Beyond Paycheck to Paycheck

at January 5, 2009 in Tax. 1 Comment

You may recall that at the outset of the financial crisis, a time that now seems relatively calm, Congress provided for an Economic Stimulus Payment. Many married couples and single individuals received $1,200 and $600, respectively, as a result of this program. Although there has been talk for months about a second stimulus payment nothing yet has passed.

However, recovery rebate credits are already in place.

You: What are those?

The Recovery Rebate Credit exists to allow those who didn’t qualify to receive the maximum Economic Stimulus Payment in 2008 a second shot at the federal government’s coffers in 2009.

Frequently Asked Questions about the Recovery Rebate Credit (RRC)

You: Who gets the RRC?

Basically, only people who fall into one or more of the following categories are eligible for the RRC:

Your income dropped from 2007 to 2008 so that you now qualify for a larger payment
You had more eligible children at the end of 2008 than you did at the end of 2007
You could have been claimed as a dependent in 2007 but could not for 2008

You: How do I get the money?

Unlike last year’s economic stimulus payment, the RRC will not be paid via a separate check. Instead, the amount of the RRC will increase your 2008 income tax refund (or decrease the amount you owe). You simply enter the amount on line 70 of Form 1040, should you qualify.

You: How much will I get?

A calculator is being created by the IRS to help with this calculation and will be available in February, 2009.

# # #

Anyone else out there expecting a payment - why? Birth/adoption of a child or is there a silver lining in a lower income year?

Is anybody still waiting to receive their stimulus payment from last year? What’s the latest “they’ve” told you?

"financial education"

Year-End Financial Planning Tip #4: IRA Planning Now

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at December 11, 2008 in Retirement and Tax. 0 Comments

Year-end obsessive man is here again. Previously, I wrote of the importance of using your FSA funds before losing them, maximizing your match in December and taking tax advantage of any capital losses. Today, is tip # 4 and concerns IRAs.

Don’t wait until April 15, 2009 to make your 2008 IRA contribution.

Certainly, don’t wait until April 15, 2009 to figure out where your 2008 IRA contribution money is coming from.

Whether with finances or a birthday party, when you wait to the last minute, things typically don’t go as well as you had hoped (or as if you had planned). By saving between now and next April in your IRA two good things happen:

You’ll probably increase the total amount you’re able to save because it’s not just the amount you can come up with at the deadline.

You’ll begin to take advantage of tax-deferred growth sooner and for longer.

Don’t wait. Also, remember: if you miss making your entire 2008 IRA contribution by April 15, 2009, you can’t make it up later.

Check out the 2008 and 2009 IRA limits. Disclosure: I wrote it.

"financial education"

Year-End Financial Planning Tip #3: Oh, those losses on capital (and some obtuse sports jokes)

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at December 9, 2008 in Investing, Retirement and Tax. 0 Comments

Continuing on my year-end theme, I blogged yesterday about using your FSA funds before losing them. Previously, I discussed the importance of maximizing your match in December. Today’s tip, and one of the most commonly discussed, is those capital losses.

You: What are capital losses?

When the DC hockey team plays the Bruins.

You: What?

Forget it. Inside joke.

You: This is a blog.

Yeah, might be the last time I try the inside joke thing. Getting back to it: capital losses occur when you buy an investment and then sell it for less. Such investments could include stocks or mutual funds.

You: Like in my 401(k)?

Although you may very well have investments in your 401(k) that have gone down in value and that you chose to sell at a loss, such losses aren’t the capital losses I am talking about.

You: Why not? That’s what I want to talk about.

Sorry, but this post isn’t about year-end strategies concerning your 401(k) losses. Today, we’re talking about stocks and mutual funds you own outside of your retirement plans.

You: Again, why?

Because selling the stocks and mutual funds you own outside of your retirement plans at a loss can potentially reduce your taxes. Selling the investments held inside a 401(k) or IRA won’t do that.

You: Why?

Who am I talking to today, Bryant Gumbel?

You: No. Bryant who?

Forget it. Since your 401(k) and IRA accounts grow tax-deferred, you don’t pay tax when you sell investments within the plan that have gone up in value (gains). On the other hand, if you sell such investments at a loss, you don’t get to deduct that loss either. (Note: there are very rare exceptions to this rule, but you typically need to nearly liquidate your account, not a good retirement planning strategy.)

Investments you sell within a taxable account lead to either capital gains or capital losses. This year, most people who are selling investments are selling them for less than they originally paid.

