Enroll by filling out the form below. It’ll be free. And fun. (If you’ve already filled the form out, you’re enrolled and will be notified on Tuesday of course availability!)

• Begins Tuesday, March 2nd.
• All on demand. No scheduling necessary.

I’ve been combing through the survey responses given by attendees to the upcoming tax course (enrollment ends this Friday at midnight — the course is entirely free). The course begins in exactly one week and it’s going to be fantastic! Educational, to say the least.

On the survey, one of the questions I asked was whether the respondent uses a tax preparer (human, not software) and if they don’t, their reasoning. I want to discuss the main reasons why a human preparer isn’t used. Some of the responses scared me a bit. Others made sense. :)

(Before I dive into this, let me be clear that I am not directly trying to make the case that everyone should use a tax preparer — hardly. I am trying to make the case that everyone needs to be much better informed about the black box we call the tax code.)

I’m worried about the cost. It’s expensive. Benefit doesn’t outweigh the cost.

The first two sentences there don’t make sense. To be worried about the cost isn’t a real reason. I’d have to ask why they’re worrying. My guess is that it’s because they feel it’s too expensive, or that it’s not worth the potential savings.

To “it’s expensive”–that needs to be qualified. Do we say something is expensive based on some fixed number in our head? Is a car expensive, but a tricycle inexpensive? Or do you need to evaluate “expensive” as it compares to the value of what you’re getting? That’s why I like that third related reason, where the respondent is weighing the cost and benefit of a tax preparer and making a decision.

Be careful about this. My hope is that the course will help people see that they would be benefited by help, or that they clearly wouldn’t be. But either way we’ll be making an informed decision and that’s what matters.

My situation is simple (straightforward, easy, etc.)

Simple because you understand it and have managed to file your taxes without ever being audited? How do you know you aren’t leaving money on the table? How do you define simple? Is your understanding of The Code great enough that you’re confident in saying you have a simple situation?

This is a tough one. How do you know what you don’t know? Scary! I imagine there’s someone out there operating a sole-proprietorship where they’re leaving thousands of dollars in tax savings on the table because they’ve had a “simple” situation for 10 years and nothing’s changed.

Again, my hope is that the course will help you understand “simple” a bit better, and motivate you to educate yourself more re: The Code.

I don’t trust my finances to someone else. I like the control.

It may just be a control thing — that’s fine. But the same person that doesn’t trust their finances to a tax preparer will trust their finances to a software package? I see a huge disconnect here. If you have privacy concerns, that’s a different story, but just know that the software was written by “preparers” in a sense.

What’s scarier about this isn’t the software side of the equation. It’s the you side of the equation. I would imagine that the odds of you making an error are much higher! Do you know the implication to your answering question 13c that way?

I tried an advisor and felt like they were simply doing data entry on my behalf.

People that have had this experience definitely need to find a new advisor! I had that same experience for two years and you’re right — it’s awful. You’re paying them to do nothing more than you could do yourself–except you’d be faster at it because you’d know all the answers to the questions.

I’d encourage you to hunt for a new advisor if you feel that the only thing they’re doing is simply plugging and chugging numbers. Your advisor should be informing you frequently about possible tax strategies you can employ that will save you money. If your advisor is in touch multiple times outside of the tax season then you’ve probably found yourself a gem.

I shouldn’t need an advisor. The tax code should be rewritten.

The tax code is absolutely crazy in its complexity. It truly is mind-boggling. But this answer just doesn’t cut it! This upcoming tax course will have nothing to do with policies or politics and everything to do with the situation we’re currently in, and what we can do to keep more of our hard-earned dollars in our own pockets.

You may hold a very strong belief that the tax code needs a rewrite, but that doesn’t change the fact that today, you’re being taxed under that code. You should be aware enough to minimize your taxes, and then continue your fight for tax reform as needed.

I don’t have anyone to prepare my taxes that I trust.

This one’s huge. At YNAB we’ve had the hardest time finding good developers that 1) share our vision and 2) can code to our standard. It’s a time-consuming process to find the “right fit” — trust your gut on this one. If you have any doubts about a preparer that you’re interviewing, walk out! (And yes, you interview them).

These are just a few of the reasons people aren’t looking to a preparer. Some of them are quite valid. Participating in next week’s tax course will certainly arm you with the knowledge you’ll need to knowingly decide if the benefit of a tax preparer will be worth the cost.

