Best Tax Moves in 2010

Yahoo! Finance has an interesting feature article on taxes for 2010. While it may seem odd to think about 2010 when you are just gathering together your W2's, receipts, and all sorts of other documents for 2009, it's always best for Everyman to be proactive.

Some of the best on the list:

- Buy a Home

Not only can first-time homebuyers grab an $8,000 tax credit, but now current homeowners who have lived in their residence for 5 of the last 8 years can also qualify for a $6,500 tax credit. And remember, a credit comes straight off of the amount of taxes you pay, not off of the income that is eligible for taxation (thus, a credit is better than a deduction).

- Convert to a Roth IRA

If you think like I do, taxes will go no where but up from here. So why not pay the taxes now and avoid a higher tax bill later? That's what a Roth IRA can do for you. A traditional IRA allows you to contribute tax-free, but requires that you pay taxes upon withdrawal. A Roth does the opposite, allowing you to prepay your tax, but enjoy the ability to withdraw the money tax-free. Like I said before, I expect to be paying a higher share of my income in taxes in the future, so I'd rather pay it now at the lower share rather than waiting for the axe to fall later on.

- Take Your Capital Gains While Tax Rates are Low

The capital gains tax rate is between 0-15%, depending upon what tax bracket you fall in. However, in 2011, the top rate will be 20% - and everyone will pay at least 10%, so it may be in your interest to sell the stock before the end of the year. For example, say you have a number of shares of stock that you purchased when your child was born and sat aside for his/her college fund. Let's further assume (hope) that those shares have appreciated since that time and would be subject to capital gains taxes. Although your child may not need the funds for another year, it might be prudent to sell and be taxed at the lower rate rather than waiting until 2011 and then placing the money in a CD or other low-risk (can't say anything is risk-less any longer) investment instrument.

For the full list, click here.

Woman Takes on the IRS - And Wins!

In a story that should be encouraging to the Everyman out there, a Maryland woman has defied the odds and successfully challenged the IRS. The topic? Tuition for her M.B.A.

Why should you care? First, there is the obvious reason in that it may make it easier for you to deduct your own education expenses. However, I think it is also a step in the right direction for the empowerment of the Everyman in their ongoing battle to retain what they have rightfully earned.

Look, I'm not someone who advocates cheating on your taxes. By all means, give to Caesar what is Caesar's. However, if you can reduce your tax liability within legal parameters, why would you turn that opportunity down? Sure, the government has proven to be responsible investors and a fine example of financial responsibility (yes, that is sarcasm), but I have faith in you, the Everyman, to be able to do with your money what you wish.

Anyway, back to the story. It was ruled that the nurse from Maryland was correct in deducting her tuition expenses on her tax return for her M.B.A. from the University of Phoenix (nearly $15,000). What is more interesting is that she represented herself! Not only did she take on the vaunted Internal Revenue Service, but she did it without lawyers. There is a God!

Taxes on the Internet

There is an interesting article on the WSJ site today touching on the topic of whether or not online gambling winnings are taxable (the answer appears to be yes - go figure...), as well as the rules for deducting your losses (MUCH more vague). If you want to read more, you can check out the article here (subscription may be required).

This leads to my question - another online tax question - when do you have to pay sales tax on the Internet?

Why is this important? If you can get free shipping on an item - and avoid paying sales tax on the item - it can be a significant savings to you. For example, if you were to find a site offering free shipping on a $500 item, you could save $35 if your state had a 7% sales tax.

According to the NOLO site,

If an online retailer has a physical presence in a particular state, such as a store, business office, or warehouse, it must collect sales tax from customers in that state. If a business does not have a physical presence in a state, it is not required to collect sales tax for sales into that state. This rule is derived from a 1992 Supreme Court decision which held that mail-order merchants did not need to collect sales taxes for sales into states where they did not have a physical presence.

It is also noteworthy that some states do not have sales taxes (Alaska, Delaware, Montana, New Hampshire, and Oregon), so they do not suffer any losses through these rules.

So unless the retailer has a physical presence in your state, you are not required to pay the sales tax on that purchase. If you do live in that state, you'll be asked to pay the additional amount to cover the sales tax (this is why you'll see a tagline that reads something like "residents of VT, please add 7% sales tax to total). However, it should also be noted that, theoretically, you are liable for the tax even if they do not ask for it if they actually do have a physical presence in the state. No word on if or how this is enforced, but you can no longer argue that you didn't know about it!

Still, there are ways to save money by purchasing goods online, especially if you can get cheap (or free!) shipping. Just another way that Everyman can save a bit of money!

Cash for Clunkers - Not a Good Idea

Okay, everymen (and everywomen), it's time for a thought about government intervention:

So our spend-and-tax federal government has decided to continue to offer the "Cash for Clunkers" program, which effectively provides up to $4500 to those who will turn in their less-efficient vehicle and purchase a new, more fuel-efficient vehicle.

Don't fall into this trap! Unless you can afford to go and pay for the car up front, you'll end up doing what many participants of this program are doing: taking out an auto loan. Instead of driving that "clunker" - which in many cases is really a pretty good vehicle - that you've had paid off for years, you'll now saddle yourself down with an additional liability - a car payment. There are very few things in this world that this author despises more than a car payment. Not only does the vehicle depreciate with every mile that you drive it, but you also pay interest charges and other financing fees to drive the depreciating asset into the ground (sometimes literally!).