You: Thanks for that insight, Mr. Madden.

Touche.

The year-end strategy here is to make sure that if you are sitting on investment losers in your taxable accounts which you are considering selling, to do so prior to December 31. You can deduct your capital losses up to the total of any 2008 capital gains plus up to $3,000 of ordinary income.

You: Ordinary income? My income certainly feels very ordinary.

Ordinary income has a tax definition and includes your salary, bonus, even interest income. So selling an asset triggering a loss of $3,000 or more means, for tax purposes, that you made $3,000 less than you actually di.

You: Works for me.

Just make sure you don’t sell something just for the tax benefits.

You: Right. Can I sell an investment and then buy it right back?

Yes, but if you don’t wait at least 31 days before buying it back, then you can’t deduct any loss.

You: Why not?

Because then it is known as a “wash sale” and the rules say you can’t deduct losses from wash sales.

You: Is that where the phrase “It’s a wash” comes from?

I don’t know.

# # #

How many obtuse sports-related jokes can you identify? Are any of them actually funny?

What about personal finance comments? Ever sell something and then realize that wasn’t such a good idea after all?

"financial education"

Second economic stimulus?

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at October 31, 2008 in Tax. 1 Comment

You: Wasn’t the first economic stimulus a failure?

Well, some people feel it did help the economy.

You: What? The economy’s in the crapp toilet.

Still, some people feel the economy would have been even worse earlier if not for the first stimulus package. That said, the administration of the economic stimulus is still causing pain, evidenced by my earlier blog posting (and the fact that people are still commenting on it months later).

But today, I am going to ask you a question. Actually two questions:

Do you think we should get another economic stimulus?
Do you think we will get another economic stimulus?

Where do Beyond Paycheck to Paycheck readers stand on these questions?

"financial education"

Why you’ll pay tax on losing investments

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at October 24, 2008 in Investing and Tax. 0 Comments

You: Pay taxes on losing investments? That sounds counterintuitive.

It is counterintuitive.

You: Okay.

But it is what can happen and is likely to happen to many mutual fund holders this year as reported by The Wall Street Journal earlier this week.

You: What? I own some mutual funds. I’m going to owe taxes on them even though they’re down? That’s crazy.

It’s counterintuitive.

You: It was counterintuitive before I knew you were talking about me. Now it’s just crazy!

But it can happen. Let me explain how.

You: Yes, do that.

Remember, I’m only the messenger.

You: Yeah, whatever.

Here’s the deal. Whether your mutual fund goes up or down in value has no bearing on the income tax you pay. This fluctuation in mutual fund value is known as an unrealized gain or loss. You don’t report unrealized gains or losses, so you don’t have to pay taxes on the gains and you don’t get to deduct the losses.

You: Okay. I am with you so far.

However, if you sold the mutual fund at a gain, then that unrealized gain becomes a realized gain and, presto, you’d pay taxes. Likewise, if you sold a mutual fund at a loss, the unrealized loss becomes a realized loss and you can deduct that loss (subject to certain limits, of course).

You: Of course. But still, I didn’t sell any of my mutual funds this year and those I have went down in value, so how is it that I might owe tax from that? You know, the crazy talk from before?

Each year, mutual funds must distribute substantially all of their investment gains and income. If you own your mutual fund in a taxable account (not, for example in an IRA or 401(k)), then your pro-rata share of this distribution is taxable income to you.

You: Okay, even that seems fair. After all, my mutual funds lost money this year so they won’t be distributing income so I don’t have anything to worry about from what you just said.

Wrong.

You: Wrong?

Okay, probably wrong.

You: Why “probably wrong?”

Just because your mutual fund lost value doesn’t mean that it didn’t have any gains.

You: There’s that crazy talk again.

I agree, but again, I’m just reporting the news here. Let’s say that during February your mutual fund sold some stocks it had purchased a few years earlier and did so at a substantial gain. With this cash, your mutual fund purchased other investments which have since plummeted. The mutual fund believes, however, that in the long-term these investments will bounce back.

You: Okay, that sounds plausible.

Not only is it plausible, it’s taxable.

You: Seems like anything plausible is taxable.

Good one. That gain your mutual fund obtained in February is a taxable gain because it has been realized. But the loss on the replacement investments is not deductible because it has yet to be realized. It is an unrealized loss. Net impact to you: a taxable distribution despite the fact that your investment has gone down in value.

You: Would this be true even if I bought the mutual fund last October, before most of the gain was earned by the mutual fund?