To those reading this that haven’t yet signed up for the free tax course, you can do that below. The course starts next Tuesday and will run through the week. It’ll be… easily digestable to fit any schedule :) Signup closes Friday at midnight.

Get ready to gain new tax insights beginning next Tuesday :)

Update 2/24/10: You can see my comment below, but based on some feedback I received, my apologies if I came across as condescending or belittling in this post. That was NOT my intention.

Here it is in a nutshell. I just want you to make an informed decision about how you handle your taxes. Remember, it’s likely your single largest expense (if you’re on a wage, it’s 7.65% from every paycheck, forever), so it deserves some attention! If you gather information, educate yourself, and feel comfortable using tax preparation software (personal preference, knowledge of your own situation, etc.) that that is the correct choice. On the flip side: if you gather information and, through learning more, decide you should be going about it a different way, that’s the correct choice.

There are certainly cases where you don’t need a tax preparer. After reading this over again, it sounds like I’m saying that a preparer is the only way to go. Not hardly! I just don’t want people blindly going one direction without having their eyes wide open. Hopefully that makes more sense.

About the Course
This will be on demand. I’ll be presenting a video each day for five days beginning next Tuesday. It will be mainly video and just a little bit of text. My goal is to keep each video to less than ten minutes. Also, my goal is to have these tax videos be not boring :)

The course will be high level. As I looked at the survey responses it was very apparent that we can’t drill down to specific situations because so many people have so many different situations. It just isn’t feasible. At this high level though, my goal is to have you understand the framework and then make decisions from within that framework. I’m hoping you’ll learn some principles that will help you make decisions in a more informed way.

And of course I hope you love the course and that it meets your expectations. I think most everyone will walk away learning something that will help them have their eyes more wide open concerning taxation.

I’m a recovering CPA.

So I don’t legally “know” what I’m talking about, but I can still remember a bit from when I did. And since this is my least-favorite season of the entire year, it’s also going to become a Savings Tip topic (and the focus of a free course launch I’m working on, see below for details).

You’re Trained to be Focused on the Completely Wrong Thing

The impetus of this post actually happened this morning on the treadmill. There was a commercial for Intuit’s TurboTax…how it guides you through your taxes and then they showed this really fancy image with a guarantee seal. On Inuit’s website you’ll see this front and center:

What’s the focus of Intuit’s marketing for TurboTax? It’s about the Refund.

I don’t want to just single out Intuit. Not at all actually. Take a look at TaxACT.com’s front page:

Intuit’s fine print reads as follows:

If you get a larger refund or smaller tax due from another tax preparation method, we’ll refund the applicable TurboTax federal and/or state purchase price paid. TurboTax Federal Free Edition customers are entitled to a payment of $14.95 and a refund of your state purchase price paid.

Fair enough.

TaxACT’s fine print re: their guarantee sheds a bit more light on the problem:

If you get a larger refund or smaller tax due from another tax preparation method with the same data, we will refund the applicable product price you paid for your TaxACT Deluxe federal return.

Emphasis mine.

I won’t even go into H&R Block’s “Instant Refund Anticipation Loans.” Nasty — and a whole other story.

The focus is on that carrot dangling out in front of you. Your own money that you paid to the government in anticipation of your tax liability — your tax refund.

Even Trained Accountants Get it Wrong and Fall For the…Indoctrination :)

Back when I worked for a large accounting firm (don’t get the idea that I have tons of experience doing that — I lasted 10 LONG months), I remember sitting around the table in the cafeteria of our client. It was tax season and I was probably complaining about this very thing. One of my colleagues — a CPA said something along the lines of:

Oh, I didn’t pay any taxes this year. I got a refund.

I about lost my lunch.

If that same concept can happen to someone who passed the Reg section of the CPA exam, it certainly happens to your average Joe the…Piano Tuner.

What was the problem with my colleague’s statement? Even if they had just slipped up and really meant to say that they didn’t need to pay any additional taxes for the year…it was still alarming.

Just to be 100% clear.

1) You earn money.
2) You pay income taxes that are either withheld from your paycheck automatically (so you’re not as aware of the expense, removing you psychologically from it and encouraging just the problem we’re discussing here — a HUGE lack of awareness) or you’re required to file quarterly estimates.
3) By April 15 of each year, you calculate what you actually owe and either pay more (because your estimates weren’t enough) or you’re paid a refund (because you paid too much).

