidance.

How long has it been since you’ve been granted the option and exercised it? In order to qualify to pay a lower capital gains rate on all the gain, you need to wait at least 2 years from when the option was granted and one year since you exercised the option before selling the stock. If you sell the stock before then, you’ll have to pay ordinary income tax on the difference between the value of the stock when you bought it and the fair market value of the stock at that time.

It pays to wait, but not too long. Options (or the employer stock after you exercise the option) are risky because your money is tied up in just one stock. That’s why you may want to exercise your options and sell the stock to diversify the money as soon as you’re eligible to do so at the lower capital gains rate.

How much of your net worth do the options represent? If it’s more than 10-15% and you need to hold on to them for tax purposes, you may want to talk to a financial advisor about what options (no pun intended) you have to hedge against the risk of a falling stock price. Otherwise, you may see a significant decline in your net worth should something happen to the stock price.

Incentive stock options can be a great opportunity to participate in the success of your company. However, there are many pitfalls to avoid. Just make sure you understand all the ramifications before making any decisions and consult with qualified financial or tax professionals as needed.

 

 

What Are Miscellaneous Itemized Deductions and Are They Worth Tracking?

March 01, 2017

Editor’s note: Please note that all miscellaneous deductions were eliminated with the passing of the Tax Cuts and Jobs Act of 2018, but would still apply for tax year 2017 and prior.

Whenever I’m asked for “little known” tax tips, I can’t help but be a little annoyed. Part of the reason they are little known is because they apply to so few people, at least when it comes to deductions that fall under the “miscellaneous itemized deductions” umbrella. Things like tax preparation fees, unreimbursed business expenses and the home office deduction for employed workers – these are all deductions that I personally have in my life and yet I see no tax benefit because the only way they are actually deductible is if they exceed 2% of my adjusted gross income. In other words, a married couple who makes a combined $100,000 would only be able to deduct miscellaneous items that exceed $2,000, which is 2% of their income. That’s a lot of unreimbursed expenses.

However, I still track mine just in case. I probably won’t have a deduction in a normal year, but should something big come up or we have a year of unexpectedly low income, I want to be able to take whatever deductions are available. Here are the common deductions that may be worth tracking, even if you don’t get to write them off, as well as some expenses that people think are deductible but aren’t:

Common deductions worth tracking

Unreimbursed business expenses. Anything you pay out of your own pocket that applies directly to your job but you can’t put on your work expense report falls in this category. For example, when I travel for work, we have daily meal allowances. They’re reasonable, but sometimes I like to treat myself to a nicer dinner than the guidelines allow. I keep track of the amount I spend over the per diem limit as an unreimbursed expense.

Another example is a professional organization I belong to here in Chicago. My membership doesn’t fit my company’s expense guidelines, but it’s still work-related. I wouldn’t be a member of this group if I didn’t have my job. Other examples would be if your employer doesn’t reimburse at the full IRS-allowable mileage rate or if you subscribe to any magazines for your field. The full IRS list is here.

Tax preparation fees. Even if you do your own taxes, chances are you have to pay for the software or at least filing fees. Make a note of this expense in your tax files just in case you have other miscellaneous deductions that you can add on for a deduction.

Appraisal fees. If you made a gift to a charity that required an appraisal or if you had a casualty loss that required you to get an appraisal for insurance purposes, those are deductible in this category.

Any of these expenses. Many of the expenses that qualify may be one-time things that you didn’t know you could deduct, like repayments of Social Security benefits. It’s worth reviewing the list each year to see if you paid any of these things, in case they push you over the limit.

What’s not considered a miscellaneous deduction

Funeral expenses. If you prepaid your funeral expenses or purchased your burial lot ahead of time, those are not tax deductions, contrary to popular belief. However, once you’re gone, if you have a taxable estate, those expenses may be applicable there (something worth noting for executors of estates.)

