Real World Finance$

Monday evening (just after 10 pm) I finally got the tax forms from my side business from our accountant.  I got to claim my part of the loss for the year minus some carryover loss for next year (we are close to getting our first customer, so hopefully there will be some inflows for the first time this year).  The losses added about $400 to our refund for the year between State and Federal.  I stayed up late entering the form and verifying everything before I e-filed my taxes around 11:30.

Yesterday, I got the direct deposit from my State tax refund!  Talk about service!  The IRS is estimating I will have the Federal by the 22nd.

Yesterday was also a pay day for me.  The  exciting part about that is that it was also my first paycheck with employer matching in my 401(k)!  With all that excitement I sat down to update my MS Money file through the end of the month.  The only update I didn’t put in was my next paycheck this month.  I did enter all of our bills through the end of the month (including the four thousand dollar debt payment on the AC) and were are already showing a gain to our net worth of like $2500!

Yes, we will be spending more money on groceries and gas sort of stuff, but that is pretty minimal to another paycheck coming in.  It’s gonna be great this month to see our credit card debt under $50k and our net worth taking a nice big leap forward.

Free Lunch is a book written by David Cay Johnston, a New York Times investigative reporter.  

I had seen a short interview with Mr. Johnston on PBS 6 weeks or so ago.  He was, of course, promoting his book.  With the current election going on, the topics of taxes and government have been on my mind, so this was a very timely read. 

If you are like me, you’ve often wondered why governments lately seem so eager to give tax incentives to businesses to move into their city/county/state.  The common thinking is that those businesses create jobs and generate tax income above the incentives they are given.  As Mr. Johnston shows, there has been little study or regulations to insure that actually happens.  Promises of big businesses to bring in revenue don’t tend to live up to their hype.  In the end, the tax incentives are played off of different cities as an enticement for who will give the most.

I’ve noticed a lot of this here around St. Louis in the last several years.  In an effort to increase the tax base and revenue of the city, they offer incentives in the form of taxes for businesses to relocate inside the city limits.  Yet, we recently had a ballot initiative passed for a half cent increase to sales tax to pay for police and firefighter pension obligations.  Seems we gave away more than we were getting and couldn’t pay for pensions.

Johnston weaves a very elegant story across many industries and parts of the country showing how everyone from professional sports team owners to health insurance companies to home burglar alarm companies are getting a “Free Lunch” thanks to tax dollars.  As a fiscal conservative, I am very pro-market economy. 

To hear is tales of how we are skirting the free market and the end results is very eye opening.  The conclusion of the book is also very well worded and I tend to agree with his point on the best way to fix the problem.  He proposes, in short, that the people of the country pay the full cost of our government.  Including everything from having a house in DC to one in their District to travel and expenses back and forth and other expenses the congressmen see fit.  The caveat to that suggestion is that all their expenses should be transparent and reported publicly on  a congressional website.  He also suggests there should be stiff penalties for ANY kind of gift received.   While more expensive, it should open up the opportunity for the less well off to get into politics as well as cut back on the need to give away things to companies being lobbied for.

While this may not seem to be directly related to your personal finances, taxes are probably the largest single expenditure in the budget of most Americans.  Yet, we often know very little about what happens to that money.  I highly recommend reading this book for an eye opening perspective of what is happening to the 20% of your budget you pay in taxes every year.  One out of every five dollars you make goes to the government for something.  If it was you spending that money, you would watch those expenses like a hawk to keep them under control.  Yet we typically foget those and consider them a sunk cost.  Personally, this book really got me fired up to take control of that 20% of my budget.

I’ve had several posts recently on income taxes and wanted to dig a little deeper.  Here are a couple of my previous posts:

• Tax Credits are Awesome - This will give you a review of the difference between adjustments, deductions and credits when it comes to taxes.
• Taxes and the Rich - This gives some detail on what we are going to talk about including this great link over to an article at Free Money Finance

To get some more detail, I downloaded some tax data from the IRS and used it to do a bit of analysis.  The IRS provided information gives a year by year tax summary from 1986 to 2005.  Here is a summary of the tax data by income group for the year 1986.

Most of these numbers come directly from the IRS with the exception of the Avg. Real Income.  For that number, I took the Total Income, subtracted the Total Income Tax and divided that by the number of Returns.  Here you can see that the top 1% of earners had 15.24% of the income and paid 25.39% of the income tax at an average tax rate of 21.78%.  In contrast, the bottom 50% had slightly higher total income of 15.55%, but paid only 6.67% of the income tax at an average rate of 5.61%.

For 2005:

Here the numbers have changed a bit.  The top earners now have 21.79% of the income, and pay a considerably higher 38.42% of the taxes for an average rate of 21.39%.  The bottom 50% have now dropped in income share to only 12.62% and pay even less of the income tax at 3.17% at an lower rate of 3.05%.