Unless you literally did not have a tax liability that year, you paid taxes. You may not have a tax liability if:

1) You’re dead or,
2) You earned only a small amount of income.
3) You have tons and tons of kids :)

I’m grossly simplifying with the above three points.

So know this: you very likely pay taxes every single year.

And I’m not even talking about the FICA (Social Security & Medicare) taxes that you can’t avoid (re: minimize) much at all if you’re a wage worker. Even if you did fall into #2 or #3 above, you still paid almost 8% of your wage in FICA. (By the way, your employer paid another almost 8% to FICA as well — the money which they just might pay to you if they weren’t paying it to the government, so you can choose to see that as a tax you pay as well).

You pay taxes. Every year of your life. And when you die, you pay again. Don’t let me ever hear you say, “Oh, I didn’t pay taxes this year — I got a refund.” Wrong. Wrong. Wrong.

This is Not About Tax Policy. It’s About Your Life’s Single Biggest Expense

This is not about political leanings, or tax policy. It’s about what will likely be (or already has become, and will only continue to be) the single largest expense of your entire life.

I’m guilty as charged. These Savings Tips that I’ve written have ranged from saving time and money with dinner groups to 29 Ways to Save a Fortune on Your Energy Bill.

If I were doing these tips according to bottom-line affecting expenditures, I’d probably be writing about tax savings two out of every five times. For almost everyone.

Going Back to the Refund Focus. Which Way Are You Facing?

At the beginning here I established that we’re trained to be refund-focused. With tax compliance software we’re trained to drop in data (what we’ve done) and have the computer spit out what we owe or are owed. We’re complying. We’re facing backward.

Over a year ago I wrote about preferring head-on to rear-end collisions (the metaphor breaks down quickly in real life, but you get my point) when it comes to making spending decisions. You want to be proactively looking forward and acting — not looking backward and reacting.

Taxes are the exact. same. way.

Remember TaxACT’s guarantee from above? How they mentioned the same data? They’re basically saying that their software will return the same result as another software because both softwares do an excellent job of looking back, crunching the numbers, considering the rules and spitting out the liability. Hang on to that thought.

If Things Were Simpler, It’d Be Easier. But They’re Not, so Let’s Move On

We can lament and moan (I do my share of it) about how economically costly tax compliance is. How it’s a huge drain (as a whole) on the economy with no value-add. How a client I worked on employed 35 people full-time to make sure their M-1 (that’s a C-Corporation’s return, that has maybe…12 boxes to fill out) was correct…

But we won’t.

Things aren’t simple. Life is complex. In honor of the season premier of Lost tonight, I’m going to say it’s a lot like that black cloud that haunts the island. It’s always there. Nobody knows what it is or how it works. And it kills you.

At the end of Lost this season, perhaps we’ll know how it works. At the end of this tax season, we still won’t know how the tax code works.

So, let’s just get comfortable with the idea that the tax code will always be complex.

Even for those situations where the tax scenario really is simple, we have divergent voices. The New York Times wrote a very interesting article days ago, “Why Can’t the I.R.S. Help Fill in the Blanks?” that cast some of the large tax preparation software backers in a negative light.

The gist: California uses ReadyReturn, where they send eligible Californians a pre-filled return. The data can then be validated by the person, but it “gets the ball rolling”. It costs the state $.34 to process a ReadyReturn, while a paper return filed in the traditional way costs $2.59 (not including the taxpayer’s savings in both time and possibly money).

The tax preparation software lobby pushes against this for obvious reasons. Intuit’s response is here.

Whichever side of that debate you’re on, it’s clear that there are interests hard at work on both sides, furthering their own agenda. What I want you to take away from this Savings Tip is that you need to have your own agenda.

What To Do About Your Single Largest Expense

The agenda is simple. Minimize it. Minimize your tax liability. Educate yourself.

My real awakening to this situation happened last year during preparation of our 2008 personal return. Before I get into that, let me tell you about my brother-in-law, Casey.

Casey is a tax preparation…guru? Yeah, guru’s the right word. He might be partially insane as well — he loves this stuff. Absolutely loves it. I’ve seen him become giddy over some strategy. It’s a sight to behold.

He’s also a straight-arrow. He deals in blacks and whites. Prior to using Casey, I used another CPA to prepare my taxes and heaven only knows how much money I overpaid (he was lousy, and I should have fired him immediately. Plenty of warning signs told me as much). This was all apparent once Casey got a hold of my tax documents for the 2008 return.