Commissions paid to a broker. Fees for investment advice are deductible, leading many to believe that they can also deduct commissions. Instead, commissions become part of the cost basis of the investment purchased, so you’ll realize the tax benefit when the commission reduces the amount of your capital gain when the investment is sold.

Lost or misplaced cash or property. Losing something is not the same as someone stealing it or having it ruined due to a fire, flood or other event, which would make it a casualty loss (reported on Form 4684.) But just leaving your phone somewhere and not having it returned to you or dropping your wallet on the street is not deductible. There are no tax benefits for being careless…

Any of these expenses. Claiming a deduction for any of these items on your tax return could result in a tax levy from the IRS or sometimes even a full audit. While it seems like you should be able to write some of these things off, the bad news is that you can’t. C’est la vie.

I keep a file for receipts that would apply should I end up in a tax year where the total of these expenses might exceed 2% of my AGI. As I prepare to file taxes at the end of the year, I just do a quick review of the expenses that qualify to make sure I’m not forgetting anything, then recycle those receipts if they don’t add up to enough. So what do you think? Are these expenses worth tracking to you?

 

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.

 

 

Can You Deduct Your Student Loan Interest?

February 22, 2017

Don’t you just hate making student loan payments? Besides the fact that your student loans (hopefully) enabled you to earn a degree that allows you to command a higher income than you would without it, at least there is a small tax benefit to those loans for those who qualify. Here’s the skinny on what you need to know to maximize your deduction:

There are income limits. If you’re single and your AGI exceeds $80,000 or you’re married and your combined AGI is over $160,000, you can’t take any deduction at all. There are also phase-outs, which means you can still take some of the deduction but not all of it. Those limits start at $65k for single and $130k for married people. If you use tax software or a tax professional to prepare your taxes, the amount will be figured for you.

You can only deduct the first $2,500 paid in interest each year. Probably the biggest mistake I’ve seen here is when people think they can deduct payments. It’s actually only the interest you can deduct, so even if you’ve made well in excess of $2,500 in actual payments, you may not have a $2,500 deduction.

Your loan provider will tell you how much interest you paid. You don’t have to do the math to figure out what portion of your payments were for interest and which went toward the principal. Just look for Form 1098-E from each of your lenders. If you’re signed up for electronic delivery of statements, then you’ll probably have to log in to find your form. Look for a link to “Tax Documents” if your lender doesn’t make it obvious on their home page.

You can deduct interest from multiple loans, but they have to be qualified. If you have multiple loan accounts or lenders, you can add up all those Form 1098-E amounts for your total deduction. But the loan has to be considered a qualified student loan. If you refinanced by taking out a home equity  or 401(k) loan or even just borrowed from a family member to lower your rate, you can’t deduct that interest.

If you claim student loan interest on your tax form and the IRS doesn’t receive a corresponding 1098-E from a lender, you can count on getting a letter asking you to prove the interest was paid on a qualified student loan. If you’re not sure if your loan is considered qualified or not, ask them for your Form 1098-E. If they are unable to provide one, it’s not qualified.

I know that paying student loans is no fun. Hopefully, this small tax benefit will offer a little silver lining though. (In addition, reflect on what your finances would be like if you hadn’t earned that degree.)

 

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.

 

How To Deduct Your Home Office On Your Tax Return

February 15, 2017

Updated in 2018 for the Tax Cuts and Jobs Act of 2017

If you have any self-employment income AND you have a home office that serves as a primary place you do “office work,” then the home office deduction is most likely available to you provided you meet the IRS qualifications. In order to qualify as a home office for tax purposes, your space must meet two requirements:

  1. Regular and exclusive use: The space you are claiming as your home office must only be used for that so if you work at your kitchen table, that wouldn’t qualify. I sectioned off a corner of our family room for my office. That qualifies because no one else uses that specific space for anything but my work.
  2. Principal place of business: You have to show that your home is your primary place of business, although there are some situations where you may still qualify even if you have a separate place where you also do business. Check the IRS regulations to see if you qualify.

