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Taxes

Whittling Down Our Paychecks to Save on Taxes

March 20, 2017 by Andrew Leave a Comment

Tis the season to file tax returns for 2016.  This is the first year we paid someone else to do it.

Taxes are the largest financial burden that you will shoulder throughout your life, even more so than buying a house or car.  You get the same amount of government services as your neighbor does regardless of who pays more, so I am in the firm mindset of paying as little as legally possible.

My tax idol is the Root Of Good blogger.  He had a great write up a couple of years ago about paying $150 of income tax on a $150,000 income.  I’ve linked to it before, but here it is again because it is a must read for anyone looking to downsize their tax burden.

2016 was the first year that we were able to ‘max out’ all of our tax sheltered retirement accounts.  I ran the numbers and thanks to that saver mindset we managed to avoid an enormous tax bill.

So how exactly did we do it?

Let’s run through the approximate numbers.
Our combined gross income from day jobs was about $133,000.  Shae contributed the employee maximum ($18,000) to her 401k plan.  I also contributed the maximum to my employee 401k plan.  As an added perk to being self employed, I also get to put on the hat of the employer and contributed another $8,000 to my 401k plan.

Shae has good benefits, and one of those is a flexible spending account for dependent care.  She was able to tuck away $5,000 into that account tax free.  Health and dental insurance also come out of the paycheck before taxes are applied, so that was another $3,100 and $350 respectively.

With all of those pre-tax deductions in place, our taxable salaries shrunk down to $80,550.  From there, we have to start adding back some side income.  We made $1600 of taxable interest by churning bank account bonuses.  Our brokerage account kicked off $800 worth of dividends from VTSAX (Vanguard Total Stock Market Mutual Fund).  $750 of those are qualified dividends and depending on your income level don’t get taxed.  We also had rental income for the first time thanks to the addition of our first apartment building.  We only owned it for 2.5 months in 2016, so it is just a glimpse.  While on paper the $150 profit seems paltry, that comes after the magic of depreciation write offs.  We were able to write off around $900 worth of depreciation for the building because in the eyes of the IRS, all buildings will be worth exactly $0 in 27.5 years.  The secondary ‘hidden’ profit that has not been realized yet is the $400 of mortgage principal that was paid off in 2016.

Rounding out the additions and subtractions, we had $2300 in long term capital gains from selling off a chunk of our VTSAX investment to put a down payment on the apartment building.  Like qualified dividends, if you can stay in the 15% tax bracket, you don’t have to pay taxes on LTCGs.  We also fully funded each of our IRA accounts, so that is another $5500 x 2.  Finally, I was able to deduct a portion of my self employment tax.  It sounds like a sweet deal, but self employed people still get royally screwed in taxes.  Normally you as the employee pay half of your Medicare and Social Security taxes and your employer pays the other half.  Self employed folks get to wear both hats and foot both bills so this deduction is a little way to partially offset that.

In the end we finally get to the Adjusted Gross Income, AGI, of about $71,400.

From there, we get to deduct the Standard Deduction and 3 Personal Exemptions.  With the addition of Frugal Girl in 2017 we should pay even less next year!

Taxable income comes in at $45,900 and the tax is about $5,600.  We get one last hurrah before the cash register dings and that is in the form of a $1,000 child tax credit.  Apparently the government wants us to have kids.

There you have it, $4,600 of income taxes on $133,000 gross income.

Now, the important question and why I bother getting onto this soapbox to ramble on about tax sheltering your hard earned money – How much would we have had to pay in taxes if we didn’t contribute to 401ks, IRAs, and Dependent Care accounts?  Let’s run the numbers again with those key differences highlighted.

 

The gross salaries stay the same, but now the 401k’s and dependent care go unfunded.  We really enjoy that big fat paycheck, but it isn’t as rosy as it may seem.  The tax man cometh.

In the hypothetical, we also ignore setting up and contributing to IRAs.  Our adjusted gross income has ballooned from $71,400 to $131,400.  This is bad.  We just moved from the nirvana 15% tax bracket where Uncle Sam is willing to give us a break to the 25% bracket where we need to ‘pay our share’.  Suddenly qualified dividends and long term capital gains are now taxable.  Working down the numbers we eventually come to the conclusion that the unsheltered strategy leaves us with a tax bill of $21,700.  By using tax advantaged accounts, we saved $17,100 in federal income taxes.  The effective tax rate jumps from 3.5% to 16%.  OUCH!

It is practically a “max out one 401k and get one free” kind of deal.  BOGOs on retirement plans.  I’ll take 7 please!

Even with our usage of tax sheltered accounts we still paid boatloads in Social Security and Medicare taxes.  At least with those you’ll likely see anywhere from 60-80% of it returned to you unless you die early.  I also like to pretend that those payments go directly to our parents.  It makes it a little easier to stomach when you think it is going to someone you know.

It took us years of concentrated effort to get to the point of maxing out retirement accounts, so don’t get discouraged if it seems a long way off or impossible.  Even contributing an extra 1 or 2% of your paycheck is a big help and often times the easiest way to ramp up is to tuck away any bonus or promotion money.

Anyway, I just wanted to show a real life example of the power of putting away money into tax advantaged retirement accounts.  We made a lot of mistakes on our way here and there is still a lot for us to learn.  I hope it is useful for someone and if you have any tax tips that I should have mentioned please leave a comment!