Couple of thoughts:

1. Most people are not going to get the benefit of $4,500. This would entail that your car was literally worthless. If your car was worth $3,000, they are NOT going to give you $3,000 + $4,500 for your car. No, you'll still only receive $4,500. So when you try to justify the purchase of a new car by telling yourself you're getting $7,500 or $4,500 off, don't fool yourself. You're really only getting $1,500 more than you would have had you traded your car in before this program. Is it really worth putting yourself into a position where you have monthly payments to drive a depreciating asset for a $1,500 break on the new car?

2. More directed at the government: say I was driving around a 1987 Caravan (I apologize if some car fanatic out there is saying "they weren't around then!" - I'm not sure when they were first produced, but that's not the point). And my neighbor, who is relatively better off than I am, is driving a 2000 Caravan. While I might be able to get $4,500 for my nearly worthless '87 Caravan, I can't afford to pay for a new car, even with the $4,500 'discount'. Now my neighbor: he can afford to go out and get that brand new car through the "Cash for Clunkers" program. What happens to that 2000 Caravan? It gets destroyed (by law, they must destroy the engine/tranny). Therefore, I'm still stuck driving an even less fuel-efficient vehicle, while a newer one is destroyed. Not only is it a waste, but it decreases the number of used vehicles available - driving the price of used vehicles higher - and giving less work to your local mechanic.

Does anyone else find it interesting that the government is running this program - and they are one of the largest shareholders in the industry? Go figure...

Dialing BACK on Equity Exposure?

I have to comment on this article, found on CNN's Personal Finance site.

The article talks about a "young" couple (38 and 41) that have recently married and are looking for guidance as to what to do with their portfolios. They have a goal of purchasing a new home together in 3 years and make a combined salary of $170,000 per year. So what's my complaint?

The financial planner in the article recommends that they reduce their equity exposure from 80% to 70% of their total portfolio.

WHY? Now if you were planning on doing this a year ago, that would have been a smart choice. However, what you're encouraging now is counter-productive. In essence, they'll need to sell at the bottom of the market cycle to reduce their exposure to equities. If they should be doing anything right, they should keep their exposure at the level they are at or even INCREASE their exposure. Why do I say this?

Equities are at relatively cheap levels. If you've stayed in this far, the WORST thing you can do is to sell. At $170,000/yr, with no kids, they should still be able to reach their goal of $50,000 for a down payment in 3 years time by investing their savings in an online savings account, such as ING Direct.

Disagree? Let me know.

First-Time Home Buyer Tax Credit: Positive?

Real estate professionals, home builders, owners, and many others hope that the new tax credit for first-time home buyers will spur on the housing market out of the state of doldrums it now finds itself in.

While a similar tax credit boosted the housing sector in the 1970’s, a key difference comes with this year’s $7,500 tax credit: it has to be repaid, which turns that credit into the likes of an interest-free loan that must be repaid over 15 years.

According to the National Association of Home Builders website, in order to receive the credit, the closing has to occur before July 1, 2009.

Sounds good, right? I’m not sold…

1) You still have to repay the “credit”. This could end up getting people in trouble if they stretch themselves thinner than they should. Also, many will claim that they did not know it had to be repaid and will likely spend it as such.
2) You don’t receive your “credit” until you file your taxes, unless you change your withholding in the current year (which will raise your take home pay).
3) How much impact will this really have? I don’t foresee home prices halting their decline. I’m going to be potentially in the market for my first home in the near future, but with prices continuing their descent, I’m content to wait for the bottom (even if I do miss the exact bottom by a few months, I don’t feel that we’re there yet). Even Alan Greenspan, the former Chairman of the Federal Reserve believes that we are nine months away from the bottom. Why would someone jump in now? If it turns around, they’ll be right there to jump in (remember, they don’t have houses to sell and can react fairly quickly to market changes).

What would make this work? The answer seems obvious: treat this as a true credit and not an interest-only loan. In other words, don’t require repayment. But is that really the remedy of best choice? To have the government involved in propping up artificially high prices rather than letting the market complete its correction? Not to mention, pumping more money into the economy without production breeds further inflation, does it not?

All in all, I see this tax “credit” as having very little impact and simply adding to the complexity and confusion of our tax code (which is why I believe in proposals to eliminate the income tax and simply go with a national sales tax – but that’s another post!).

So, Everyman, what does this mean to you and your common sense financial decisions? First of all, this whole meltdown should remind us that we shouldn’t overspend our means. People are foreclosing because they thought that if they stretched themselves out, the market would continue to climb and they’d be able to win their gamble by selling for a higher price and taking a profit. But obviously that didn’t work out so well. Instead, it left millions without the ability to pay for their mortgage. And while the government is doing its best to bail out those that were greedy with their money, you shouldn’t put yourself there in the first place.

Be smart with your money. If you can’t afford it, don’t buy it!

Not Everyone Minds Housing Prices Dropping!

Looking through some economic data, I came across what I thought was a very interesting graph (which you’ll see below). It shows that, while housing prices were on a torrid pace through much of the last decade, the percent of income that households are spending on housing is only barely above average since the data set began in 1975.


Because of the housing spike, I expected to see a much higher peak toward the end of this graph, as wages have in no meaningful way kept up with the intense uphill climb of housing prices (and thus, housing would make up a larger portion of household expenses). Why is this? I can think of a few reasons – 1. People couldn’t afford the homes in the first place. Once the introductory rates (i.e. ARMs or Interest-only loans) jumped, they bailed (while leaving the recorded sale price of the home at a record high). 2. More families are relying on dual-incomes. This, naturally, raises the median household income, even though the family is putting in many more hours to be able to afford that same house (instead of 40 hours per week, now it’s 80). My wife and I would like to be able to have one of us at home when we have young kids. But more and more people that we know have found that to be practically impossible.