It’s the kind of thing where taking an expense here instead of there saved me over $10,000. I’ve been trained in taxes. The Reg section of the CPA exam was my shining moment (a 94 baby! Nothing to show for it now). I had class after class in school. I know enough to know that I need help.

$10,000 (and change)!

We used the money to help us pay down the mortgage.

But that money would have been gone. Forever. There’s literally nothing that you’re given in return for the extra you pay on your taxes. You are flushing money down the toilet. Stop doing that.

Casey’s in the know about this stuff though. He soaks it up. He prepares return after return and sees different situations. He dives into the tax code — discusses strategies and knows the forms inside and out. He’s a phenomenal resource.

I don’t think he’d want me to disclose what it cost me to have him prepare our 2008 taxes, but I will say it was a bargain (and I didn’t get any family discount :). An absolute, no-brainer bargain.

But here’s where the real value comes. Casey now can sit down with me and help me look forward and begin planning. For the 2008 return, he hadn’t seen anything going on prior to having my documents in hand. He was forced to comply and we still did phenomenal.

So the real value comes in being able to plan and structure things in such a way that your tax bill is minimized. Having that ability is, as Michael Scott (The Office) would say, “Incalclacable.”

I led into this talking about tax preparation software. I think, on net, it’s a positive thing. But don’t be deceived. No consumer-facing software is forward-looking. No tax prep software would have told me that I just needed to take my health expense here instead of there. It would have just accepted my answer and moved on. Did you hear that flushing sound? :)

The savings we found had to do with how we were handling health insurance premiums in relation to adjusted gross income (AGI) that was on a threshold of causing phaseouts for roth contributions, child tax credits, and I believe some itemized deductions. Sound like a foreign language to you? Embrace it.

After quite a bit of prodding, cajoling (begging?), I convinced Casey to help me put together something that would help that Piano Tuner I mentioned above get a handle on their tax situation. What we’ve cooked up isn’t quite ready yet, but will be soon. If you’re interested in taking part in a free course all about tax minimization, drop your first name and email in the box below:

Remember, you need to have your own tax policy: Educate yourself. Pay as little as possible and use the savings to reach your financial goals.

And please, please, please people: Do not turn this into some raging political discussion. I’m not talking about tax policy. I’m talking about taking the tax hand you’ve been dealt and proactively making the most of it.

This tip is specifically written to comply with US tax law. I’m not a tax attorney, or qualified tax professional, so seek competent, professional advice before actually implementing this suggestion.

Giving to Charity — the Normal Deduction
When you give to a charitable organization, the IRS allows you to deduct that contribution from your taxable income. For instance, if I had $60,000 of taxable income and donated $6,000 to a qualified charitable organization, my taxable income would be $54,000 ($60,000-$6,000).

What are the tax savings from this? It depends on my marginal tax rate. For the sake of this example, let’s say it’s 20%.

Without the charitable contribution, my taxes would be $12,000 ($60,000 * .20).

With the charitable contribution, my taxes would be $10,800 ($54,000 * .20).

Total tax savings as a result of the contribution: $1,200.

(The quick way to calculate the savings associated with any deduction is to multiply the deduction by your marginal tax rate. In this case, we would do: $6,000 * .2 and get $1,200.)

But this isn’t the Savings Tip.

Giving to Charity — the Souped-Up Deduction

Let’s suppose that instead of giving $6,000 in cash to a charitable organization, you gave $6,000 of an appreciated asset. For our example, let’s pretend you bought into XYZ stock at $1,000 and it has now appreciated to be worth $6,000. Let’s also assume that you had held the XYZ stock for three years.

First, let’s do an example without the charitable contribution.

You decide to sell the stock, in order to donate the $6,000 to a charity. Because you’ve sold a capital asset, you’re subject to the capital gains tax (remember, governments tax us buying, earning, growing, and dying). In this instance, your capital gain is $5,000 ($6,000 – $1,000). The capital gains tax is either 15% or 5% depending on your situation. For this example, let’s assume it’s 15%. The tax due on this sale of XYZ stock would be $750 ($5,000 * 15%). (Special Note: If the XYZ stock had been held less than a year, it would be classified as a short-term capital gain and would be taxed at our example person’s ordinary tax rate of 20%, so the tax on the realized gain from the sale would be $1,000, not $750).