Yes. In fact, it would be true even if you bought the investment in March of this year, after the underlying stocks sold at a gain were sold.

You: More crazy talk.

Hey, it’s plausible.

You: So it’s taxable.

Indeed, so buyer beware. Make sure to double-check with the mutual fund company before buying any mutual fund in a taxable account before the end of the year. If they intend to make a sizable distribution, it may be a good idea to consider waiting to invest in that fund until after the distribution is made.

# # #

Has this ever happened to you? Can you think of more “crazy” examples of taxes being assessed against “unreal” gains? I can.

"financial education"

First Time Homebuyer Tax Credit: When a credit isn’t a credit but it’s still free money

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at September 24, 2008 in Housing and Tax. 2 Comments

Not surprisingly, government has found another way to make something that could be so simple so very complicated.

You: How so this time?

The relatively new first-time homebuyer tax credit.

You: Did this just come out because of the most recent financial crisis?

Actually, it came out a few months ago before the most recent financial crisis. But it was definitely added in response to falling home prices. Here’s what you need to know:

Qualification

In order to be eligible for the first-time homebuyer credit, you must meet the following conditions:

You must buy a principal residence (not an investment property or a second home) after April 9, 2008 and before July 1, 2009.
If you file single or as head of household, your modified adjusted gross income must be less than $95,000 to receive any credit (and less than $75,000 to receive a full credit). If you’re married, those two numbers increase to $170,000 and $150,000 respectively.
You must not have owned a principal residence during the last three years. Same is true for your spouse, if you are married.

Provided you meet all of the conditions above, here’s what the credit means for you:

Show Me The Money

Since the credit is 10% of your home’s purchase price but is subject to a maximum of $7,500, anyone who purchases a house costing $75,000 or more and meets the criteria above receives the same $7,500 credit. Note, however that the credit is refundable. That’s huge.

You: Why?

The fact that the credit is refundable means that you can get the full $7,500 even if your total tax liability was less (or even zero). Many other credits are only actually payable if you would otherwise have a tax liability.

You: Okay, now in English.

Say your tax liability for the year is $1,500 and you had $2,000 withheld. Ordinarily, you’d receive a $500 refund.

You: Easy enough.

Now, say that you’re eligible for the first-time homebuyer tax credit but that the credit was non-refundable.

You: But it is refundable.

Yes, but I’m trying to provide an example so you can understand the importance of the “hugeness.”

You: Right.

If it were non-refundable, your tax refund would increase to $2,000 because the credit would reduce your income tax liability to zero, providing you with a full refund of the entire amount you had paid through withholding.

You: But since, it’s refundable . . .

You get more. In fact, you get the whole $7,500 credit. The first $1,500 of it wipe away the tax you’d otherwise owe and the next $6,000 becomes “refundable.” Plus, since you already paid $2,000 through withholding, the refund you’d actually receive would be $8,000.

You: That’s a huge refund.

Pun intended?

Then, The Government Takes It Back. Slowly.

You: I don’t like the sound of that.

You shouldn’t. What happens next makes the credit not really a credit and more of an interest-free loan:

Over the 15 years starting two years after you claim the credit, you have to pay 1/15 (or $500) back to the government each year.

You: What? How?

You have to pay the credit back through a $500 reduction in your refund or a $500 increase in the amount due on each of 15 consecutive tax returns.

You: That doesn’t sound like a credit - it sounds like an interest-free loan.

It is. It’s just like the interest-free loan some people give to the government every year because of consistent over-withholding on their paychecks. But this interest-free loan is a good thing because it’s you are the one who is not paying interest. To be sure, an interest-free loan is not as good as a pure credit that you get to keep forever, but $7,500 is still a nice chunk of change in the form of an “interest-free advance” for the nominal effort of claiming it, if you are eligible.

Note, if you sell your home before the 15 years are over, you owe the remaining balance when you next file. If, however, you sell your home for a loss, the government eats the remaining balance. Same thing is true if you die before the 15 years are up.

You: They actually considered my potential death that when writing the law?

I wouldn’t say your death specifically but death in general: yup

According to the web site Federal Housing Tax Credit, you could save over $8,000 in interest payments compared to likely alternative of financing the full $7,500 over 30 years One last thing: if you know you’re going to qualify, don’t wait until April to get your money. Adjust your W4 at once or you’ll be giving the government an interest-free loan on the interest-free loan they are trying to give you!