If you’ve determined that you indeed do have a home office for tax purposes, then it’s important to understand how to calculate what you can deduct. There are two methods for calculating your deduction, and you can use a different method from year to year.

The Actual Expense Method

This is best for taxpayers who have a large amount of space and keep meticulous records of expenses. (The home office deduction is reputed to be a red flag for audit, although the IRS does not corroborate this.) The actual expense method is pretty self-explanatory. You deduct the actual amount of the expenses related to your home office.

Home office expenses

Figuring the percentage

To determine the percentage of your home that qualifies for business use, you need to measure the space compared to the total size of your home. The IRS offers these two examples:

Example 1

  • Your office is 240 square feet (12 feet x 20 feet).
  • Your home is 1,200 square feet.
  • Your office would be 20% (240/1,200), so that is also your business percentage.

Example 2

  • You use one entire room in your home for business.
  • Your home has 10 rooms, all equal in size.
  • Your office would be 10% (1/10), so that is also your business percentage.

The Safe Harbor Method

This is best for people whose office space is 300 square feet or less and don’t want to hassle with tracking records. Here’s how the safe harbor method works:

You calculate your deduction by multiplying the square footage of your home office (but not to exceed 300 square feet) by $5. That’s it! In other words, the maximum amount you could claim each year would be $1,500.

A few final things to consider

  • Your home office deduction cannot exceed your gross business income for the year, but if you use the actual expense method, you can carry over any amounts that you are unable to deduct to future years where you also use the actual expense method.
  • IRS Publication 587 has more information, including several easy-to-use worksheets that can help you figure your deduction.

 

This post is not meant to replace the advice of a paid tax professional who can give you specific guidance on your own unique situation. Please consult your CPA or tax preparer if you are not certain whether you qualify to take this deduction.

 

 

How to Avoid Taxes on a Home Sale

January 20, 2017

Someone recently asked me if they were going to have to pay taxes on the sale of their home. They were downsizing out of a big house and were going to move into the “in-law quarters” of one of their children’s homes. This person was absolutely 100% convinced that he was going to have to pay taxes on the gains from the sale of his house since he wasn’t “rolling the gains” into a bigger house.

When I told him what the tax code says about capitals gains tax, he told me I was wrong. So with him in the office, I called a friend (on speaker) who is a CPA and asked what the tax implications were for selling a home. The CPA said exactly what I said, without prompting, and the soon-to-be-seller was still dubious.

So what is the real story on how the gains from selling a home are treated? According to IRS Topic Guide 701, you can exclude up to $250,000 (single) or $500,000 (married) of gains from the sale of your house IF it has been your primary residence for 2 out of the last 5 years. That’s it. It’s that simple.

There is no rule today about what you have to do with the proceeds. There were things like that in the tax code in the past, but the tax code is an ever-evolving entity. The biggest test is the 2 out of 5 years, which is very easy for most home sellers. IF the house has been your primary residence for the last 2 years, you’ve got a $250,000 or $500,000 tax-free gain.

If you’re married and your home has appreciated by $600,000, CONGRATULATIONS!!! The tax on the sale of your home will be $600,000 (gain) – $500,000 (exclusion) = $100,000 (taxable gain) * 15% (capital gains rate) for a $15,000 tax upon sale. You can buy a house, watch it go up in value by $600,000 and only pay $15,000 in taxes!  The tough part is finding a house that goes up in value by $600,000!

Here’s how you could possibly use this piece of the tax code creatively and to your advantage in a time when housing prices are rising. It’s a hypothetical situation and I can’t imagine anyone really doing this, but it illustrates the tax code’s interesting nature. You’d have to live as a bit of a minimalist to make this work. Moving a bunch of “stuff” can be time consuming and expensive, so the less you have to transport from one place to the next, the easier this is.  This only works if your home value increases regularly……

Step 1 – Buy a house.

Step 2 – Live in it for 2 years.

Step 3 – Buy a second house, move into it and rent out house #1.

Step 4 – Live in house #2 for 2 years and buy house #3, renting out houses #1 & #2.