BUT, you can completely avoid the capital gains tax if you simply donate the stock to the charity. The charity can then sell the stock and have the $6,000 in cash (less a tiny selling fee probably). So, you avoid a $750 capital gains tax because your basis increased from $1,000 to $6,000, but you get the full deduction available to you of the current value of the stock at $6,000.

This is the scary thing about taxes. You can do something one legal way and pay more. Or you can do it another legal way, and pay less.

This is also why you should get great advice. TurboTax is fine and everything, but it would never tell you what you should have done, only what the tax ramifications are from what you have done. I’m actually working with an extremely knowledgeable tax person about putting together some fantastic ways to save on taxes. We’re still in the concept stage, but I’m pretty excited about it.

Takeaway: If you’re going to be selling some stock, and you give to charities, considering giving the appreciated stock (or a portion of it) to the charity to avoid the capital gains tax.

There is a bit of “conventional” wisdom out there that I just don’t understand. I take that back. I understand it. I just don’t understand how seemingly intelligent people subscribe to it. It is even touted by CPAs and Financial Advisors as great advice. The idea is that it is good to get or keep a mortgage because it is a tax write-off.

I have lost track of the number of people that have told me that the reason they are not paying off their mortgage is because it is a tax deduction. Another comment closely related to that on is when people buy things for their business that they don’t really need because it is a tax write-off. It has to just be an excuse to spend the money, or a convenient justification in their minds, because it just doesn’t make sense to me.

So Let Me Get This Straight
Here is an example. A client came to me a little while back and he said that he planned to take out a much larger mortgage on his house. When I inquired why he explained to me that his CPA had told him that he needed more deductions to get his tax bill lower. The CPA suggested taking out a much larger loan on his home and showed him how much he would save on his taxes.

“So,” I said, “you are going to pay $10,000 more per year in interest to the bank so that you can pay $3,000 less to the government in taxes? You must really, really hate paying money to the government!” Why on earth would someone put themselves $7,000 more in the hole to avoid taxes? It seems like they are taxing themselves more in the process.

I’m All for Paying Fewer Taxes
Don’t get me wrong. I have no desire to pay more taxes. I try to find every honest way to save my clients tax dollars and help them keep what they earn. But I wouldn’t suggest that they spend more than the tax savings in order to get those savings.

Now, if you have to have a mortgage, then by all means you should take the tax deduction for it. But please don’t get a bigger mortgage so that you get a bigger deduction. And don’t take out a home equity line of credit to pay for your vacation so that you get a deduction for the interest you pay on the cost of that vacation. No matter how big the deduction, you are still paying more for the vacation! You only get a percentage of the interest, not a dollar for dollar reduction of the price you paid.

One More Example
There is a guy I know that owns his own little business. Almost every time I talk to him he tells me about the new tools or equipment that he just bought. Then he smiles and says, “Hey, it’s a tax deduction.” Maybe he is just taunting me. But it is not like the fact that the tool is a tax deduction makes that tool free. Especially if he is not making a lot of profit on this business, which in turn means that his tax bracket is not very high. So, maybe he saved 20% on the tool when you take into account the write-off. He still spent the other 80% on a tool that he didn’t really need. It is the same logic that leads people to by things that are “on sale” that they never would have bought otherwise. I don’t care how much you saved – if you wouldn’t have bought it otherwise you just wasted your money.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional. 

Considering the current Real Estate downturn, there is a pretty good chance that some who read this blog are in the process of losing their homes. Hopefully the percentage of readers in this situation is smaller than the national average because you have learned to budget well. Even if you are not in this situation, there is a really good chance that you know someone who is and, if so, this article may help them know what to expect from a tax standpoint.

The Way it Normally Works

The IRS looks at all debt that is reduced or forgiven in one way – as taxable income! Why? Because then they can tax it! No, it actually makes sense. If you owe money and the debtor forgives the debt, what that really means is that they paid the debt for you. If they paid the debt for you it is the same as if they paid you and then you paid the debt. So, the debt paid is considered income. (Another way to think about this: If this were not the case then we could all have our employer just by our food, housing, entertainment, etc. and we would never have any income to report and no one would ever need to pay taxes.) Since the debt that is reduced or forgiven is income you may now owe income tax on that portion that was eliminated. So not only did you lose your house because you couldn’t make the payment, but now you have a big tax bill to boot!