Posted in: Finance Tagged: Taxes

2015 Property Tax Bill

April 16, 2016 by Andrew Leave a Comment

Our 2015 property tax bill is now viewable online.  We should be getting a paper copy in a few days.  It is interesting because we are in almost a polar opposite of my parents.  They have a very high county income tax, but pay almost nothing in property taxes.  We have no county income tax, but extremely high property taxes (along with a flat state income tax and high sales taxes).

Screen Shot 2016-04-16 at 9.13.06 AM

Public schools aren’t cheap.  There is no such thing as a free education.

Posted in: Finance Tagged: property, tax, Taxes

It’s That Time of Year Again – Tax Season

March 2, 2016 by Andrew Leave a Comment

Screen Shot 2016-03-01 at 3.38.34 PM

I just submitted our Federal and State income taxes for 2015.  The numbers were very similar to 2014.  We had an effective tax rate of 11% with total income compensation that would place us in the 25% bracket.

This year, like previous years, we did our taxes ourself using pen and paper.  Maybe sometime in the future we will switch over to an accountant or software, but our situation isn’t overly complicated (yet).

  • One W2
  • 1040
  • Ordinary/Qualified dividends
  • Schedule C (business income)
  • Schedule SE (self employment tax)
  • Schedule D (capital gains tax)
  • Form 8949 (helper form for Schedule D)

I like doing taxes ourself because it forces us to learn about the tax code and helps identify what changes we can make to reduce how much we pay.  Software tools such as Turbo Tax like to advertise guarantees for the best refund possible, but they don’t give advice on how to improve for next year.

Screen Shot 2016-03-01 at 3.38.52 PM

For instance, this year I learned that we did not qualify for the dependent care benefit.  I had written previously about using both a FSA, flexible spending account, and the DCB but it turns out that our FSA of $5000 disqualifies us from any DCB credit.  What I did learn however is that it would work with 2 or more dependents.  Tax software isn’t going to tell you that.

Our goal for 2016 is to dump as much money as possible into tax protected accounts.  Taxes in general, but especially income taxes are our largest expense now that our house is paid off.  In 2015, federal income tax, state income tax, property tax, and sales taxes took about a twenty thousand dollar bite out of our budget.  Ya, I don’t like taxes.

You can view last years discussion on taxes here.

Posted in: Finance Tagged: Taxes

End of the Year Tax Forecast

December 16, 2015 by Andrew 2 Comments

With the end of the year in sight, it is time to do our annual tax forecast.  Shae and I like to gather up our numbers and estimate how much of a tax liability we will have in April.  Now is a good time to do it because there is still time to make adjustments to IRA contributions and 4Q estimated payments (due in January) for my business.

A really simple tool to use is Intuit’s TaxCaster.  Intuit is the company that makes TurboTax and Mint.com.  After putting in our numbers, it looks like we’ll end up overpaying if we stay the course.

Tax Caster

Our total tax bill will be about the same as 2014 even though we made more money in 2015.  We were able to squirrel away more income into tax deferred accounts such as 401ks and IRAs this year.  Self employment tax continues to be a major bane as there are no loop holes to get out of it.  Ugh!

For 2016 our goal is to drastically reduce our tax liability by fully funding our retirement accounts.  This year we finished paying off our house so we shouldn’t need as much cash flow in the coming year.  If you want to read a truly inspirational account of one couple paying a meager $150 in income taxes on $150,000 income go read this blog post here.  Spoiler alert, the answer is to shove as much money into tax sheltered accounts as possible and have lots of kids (ok, just 3).

Posted in: Finance Tagged: Taxes

Tax Season

March 17, 2015 by Andrew Leave a Comment

Yesterday I mailed off our federal and state tax returns.  2014 was a good year for us, both in income and reducing our tax burden.  Reducing the amount of taxes that you pay is in my opinion, the best way to increase savings.  You don’t have to work any harder (more hours, second job, etc.) and you don’t have to decrease your spending (i.e. being frugal).

Our marginal tax bracket was 25%, but by contributing to tax advantaged retirement accounts, like a 401k, we were able to drop down into the 15% marginal tax bracket.

Our effective tax rate, what percentage of our income we actually had to pay after all of the deductions and credits was 10.96%.  In other words, we had to earn $1.12 in order to spend $1.  You can figure your own effective tax rate by dividing your total tax (line 63 of form 1040) by your total income (line 22 of form 1040).

The following chart from 2010 shows effective tax rates (AGI instead of net income) grouped according to the income earned.  Our rate is high for our income because it includes the self employment tax (social security and medicaid that is normally paid by your employer).  If we fiddled with our numbers and took out the self employment tax and used adjusted gross income instead of net, our rate would be 6.2%

Screen Shot 2015-03-17 at 1.02.43 PM

 

All in all, I feel like we are successfully managing our tax burden.

Some other points of interest

Our effective rate dropped about 1% point from 2013, thanks largely in part to Frugal Boy.  The extra deductions and credits that come with having a dependent make a sizable difference in your tax bill.

Here are some previous blog posts about reducing one’s tax burden:

  1. Saving for College – This helped save us money on our state taxes
  2. Harvest Time – Discusses how to optimize the selling of stocks to minimize capital gains
  3. Childcare FSA vs Tax Credit – Explains how to make dependent care more affordable for dual income families

Last year’s post about this topic can be found here.

Posted in: DIY Tagged: Taxes, tips
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