To put thing in perspective, here is the percent change of each of these numbers over that time period.

• Number of Returns - As expected, the number of returns grew at the same rate for all categories, which is the same rate of growth of the population.

• Income- It seems that the income gap has increased as you move up the ladder.  I’m sure part of that has to do with the fact that higher income individuals not only have a higher income to increase, but also are more likely to have investments earning income that lower income individuals are less likely to have.

• Average Income- Even on average, the income for the top 1% has grown over 200%, but way overshadows the 71% growth of the bottom 50%.

• Total Income Tax - It appears that this might help wipe out some of those income gains from the upper brackets.  The top 1% of earners are paying a whopping 285% more income tax with only 200% more income.  That compares to a mere 21% income tax increase for the bottom 50% of earners while they received a 71% income growth.

• Average Tax Rate - And people say the rich are getting all the tax breaks? How about a 1.79% decrease in their average tax rate compared to 45.58% decrease for the lowest 50%?

• Income Share - You see here what we had noticed before on the average income growth, the lowest 50% actually dropped in their share of the total US income while the top 1% showed gains.
• Income Tax Share- In comparison to the income, the groups shares of income tax paid were polar opposites.  The bottom 1% are paying 50% less of the income tax while the top 1% is paying 50% more.
• Real Income- Here’s more of the real test.  The bottom 50% of earners saw their real income gro by 75.85% over the 19 years while the top 1% had real income growth of 203.17%.  To put that in perspective, I figured the annualized growth rate for each category as well.  The bottom 50% saw their real income grow at 3.02% each year, barely outpacing inflation.  The top 1% saw their real income grow at 6.01% a year.

You can see from the above, that really both sides of the tax argument probably have valid points.  Yes, the rich are getting richer as their real income is growing faster.  The poor however, aren’t getting poorer, they just aren’t getting richer as fast.  There are plenty of very valid reasons for that as well. 

I did a little math though on the 2005 tax numbers.  If you were to take the total income tax paid by the bottom 50% of wage earners and divide that among the number of returns filed in all the other brackets, you would get an average additional tax bill of $613.41 per return.    Without giving people in the bottom 50% more money, taking away all their taxes is about as much as you can do tax wise.  That average amount seem pretty minimal and I personally wouldn’t really notice it as I’m getting back more than that on my refund this year. 

Of course, then the next group up would surely complain about their tax burden and so on.  Someone has to pay taxes and there is bound to be some disparity.  While I would like to see some simplification of the rules, I think the current breakout works pretty well.  What do you guys think?

While I was starting work on our taxes over the weekend, my wife asked a question about some tax terminology.  Why?  I don’t know, she brought it up!

Anyway, we discussed what the different terms meant and when they were calculated.  So, I thought I would share some of this with you as well.

First, you start off with your Gross Income for the year.  From there you get things deducted out such as 401(k) contributions, pre-tax medical insurance, etc. from work.  This give you a taxable income that is reported on  your W-2 that you receive.  You next have the following 3 categories, in order.

1. Adjustments - These are things such as student loan interest that come directly off of your taxable income before you calculate taxes.  There is no minimum here to take advantage of an adjustment.  We’ll have about $700 of adjustments this year, which will save us $175 in taxes (or 25%).
2. Deductions - After your adjustments, you arrive at your Adjusted Gross Income (AGI).  From here you now take off deductions.  A standard deduction for a married couple is current about $10,700 per year.  You receive that as a minimum.  If you have deductions such as mortgage interest and real estate taxes that are greater than that minimum, then you file the “long form” and specify those deductions to reduce your taxable income further.  This year it looks like we will have deductions of around $19,000.  Because the standard deduction was $10,700, we only save in taxes for the deductions we have above that amount, so this will save us an additional $2,075 in taxes (25% of 19000 - 10700).
3. Credits- These are the mother load here.  After you’ve factored out your deductions and calculated how much tax you owe, these come straight off of your tax bill.  For instance, if you would owe $10,000 in total taxes for the year and you receive the $1,000 child tax credit, your tax bill is only $9,000.  If you are taxed in the 25% bracket on the last bit of income like I am, then you would have had to have an additional $4,000 of income to pay the $1,000 in taxes you just saved.  A pretty sweet deal I must say.  This year we’ll have about $1,500 in credit due the child tax credit, some final payments for my MBA and a credit for installing our high efficiency heat pump this year.

Now, around St. Louis (well, Missouri in general) there is a wonderful Historic Preservation Tax Credit.  It is a program that allows qualifying properties to be rehabbed to historic specifications and the rehabber can receive up to 50% of the rehab cost back in tax credits.  So, let’s say you buy an old house and spend $40,000 to fix it up and barely squeak out a profit when you sell it.  You’ve now got yourself $20,000 in tax credits.  You can now apply those to your taxes (these are state only, though there are some federal programs as well) and likely not pay any taxes for several years. 