Relief for a Short Period of Time

Because the housing crisis is so big, and in an effort to lessen the economical impact of the foreclosures, in December 2007 President Bush signed the Mortgage Debt Forgiveness Act of 2007. The act allows for mortgage debt relief to not be included in income for those whose mortgage debt is forgiven between January 1, 2007 and December 31, 2009. So, if losing your house is inevitable, I guess now is a “good” time to do it.

Some of the “Nitty Gritty” Details

Probably the most important footnote to this is that only the portion of debt that was used for the construction, purchase, or significant improvement of the home qualifies for the benefits of the Act. In other words, if you used part of the money from your mortgage to consolidate debt or pay for a vacation, etc., then that portion is still considered income and is subject to taxes. For example, if the amount of money used for things other than the home is $55,000 and the amount of debt forgiven is $90,000, then only $35,000 of the debt relief is not included in taxable income.

A second important note is that this tax relief only applies to a principal residence. So, if it is a second home or a vacation home then the debt forgiveness will be treated as it always has – taxable income.

There are a few other details to the Act as well, but they don’t apply to most people and/or they aren’t within the scope of this BLOG. My intention is just to give you an idea of the overall tax consequences of debt forgiveness and the effects of this Act.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

If you knew me, the title of this article would be reason to take pause. However, there are a few things that our government does that are worth taking note of, understanding, and then implementing into our lives. One thing in particular is the way that they tax us.

Withholdings – A fairly recent, extremely brilliant development

Did you know that we used to pay our taxes once a year at “tax time?” Depending on your age, your parents or your grandparents lived in a time when there was no such thing as taxes being withheld from your paycheck. Then, as a way to finance the war, the government began asking us to send in estimated tax payments (as part of our patriotic duty). People weren’t too keen on the idea. So the government began to offer incentives for doing so. Eventually the incentives became enticing enough that many were lured into the trap. And from there we slid down the slope to where we are now – being charged penalties and interest for not paying as we go!

So, why is this so brilliant?

How often do you take note of the amount of taxes that were taken out of your paycheck? Could you tell me, without looking, what that dollar amount is? Could you tell me, without doing the math, what that amount adds up to per year? Unless you are in the small minority you probably don’t have any idea. That, right there, is part of the genius of the plan. (That “small” amount of money is taken out of your paycheck before you ever see it, think about it, touch it or wonder what you might be able to do with it if you didn’t have to pay taxes.) The vast majority of people never even notice that it is gone. All that matters to them is the net amount in their wallet.

Unbelievable!

I can’t tell you how many people I have spoken to that tell me they don’t pay any taxes. It is hard for me not to laugh. Many love the fact that they get most or even “all” of their money back from the government. For them it is like a highly anticipated bonus that comes once a year and they can’t wait to find out how much they are going to “get.” This is like thinking you are getting a great deal from your credit card company who gives you 3% cash back (while charging you 12% and the store you bought from 2%). Who is getting the great deal?

Few are the people that actually get all of their money back. The largest tax that most people pay is FICA (Social Security and Medicare). Do you realize that you pay 15.3% of your earnings for this tax, which is separate from any income tax that you are liable for? Now, if you are self-employed you are probably painfully aware of this fact. If you are an employee you might think it is only 7.65%, if you have done the math. This is the subject for another entry, but let me leave it at the fact that 7.65% shows up as a withholding on your pay stub and the remaining 7.65% (to make a total of 15.3%) is not shown on the stub because the employer takes it out when deciding how much you will get paid and then pays it to the government. You don’t get this money back because it doesn’t even figure into you income tax liabilities (in most cases).

So Am I Just Venting Or Is There A Point To All Of This?

The point of this is that nearly all of us go along in life, planning our budgets based on the net amount of money that we earn after taxes. We usually don’t even think about the money that we paid in taxes because we can’t get it back. So we think of it as a cost of living, or of working, really. If taxes go up we might feel a little frustrated, but then we forget about it and move forward. We make life work regardless of the amount coming out of our checks. This is the brilliance of tax withholdings. We just don’t notice how much we are really paying and we move forward without thinking about it. I truly believe that if everyone had to write a check once per year for the full amount of taxes that they owe (Income, FICA, FUTA, SUTA, Sales, Property, etc.) that there would very quickly be a revolt and the tax laws would change very fast.