"financial education"

Once in a lifetime opportunity for new college grads

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at July 28, 2008 in Cash Flow, Saving Strategies and Tax. 3 Comments

Congratulations! If you just graduated from college, there’s a good chance that you’ll make more money in 2008 then you did in 2007.

You: That’s what they tell me.

In fact, you’ll also make quite a bit more money in 2009 than 2008.

You: How do you know that? You know my raise?

Nope, but in all likelihood, you’ll work less than eight months full-time in 2008. In 2009, you’ll work the whole year. So even if you don’t get a raise at all, your income should dramatically increase from 2007 to 2008 and again from 2008 to 2009.

You: That’s cool, I guess. But where’s the opportunity?

Tax-planning.

You: Sounds boring.

It is boring. You want excitement, go here. That doesn’t work, try visiting here. You want tips that can help you financially, keep reading.

You: Okay. Go ahead, bore me.

Last week, I told you how to determine how little you can withhold without owing the IRS any interest or penalties. If you are a recent graduate who will make dramatically more each year than the previous, you have a major opportunity to increase your net pay right from the outset.

You: Increase my net pay? Maybe this isn’t as boring as I thought.

You don’t want a big income tax refund, right?

You: Right. I don’t. We covered why an income tax is a bad idea earlier.

If you just complete Form W-4 without any thought, you’ll probably put in “1″ for the number of allowances (line 5). As a result, you’ll wind up with a big refund, since the amount withheld each paycheck assumes that you’ll earn your salary for 12 months. Since you’ll only earn that salary for a few months of 2008, too much tax will be withheld. That’s the first reason why you’ll want to increase your allowances to lower your withholdings.

You: Is there a second reason?

<Think game show voice-over man speaking:> In fact there is!

Since you only need to withhold the amount of your prior year’s tax (virtually nothing in 2007 if you were a full-time student), you can even further increase your allowances and thereby dramatically reduce your withholdings.

Increasing your net pay in this manner will allow you to get more money in your hands when you need it most, thanks to the start-up expenses of life including a security deposit, work clothes, and initial emergency fund savings. Just make sure you have enough around next April to pay the piper (should you actually owe the IRS). You can use this handy withholding calculator to help you calculate your allowances (designed to make it so that you neither owe much or get a big refund) or you can spend four days and use the one available at this site.

Figuring this all out is worth it. Personally, I put 10 allowances my first two years of working after graduate school, and still got refunds each year. Not as big as they would have been without adjusting my withholding, but having that money in my initial paychecks to use as needed definitely allowed me to save far more far earlier in my career than I otherwise would have been able to.

Start saving right away by being fiscally responsible. There’s never a better time to develop good, smart financial habits than today.

Let me know what you think and how this works out for you. . .

"financial education"

Friday Q & A: Can I lower my tax withholdings?

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at July 25, 2008 in Q & A and Tax. 0 Comments

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

Michael-

I have a question about the W-4 and changing number of exemptions. I graduated from law school in May 2007 and started my salaried position in Nov. 07. So, if I was to change number of exemptions (I used the withholding calculator on your website and it said to change exemptions to “6″) - would I then OWE money to gov. next April instead of getting a refund? Would there be any other foreseeable disadvantages- any tax penalties?

I was just wondering because I have not had the same salary for several years and since I will be making more for 2008 than i did for 2007, would it be smart to change # of exemptions and take more $ now instead of bigger tax refund or could this backfire next April (could i owe a lot of money to government)?

Thanks so much-love your book!

–Renee R., Chicago, IL

STRAIGHTFORWARD ANSWER

Renee, the calculator tells everyone to put in “6″ so I’m not sure what to tell you.

Just kidding!

In determining the number of allowances to use, the calculator attempts to make it so that you will neither owe nor receive a refund.

More Detailed Explanation

This is a great question, Renee. As you’ve learned, consistently receiving an income tax refund is not a good thing. It amounts to you making an interest-free loan to the government. Don’t be so generous. Instead, adjust your allowances so that each one of your paychecks increases throughout the year. By increasing your allowances, you will reduce your tax withholdings. Since your gross pay is the same and now you are having less taxes withheld, you’ll find that your net pay (what you can spend or save) increases!

The calculator at Total Candor seeks to make it so that you’ll neither owe nor receive an income tax refund. Obviously, this is only as good as the assumptions you enter. Since it’s impossible for most people to predict their exact future income tax (i.e, how much interest they’ll earn or the precise amount of deductions they’ll be eligible for), more than likely you’ll owe a little bit or get a small refund come next April.