 Some preliminary entries into my tax program and it looks like we will be getting a small refund this year of about $1,500.  This is equivalent to the credit that we will be receiving.  So, we would likely break even or so on taxes if it weren’t for credits.  That’s the way I like it to be.  We also had a bit of liability from my wife’s babysitting job.  She made just a few thousand this year and we never bothered to pay estimated taxes.  Turns out our liability is only like $700, and will be half that or less this year as she is only babysitting through the end of the school year and calling it quits. 

I’ve also got a small business start-up I’ve been working on with some friends of mine.  I funnelled somewhere between $500 and $1,000 into this last year that I will get to write off as a loss once I get the final number.  That might make things a bit better as well.  We are working now to get in touch with some VC guys to bring a salesman on board as our product development is done and the provisional patent is filed.  Wish us luck!

Anyway, have fun starting work on your taxes.  I’ll likely not get a chance to file mine as early as I’d like, but we’ll get there and get that money in the savings account to make some extra debt payments this year!

I was browsing through my Feedburner information when I noticed an unfamiliar blog in my referring sites list.  So, I wandered on over to Debt Free to Live at the Beach to check it out.  Debby has the right idea in my opinion.  Getting out of debt and moving to a warmer climate is high on our priority list as well.  Her most recent post reminded me of the annual HGTV Dream Home Giveaway.  This year they have designed a beach house in the Florida Keys.  It’s a very cool looking place. 

I decided to browse through the rules section and see what happens if you were to win this price.  The home was valued at approximately $2,000,000 and additional prizes such as furnishings and a new car add another couple hundred thousand to that for a total of $2,206,500.  Here are some of the general prize conditions from the website (emphasis mine):

The HGTV Dream Home shall be conveyed to the Grand Prize Winner without representations or warranties, express or implied, other than those, if any, provided by the contractor/developer (”Developer”) from whom HGTV has agreed to acquire the HGTV Dream Home, and other than any applicable manufacturers’ warranties. Real estate transfer taxes, deed recording charges and closing costs, if not the obligation of the Developer pursuant to an agreement with HGTV (the “Home Contract”) to acquire the home, shall be the sole responsibility of the Grand Prize Winner, as will all current and future real estate taxes and all other taxes, costs, fees, and expenses related to the maintenance of the house commencing as of the date the Grand Prize Winner accepts the Grand Prize. Title insurance and homeowners hazard and liability insurance shall be the sole responsibility of the Grand Prize Winner

All costs, taxes, fees, and expenses associated with a prize or the acceptance and use of any element of a prize not specifically addressed above are the sole responsibility of the respective winner. All federal, state, and local taxes on prize are winner’s responsibility. Winner will be issued a 1099 tax form for the ARV of the prize.

Wow, with an ARV of over 2.2 million, I don’t think I’d want to see that 1099. While it might be a great place to live, the only way to afford the taxes on a prize that large is to sell it and use the proceeds to pay the tax bill. Which, were I to win, would have to be the mode of operation. The winner of the drawing is notified by mid March, so I’d have 9 months to get it sold and be ready to pay the taxes on everything. Luckily, even if you sold it well below value I’d have more than enough to pay those expenses plus all my current debt and mortgage as well.

I’ve heard stories in the past about a winners of this prize not being able to afford actually living in the home.  Wish me luck.  I would encourage you to enter as well… but that would lessen my chances of winning!

I couldn’t resist posting a link to this article on Smart Money:

A 2008 Year in Review a Year In Advance

Of course, they are really just talking about predictions for the next year, but writing it as a Year in Review makes it more fun!  Here are some of the highlights and predictions I found interesting…

Who would have dared to predict during the summer dog days … Or that crude would crash 50% all the way down to $80 a barrel?

Yikes!  Down 50% to $80 a barrel.  That’s a bit scary.  Good thing we have a more fuel efficient car now and that I take the bus to work (run on bio-diesel no less).  In reality, I take that line as a bit of a jab at all those doomsayers crying about how high gas prices are going to go.  I’m not sure what makes some news reporter an expert in oil and gas prices in the future.  Maybe they’ll eventually learn they are always wrong and shut up for once!

Mike Huckabee has already been forced to acknowledge that his campaign pledge “to completely eliminate all federal income and payroll taxes” will require much Christian patience given the political realities.The very notion of a President Huckabee had seemed so far-fetched in June, with Hillary Clinton holding a commanding lead in the polls as the recession deepened and consumer confidence continued to plummet. But Michael Bloomberg’s late entry into the race changed everything, splitting the block of voters who believe in evolution while underscoring the creationist candidate’s god-given homespun charm.