And herein lies the lesson: The government has figured out the best was to get us to put away 10-50% of our money without giving it a lot of thought. Why don’t we use the same psychology on ourselves when it comes to saving? If we truly have our own best interests in mind we should set up an automatic “withholding” plan from every paycheck that we earn to save for the future. Automatic savings plans are the best way that I have ever seen for people to put away a good amount of money.

The similarities between taxes and automatic savings are striking. When I talk to people about starting to put away a set amount every month they often wince. Even those who are already doing it and seeing the success of the plan wince when I talk to them about increasing the amount. This is the same reaction that people have when taxes go up and their withholdings increase. In both cases they wince, wonder how they can do it, and then they move on and forget all about it! I can’t tell you how many times I have heard people say “I don’t even notice that it is missing.” And, like taxes, when someone has to write a check for their investments once a year it is a much harder, and often impossible thing for them to do. The government is really good at getting our money from us. We should follow suit in gettingey from ourselves as well.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

Real Estate can be an important and often successful part of a wealth-building strategy. For this reason, many people buy investment property. However, a major barrier to entering the Real Estate market for many people is a lack of money available for a down payment. Even those who have done a great job saving for their retirement often have most of their savings tied up in accounts that are penalized if the money is withdrawn before age 59 1/2. What most people don’t realize is that the money in a retirement account such as an IRA or an old 401(k) can be used to buy Real Estate or other non-traditional investments. With a self-directed IRA, these funds can be used to make such an investment.

What is a self-directed IRA?

All retirement accounts are maintained in the name of a custodian. A custodian exists, in part, to assure the IRS that you have not tapped into your accounts during the year (thus triggering taxes and potential penalties). In addition, these custodians often assume a level of fiduciary responsibility. As a fiduciary they limit the investments that you can choose from so that they are not held liable for allowing you to invest in something “crazy.” Such custodians will not allow use of a retirement account to invest in Real Estate.

However, a few custodians offer what is called a self-directed IRA. In this case the custodian withdraws its fiduciary responsibility and allows you to choose the investments that you think are appropriate. With this option, you can take the money that is in your IRA, or that is in a 401(k) from a previous employer, and use those funds to purchase investment property, precious metals, or even a new business. The ability to use these funds in such a way allows for significant risks to your investment, but also offers two great benefits that would not otherwise be available.

Two Great Benefits of a Self-directed IRA

The first benefit is probably obvious from what has been said so far. You are able to invest the money in your retirement savings account in almost any way that you feel is best. You can choose the investment that you think will bring the greatest success in preparing for your future needs and you have a source of money for such investments that you may not have realized was available to you.

The second benefit may be quite as obvious. This benefit comes at tax time. Since the property is held within an IRA, all income and gains are tax deferred. No longer do you have to pay taxes each year on the rental income, but can defer that income to a future time. You can keep the income within the IRA account and reinvest it elsewhere, or have it in reserve for future expenses. Even more exciting is that if you decide to sell the property and buy another, or even if you just keep the gains and invest in something else, it isn’t necessary to deal with the headaches of a 1031 exchange. Timing of sales and purchases can thus be made when they are optimal instead of being forced to buy something within the strict 1031 guidelines in order to avoid the taxes.

Some Words of Caution

Of course, you must use great prudence and caution when investing your retirement savings. You should not, for example, “put all of you eggs in one basket” by using all of your money to buy one property. You must also be aware of the many risks that are inherent in Real Estate, including a measure of illiquidity.

Additionally, you must remember that the IRA owns the property. Should you need to make repairs or replace the roof that money needs to come from the IRA. Otherwise, if you pay for anything out of pocket, it is considered a contribution to your IRA (subject to all of the limitations of an IRA). Therefore it would be wise to have a significant portion of your IRA money in reserve (not invested in the property) so that you are free to make adjustments as needed.

You also need to be aware of some special rules. For example, you must use an independent property manager to receive the income and pay the expenses. Remember, the IRS doesn’t want you to touch the money in your IRA, and in this situation any money involved in the investment would count. The property manager would collect income and send it to the IRA custodian would bill the custodian for expenses. The custodian will also charge a fee for this service. You still have control over the property manager; you just can’t touch the money. The rules for owning a business within an IRA become even more complicated. With any such investment you must be sure that you first completely understand how it works.

