Common Cents # 50 Tax Time

 

Common Cents – Tax Day 

There are only three things that I know a lot about: the Bible, photography, and taxes. I also have opinions about music and cars. For the price of a cup of coffee, I will talk all day about music and cars. If you want to talk about the Bible, I will buy. But for taxes and photography, I like to get paid.

Since April 15 is Tax Day, and almost a national holiday, let’s talk tax for free. First, taxes are often due a different day than April 15 because of weekends, holidays, or just because the IRS needs more time. The due date this year is May 17, except for the estimated tax due date which remain April 15.  The drop-dead, jigs-up due date, as always, is October 15.

I have been a business owner since I was sixteen in 1964. I got serious about running a business to support my family in 1973. That means I have had forty-eight years of hands-on business experience. I decided early on that I would not let the tax code cloud otherwise good decisions. It is important to understand taxes but letting the IRS and tax laws dictate how our business operates is a bad idea.

The tax laws change frequently and almost always for political reasons. A tax-motivated decision this year may be a bad decision next year.

For example, owning a home is the most common way for middle-class Americans to build wealth. Buying a house when we can afford to do so is a great idea. Buying a house because we can deduct the mortgage interest and property tax to save money on taxes is a bad idea. I have had many tax clients who were excited about the big refund promised by a realtor because they bought a house this year, only to find that it made no real difference, usually because the standard deduction was greater than their mortgage and property tax deduction. The standard deduction and even the deductibility of interest change regularly. Making charitable donations are always a good use of resources but doing so just for the tax deduction is always a bad idea. Either we have a desire to give, or we don’t. A tax deduction might be a bonus, but it should not be a motivator. Having a baby to get another exemption or child tax credit is not good long-range planning.

That does not mean we can ignore tax implications of our decisions. A few years ago, I had a tax client who cashed in a large IRA to buy into a retirement community. An IRA distribution is taxed as ordinary income so she had less for this purchase after paying tax on the investment. She then sold her home of many years, much of which went to pay the taxes on the IRA distribution. The sale of the house was tax exempt. If she had waited to buy into the retirement community until she sold her home, or even taken a home equity loan until the house sold instead of cashing in the IRA, she would have saved tens of thousands of dollars in taxes.

Small timing adjustments can make a big difference too. For example, if we are nearing retirement, we must not take money from our IRA or pension account the same calendar year as our salary or retirement bonus. Waiting until the next year could put us in a lower bracket, especially in the amount of tax on Social Security. The taxable amount of Social Security is dependent on other income for that year. If our only income is Social Security, it is tax free. A big IRA or pension withdrawal will likely make 85% of Social Security taxable. This is huge for the average taxpayer. If we have a choice of December or January to take the money, wait until January.

Taxes don’t have to be burdensome or challenging, but they require a little thought and research to determine the best strategy each tax season. When in doubt, consult a tax professional for the best way to navigate these financial waters.

 

Common Cents # 49 - Priorites

 

Common Cents – Priorities

According to some recent estimates, about 1% of us have unlimited financial resources.   Sure, income and wealth inequality on many levels seem like big challenges. The rest of us, the other 99%, still need to set priorities for our resources, for spending and saving.

Assuming that we have a limited amount of money coming into our bank account, deciding how and where to spend the money are ongoing and important decisions. If we are married, this requires much conversation and understanding as well as compromise. Most conflicts in marriages center around priorities on handling financial resources.

The first priority should always be food and shelter, after that there are a lot of choices. Even in the basic categories of food and shelter the range of choices are huge. Do we want to spend a large amount of money on our home because that is where we spend most of our time and our surroundings are important to our self-image and general feeling of happiness? Or are we the person who finds it insane to tie up huge amounts of capital just for a place to hang our hat?

One of the most important decisions a married couple needs to make is how they prioritize spending. My wife and I decided very early in our marriage that travel was important. I think there was something in our marriage vows about Paris. I don’t remember for sure. I know that she had just returned from studying in France when we met and that was part of what she imagined our life could be together. We decided that travel was more important than a big house, designer clothes, or expensive appliances.  

We also decided that it was important to give to organizations that are able to bring hope to people and do work that we are not able to accomplish on our own.  Giving to people like this brings us a special kind of enduring joy and gratitude.

Once the basic needs are covered, the list of things we can spend our discretionary income on is endless. Do we raise horses, race automobiles, buy expensive musical instruments, or send our kids to private schools? It is extremely unlikely that an average person can do all of those things, or even more than one, if they are serious about the choices or hobbies.

Typical everyday questions around our house are things like “Do we make an improvement on our house or go on the two week vacation this year?” Cash in the IRA and do it all is seldom the best choice. “Do we buy a new refrigerator because the old one is out of style, or wait until the old one dies, which may be another 10 years?”

I know men who try to sneak a new shotgun or guitar in the house while his wife is out buying $300 shoes. This is never a good way to handle money. First, we need to concur on a general philosophy of what is important and keep the conversation open and transparent. For example, is dinner out in a nice restaurant more important than expensive shoes? Then we need a procedure for making decisions about the details. Setting a dollar limit that triggers a discussion is a good idea. Should any purchase more than $100 require a discussion with our spouse? Seems reasonable. Buying a book need not require a conversation, but a new television would.

I had a discussion this week with a friend about cars. Some people go for the least possible cost. To that person a car is just an appliance that gets them from point A to point B. For other people, an automobile is a source of pleasure and they can’t wait to get in the car and hit the road. Those two people are not going to buy the same car. My friend does not need to rationalize his Porsche to me. I get it. Another friend does not need to explain his old Toyota. I understand that too.

The point is, we need to set priorities on what is important. These are family decisions. Then we need to stick to those priorities and avoid impulse buying that we will later regret when our most important goals cannot be achieved.