Wednesday, April 20, 2016

Taming Taxes



https://www.flickr.com/photos/68751915@N05/6757828303/in/photolist-biaCV6-r3bLLd-qGtgK8-qSjpTY-pUhtYL-r37xKF-4tnSX5-6Dx9pm-njS7LN-6fnM8R-9zW28D-8JyCym-BBrrv1-6Dt2Hi-8RV3yD-6DsZm4-6DxbXb-rd1ir7-6fnExi-6fPpGY-r8qx8X-uaA1p3-q2TLsw-btTCP2-pEqJpE-6QmDL3-7TYV8-6Dt2aT-cSbQ8q-qYPiWm-6Dxbmu-dXqemK-aPCUhr-bUmuUb-nJBj59-7Xumz-cocQ3C-i33ed-6fd3zJ-9mx5XZ-r1GpX8-ec8kac-r4dsGh-3P99U-8N9Ws6-po6eEL-6Dx7BG-axuhRV-ykkWTJ-h6MeKI can’t say I completely dread April 15th. For one thing, it’s my brother-in-law’s birthday, so it’s not all doom and gloom. But finding out if I’ll get a tax refund or if I will owe money does make me a bit anxious. See, I’m one of those who believes that getting a big tax refund means you have actually lost money. You’ve given Uncle Sam an interest free loan for a year, which coincidentally means you lost the opportunity to invest that money and have it work for you. My goal, therefore, is to end up owing something like $200 to $500 come tax day – an amount small enough to pay without too much pain, but still not a refund.


For 2014, I failed miserably in this goal. We ended up owing $1,400 federal and $900 state taxes. When I found that out, I made some changes to our withholding rates. I had my wife change her withholding to the “married, but withhold at the higher single rate” level. I also had an additional $90 tax per month withheld from our combined paychecks. I didn’t know how much more the single higher rate would take, but the additional withholding added another $720 per year to our paid taxes. (I made the change at the end of April, so it only was in effect for 8 months). In theory, that should at least cut the federal tax due in April in half, assuming we would owe a similar amount in 2015. I also made an estimated tax payment of about $250 in August. Those two things together meant we withheld at least $970 MORE for our 2015 taxes than we did for 2014. I thought that would ensure our tax bill would be lower this April.

Epic fail.

The tax gods laughed at my feeble attempts to tame them. For 2015, we ended up owing $1,900 in federal taxes! That’s more than we owed the previous year, even though we were having more taxes withheld. The good news was that we got a $400 refund from the state. (The bad news is that we had to pay $400 to our CPA to do our taxes. Goodbye, refund!)

What happened?

In looking at my tax return, it seems there were three factors that resulted in a larger tax bill for me this year: online course sales, stocks, and lack of a tax credit.

Online Course Sales

My online course sales are reported as self-employment income. This means I have to pay not only my income tax, but also the Social Security and Medicare tax that is normally paid by the employer. In 2015, I had roughly $4,000 in self-employment income, which was higher than the year before, so that resulted in a larger tax bill.

Stocks

I invest my money in stock, particularly Realty Income stock. Realty Income has structured their business as a real estate investment trust (REIT). This provides the company with tax advantages but it also means its dividends to shareholders are taxed as ordinary income and subject to the higher ordinary income tax rate rather than the lower dividend tax rate that dividends from a non-REIT company would incur. Additionally, Realty Income’s stock experienced a large increase in value in 2015 and I sold my shares to move my funds into a hard money loan. That meant a big capital gains hit for me – almost equally split between the higher short term capital gains rate and the lower long term rate.

No 2015 Tax Credit

In 2014, I received a tax credit of a couple hundred dollars whereas in 2015, I did not. I have forgotten what this was for. It might have been from improvements related to an energy audit I had done, although my blog post at the time said the applicable tax credits had expired in 2013. Truthfully, I don't really care enough to go back and dig through my old tax returns to find out what exactly the credit was for because tax forms, amiright? I'm just content to identify that this was a contributor to the difference between last year and this year.

Going Forward

Look, I’m not complaining about paying taxes. The reason I owe more taxes this year is because I made more money. I’d be foolish to complain about that. And I’m not complaining about paying taxes in general. I live in this country and expect to pay my share for the benefits all Americans enjoy. I drive on the roads and interstates; the police and fire department will come whenever I may call; I fly in and order things transported by planes directed by federal air traffic controllers; I have collected unemployment benefits when I’ve been laid off. No, I’m not complaining about taxes. I’m complaining about how absurdly complicated the system is and how hard it is to make a coherent budget for them. When people end up owing taxes, the amount they owe is usually a complete surprise. The entire amount must be paid by April 15th, so there’s not really a good way to spread the payments out over time (short of paying by credit card, which will end up costing you more in interest charges).

How I’m Handling This

Once again, I’ve modified my tax strategy in an attempt to prevent another huge tax bill next year. I increased our additional tax withholding amount from $90 per month to $250. That forced me to make some adjustments to our budget, which mainly involved cutting back on the amount we were saving from our paychecks towards the Tesla (*sniff*) and a replacement for my wife’s car.

(You can specify additional tax to be withheld from your pay on line 6 of your W-4. Note that the figure you enter here is a per-paycheck amount, so this much will be withheld each time you are paid.)



In order to compensate for self-employment tax, I’ve decided to save 15% of each month’s course earnings and send it in quarterly as estimated tax payments. The self-employment tax rate is 15.3%, which is comprised of a 12.4% Social Security tax and a 2.9% Medicare tax. However, the employer portion of that amount (which is half) is tax deductible. That’s a deduction, not a credit, however, which means it reduces your taxable income, not your tax owed. So if your tax rate is 28%, you get back 28% of that 50% of that 15.3%. Yeah, taxes are stupidly complicated.

Anyway, by just sending in 15% of each month’s income, I should cover the self-employment tax and the increased additional withholding should cover anything else. I'm hoping that come next April, everything will be sunshine and rainbows!


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