What about penalties? Interest?

The IRS rules for penalties and interest related to underpaying your tax are actually very simple.

Okay, not really, but I think most people can follow them.

In order to avoid owing any interest or penalties next year when you file, you must withhold from your paychecks at least the lower of the following two figures:

90% of your total federal income tax for 2008
100% of the total federal income tax you paid in 2007 (You can find this number at line 63 of your 2007 Form 1040. If, however, your 2007 Adjusted Gross Income - line 37 of your Form 1040 - was more than $150,000, then this second figure is actually 110% of your 2007 income tax).

You: Why is this so complicated?

535 members of Congress on the wall, 535 members of Congress. . .

As long as you withhold at least the minimum of those two amounts above, then you will have nothing to worry about with regard to underpayment interest and penalties. However, you could still owe a lot of income tax with your return next April IF you choose to withhold based on last year’s tax and your current year’s income tax is much higher. That’s a sound financial strategy (since it is better to pay later rather than sooner), but you have to be sure to have the money on hand come next April.

Soon, I’ll talk about part 2 of the aforementioned calculator - using it to increase your 401(k) contributions without lowering your net pay.

"financial education"

Stimulus payments - a braggy uncoordinated mess?

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at June 30, 2008 in Ranting and Tax. 8 Comments

Last week, Nickel of 5centnickel wrote of Some Stimulus Payments Diverted to Pay Outstanding Debts.

This got me to thinking about my own personal experience with the stimulus, which I posted on that blog and have provided below:

Whatever you do, just don’t count on knowing when or how you’ll get your money. Since the stimulus was announced, I (and presumably millions of others) have been told:

Although I owed money with my 1040, I’ll receive my stimulus payment in early May via direct deposit, so long as I indicate my direct deposit info on my 1040. (I have a very “low” last two digits of my SSN.)
Early May comes and goes and I get a letter (this one from my Congresswoman; the first was from the IRS) telling me how wonderful it is that I am getting a stimulus. How much did this mailing cost? More or less than the first? How about the check and less self-congratulations about sending me my own money back.
I get another letter last Friday saying that–no matter that I had indicated my direct deposit info on my 1040–since I owed taxes on my 1040, I would be receiving my stimulus via check in about 6 weeks. Thank you for this additional unsolicited letter at a cost to the government, ahem, me, of how much?
My entire stimulus payment is direct deposited into my account earlier this week.

I’m thrilled I never called to ask the IRS what was going on (although it was nearly two months late according to the schedule they voluntarily published.)

Does anybody really believe someone would have told me the answer and be doing anything other than guessing? And my situation is about as straightforward as they come. No liens, no moves, no new accounts, on-time tax filing.

# # #

What’s been your experience with the stimulus payment so far? Get it? Still waiting? How does it compare to what you were told to expect? Did your Congressperson rent a hot air balloon to tout his/her “accomplishment?”

"financial education"

Graduation Speech Part 5: Taxes are taxing

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at June 24, 2008 in Graduation Speech and Tax. 2 Comments

Although I am often asked to speak to recent grads, I have never been asked to speak at any graduations. But if I were, I imagine I would deliver something along the lines of this speech.

Today is part 5. To see the entire speech released so far, click here and read from the bottom up.

Rule 4: Taxes on taxes are taxing

In the real world, you’re going to pay real taxes. You may have already paid some taxes, but you probably haven’t paid real taxes. You will pay far more taxes than you ever expected. It doesn’t matter how much money you make. Even those making way less than the class average; if it’s the first time you’ve had a job, you’ll be shocked at how much you will pay. Of course, the more you make, the more you pay; yet the initial shock still won’t go away.

There’s no incredible lesson here, so quit waiting for it. Sure there are strategies available to legally lower the impact of taxes, but quite honestly the most important thing for you, a new graduate, to understand about taxes is that you will pay them.

So when you’re shopping for a new car or apartment and you think about how much money you’ll be making once your job starts, be careful. If your salary is to be $36,000 a year, you won’t have three grand a month available to you. Not even close. It will be more like two grand. Crazy, but true. Far better to go in with your eyes wide open than to make the all-too-common mistake of a major irreversible financial commitment during that first summer only to find yourself struggling as your new debt starts to really suck . . . your money away from you. All this while despite you’re successfully keeping your day-to-day spending in check. Taxes are real and they can be very taxing, especially if you’re not prepared.

See, number four was quick. Not too much longer until you can throw your cap in the air and catch someone else’s

[To be continued]