Step 5 – Sell house #1 by the end of year 5 and the gains are tax-free since it was your home in years 1 and 2.  You could sell house #2 as well and pocket the tax-free gains.

With this example, you can see that if you’re willing to move A LOT and housing prices rise quickly, you could potentially never pay taxes on the gain from the sale of a house. In the real world, though, the IRS code allows most of us to sell a home with zero or a very small capital gains tax in comparison to our overall gain. Fortunately, for the dubious person in the meeting recently, he used his own laptop, went to www.irs.gov and was able to find that my answer was indeed factually correct. By the time the meeting ended, he was a surprised and happy home seller.

 

 

What a Financial Planner Told His Daughter After Her First Job

December 30, 2016

This week, I’m sharing a blog post from my colleague, Steve White:

My daughter is 22 and recently graduated college with a degree in human biology cum laude no less and she has a job working with a medical practice. (I’m a dad so I have to brag a little.) She has done several things that have reminded me why 1) being able to support yourself is important and 2) your kids do listen to what you say.

She called me when she got her first paycheck and said “Dad, I got a paycheck with a comma in it. Now you have to listen to me.” My father used to jokingly tell me that until I got a job with a paycheck, he didn’t have to listen to me, and yes, I jokingly told her the same (full disclosure – my dad did listen to me and I did and still do listen to my daughter). That paycheck with a comma in it meant that she now got to experience adult things that I’ve taken for granted like employee benefits. Her questions (and my answers) that we covered when she accepted her job included:

What health insurance do I sign up for? (the one that fits your situation) Should I check and see which one covers my prescriptions? (yes) If I take the high deductible plan, should I put money into the HSA? (yes) If I take the other plan, should I put money into the FSA? (yes)

How much life insurance should I get? (enough to cover your debt – see this life insurance needs worksheet) Who do I name as beneficiary? (whomever you want to – not me, name your mom) Wow, I don’t like thinking about if I die (Yeah, I know.)

Who is your beneficiary? (Mom) You need to name me as your medical power of attorney [see human biology major – cum laude] (I’ll think about it – aka no, let’s get back to your benefits.)

How do I fill out a W4? (What do the instructions say?) Will I have to file my own taxes? (yes) Can you help? (yes)

Thanks Daddy! (You’re welcome. What other benefit questions do you have?)

Do I need disability insurance? (yes) Why? (You’re statistically more likely to be disabled than die young – 24% chance of being disabled for 3 months or longer.)

Before she got her 3rd paycheck, she called me about budgeting, here’s how that one went:

Dad, I think I’m going to run out of money before I get paid again. (Oh, why is that?) I’ve got $23.42 in my bank account. (Yeah, I’d say that’s a possibility.)

I hate budgeting. (We all do sweetie.) Can you help me set up a budget? (Sure, I do it every day. That is one of the things I’m paid to do.)

(You remember when I decided to start watching what I ate?) Yeah, I remember you arguing with me about how many calories are in a fried pork chop. (Okay, besides that, when I thought about watching what I ate as a diet, I thought about in a negative light. I decided to think about it as an eating plan. That feels positive to me.)

Oh, I get it. I need to think about budgeting as a spending plan. (Yeah, just like you plan what you are going to eat, plan what you are going to spend.) Can you send me that spreadsheet thing you sent me before? (sure: Easy Spending Plan)

When she got her 3rd paycheck, our conversation went like this:

Dad, this morning at work, I was so excited that I got paid that I gave everyone a hug. (That’s nice.) I don’t think they expected that. (They have gotten a lot more paychecks. They have learned to restrain their excitement.)

I’m working on my spending plan and I’ve got a question. How much should I spend on lattes? (less than you do now) But I really like my soy double pump vanilla latte (I know), so what do I do? (Spend less on something else.)

But I need gas and food! (I know.) Dad – sometimes being an adult stinks. (I know.)

(Love ya sweetie.) Love you too Dad.