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.