In Conclusion

The tax benefits of this type of investment can be enormous. The ability to tap into retirement funds to make a great investment can be wonderful. But the decision to make such investments through a self-directed IRA should be made with the help of competent professionals, in order to avoid serious pitfalls. With that said, a self-directed IRA is a lesser-known option that can be a great asset in your strategy for financial independence and tax-benefited investments.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

How would you like to make your car get 220 miles to the gallon instead of 20? Or would you prefer, instead, to only pay $0.36 per gallon of gas? How about this: If your car gets good enough mileage then you get paid for putting gas in the car instead of paying? All of this is possible through some known, but sometimes unappreciated tax deductions.

For many of my clients, one of their biggest tax deductions is their car mileage. And yet this is also one of the least appreciated tax deductions, in my opinion. If you own a business, drive your own car for your employer, go to the doctor or even take boy scouts on campouts you could save money on your gas bill.

What About Bob?

To illustrate the possibilities, let’s imagine a man named Bob. Bob uses his own car to make some deliveries and visit some clients for his employer. For Bob this adds up to about 150 miles per month. Bob is currently paying $4.00 per gallon for gas and gets about 20 mpg in his Camry. Bob and his wife make a decent living and, between Fed & State, they are in a 36% marginal tax bracket.

At tax time Bob brings his records to his accountant:

1,800 miles driven for work

90 gallons of gas attributable to those miles

$4.00 per gallon average cost

Bob’s accountant prepares his taxes and shows Bob the following:

1,800 miles x $0.505 per mile = $909 in deductions x 36% = $327 tax savings

$360 gas expense – $327 tax savings = $33, or $0.36 per gallon

– or –

$33 net gas cost / $4.00 per gallon = 8.25 gallons

1,800 miles / 8.25 gallons = 220 miles per gallon

Needless to say, Bob is pretty happy he kept track of his miles. And get this: if Bob’s car was more fuel efficient and got 23+ mpg (or if gas prices went down to $3.60 per gallon) Bob would actually be getting more back in tax savings than he paid for the gas. He would be getting paid to put gas in his car!

You Don’t Drive Your Car for Work?

You may drive for work even if you don’t realize it. Many professions require some form of continuing education. If you use your vehicle for such a reason and are not reimbursed this would be qualified mileage. Even if you don’t use a vehicle for any work related reason there are still benefits to be had.

While the benefits are the greatest for business related mileage, there are deductions for other common things. Do you ever drive to the doctor, dentist, hospital, pharmacy, etc.? As long as these trips are for qualified medical reasons they are deductible at a rate of $0.19 per mile. Do you ever do volunteer work? If you drive your car for a qualified charitable organization (Boy Scouts, Church, etc) or to do volunteer work for such an organization, those miles are deductible at a rate of $0.14 per mile. So, to continue the idea of your effective mileage:

Reason for use MPG Adj. CostPersonal (actual cost) 20 $4.00

Business 220 $0.36

Medical 30 $2.63

Volunteer 27 $2.99

It is clear that the tax deduction is still worth taking note of, even if you don’t have business miles.

Is There a Catch?

No catch, but there are a lot of assumptions built into the scenario I have described – and a change in any of them would change the results to some extent. Some major assumptions are that Bob (or you) have enough deductions that you would itemize instead of taking the standard deduction. Also, this assumes that you have met the 2% of AGI limit for employee expenses or 7.5% limit for medical expenses. (However, if you own your own business the mileage deduction comes of 100% as a business expense, regardless of whether you itemize personal deductions).

The assumed tax bracket also affects the results. There are several other things to take into account as well. I recommend that you talk to a tax professional about your specific situation before assuming that these things apply to you.

I also run into two common misunderstandings when discussing this. The first is that commuting miles to and from your home and main place of business are not counted as business miles. These are personal miles in the eyes of the IRS. The second is that if your employer (or the volunteer organization) reimburses you for your mileage you may only deduct the difference between the employer’s reimbursement rate and the standard rate.

What Do I Need To Do To Claim My Gas Rebate?

In the event that the IRS wants to verify your figures (i.e. audit you) you will need to provide the following:

• Date of each trip
• Beginning and ending odometer readings for each trip
• Reason for the trip
• Beginning and ending odometer readings for the entire year

There are very inexpensive ($2-$5) record books at office stores and online. I would recommend getting one and keeping it in your car to make it easy to keep track of all the mileage that you may be able to write off at the end of the year.

The mileage rates in this article are for 2008 expenses and are adjusted each year. States may also deduct mileage at a different rate than the Federal Government.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.