In the end, Huckabee attracted a respectable number of college graduates thanks to the wily choice of Ron Paul as his running mate. Paul’s presence on the ticket caused the August gold crash once the polls began to shift in their favor, though bullion is now back above a grand an ounce following the leak of plans to cut IRS staff in half.

Yep, I admit, the idea of a President Huckabee seems a bit far fetched at present.  Though, as a Republican myself, I don’t see a strong candidate in the party at present and it could really be up for grabs at this point.  I admit that his idea of a national sales tax is interesting, but it’s probably not something this country will ever do instantly.  If we were to take that route, I’m sure there would have to be a phasing out period over time as the sales tax increases and the income tax decreases.  They’d have to be sure to work out the bugs on collecting the sales taxes before they could completely drop the income tax.

As 2009 dawns we can toast the nation’s willingness to address longstanding problems head-on and to forge a new consensus out of adversity. U.S. stocks have never been this cheap relative to the rest of the world. And it’s been a long time since real estate has been this affordable. So go ahead and lift a glass to 2008. After a year like that, we deserve a drink.

From the looks of things now, I can hardly disagree with this sentiment.  Next year does not seem to be a smooth road ahead at this point.  Then again, how did things look at this time last year?  Whatever your take on the coming new year, make it a good one for yourself and forget about all the junk predicted by the media. 

Your life is to be lived for you. 

Your money is to be saved for yourself.

I just had the following comment on my previous post about Flat Taxes by Living Almost Large.

We’d be paying a lot more in a flat tax system. But it’s the one I support because it’s more fair. It’ll catch a lot more of the higher income wage earners. But I’m a crazy left wing socialist married to Canadian, so I think paying more taxes better.

First, I never imagined someone would consider paying more taxes a GOOD thing.

Second, when people hear the term Flat Tax and that it is will make the tax system more equal, they assume that means the rich will pay more and the poor will pay less. But let’s look at the facts shall we? You can find the facts on the IRS site, or there is a summary over at Free Money Finance as well.

To have an equal tax system, everyone pays the same rate of taxes on the same dollars of income. So, every 10% of income earned in the US must pay 10% of the taxes.

Currently the top 1% of income earners (people) are making 21% of the total income, but paying 39% of the total taxes. A flat tax would mean they only pay 21% of the taxes, which equates to a 46.2% tax reduction.

On the other side, the bottom 50% of earners (people) are making only 13% of the income, but paying only 3% of the taxes. A flat tax would mean they would have to pay 13% of the tax, which equates to a 430% tax increase.

More taxes on the poor and less taxes on the rich. Fair??? Absolutely. The best way to fix the tax system, probably not.

My suggestion? Let’s reduce the tax rates at all brackets and do away with all deductions. No more tax deductions, adjustments, credits or other incentives to lower your tax bill. Put the first tax bracket at 0% up to some amount and then start at 5% and work your way up to about 20% for the top. Anyone could figure their taxes in minutes and not worry about being wrong.

It would drastically reduce the amount of paperwork and complexity involved while still keeping the current ratios of tax liability.We’d keep the current disparity in taxes paid but allow for a huge savings in staff for the IRS and CPA firms (though those employed there wouldn’t like it I’m sure). It also wouldn’t be too good for the H&R Block’s of the world who make a living selling people tax preparation.

Wow, it must be coming up on the end of the year. It seems like I’m seeing more and more posts around dealing with Taxes. Thought I would give you a quick roundup of some of them:

• No Credit Needed has A Bit About Taxes - Understanding Effective Tax Rates For 2007 - Planning For 2008
• Consumerism Commentary tells us Warren Buffett: Don’t Repeal the Estate Tax
• Free Money Finance has some Facts on Income Tax Payers
• Five Cent Nickel uses taxes as a Another Great Way to Fund Your IRA
• Free Money Finance has some Funny Sayings about Taxes
• All Financial Matters Deals with A Question From a Reader: How to Calculate Taxes

I’ve also had the following posts of late regarding taxes if you want to revisit them:

• Taxes and the Rich
• Budget Cuts - Taxes
• A Flat Tax System: What’s your view?
• The Fallacy of the Mortgage Tax Benefits

Enjoy all this wonderful information. I hope you don’t owe too much in taxes!

I just saw this excellent post over at Free Money Finance titled “Facts on Income Tax Payers“. It details that the top 1% of wage earners make 21% of the income and pay 39% of the taxes while the bottom 50% of earners make 13% of the income and only pay 3% of the taxes.

I also detailed this in my earlier post on the “Flat Tax System“.

Basically, while only 1% of people are earning 1/5th of the total income in the country, they are paying a much higher average tax rate than the bottom 50% of people. FMF details where those income levels lie.

So, this gets me back on my soap box about taxing the rich. Everyone is all for it… until they are the rich. Those top 1% most likely own or run companies that are providing a lot of jobs to the rest of us. Take away their money with taxes and they have less to invest in growing the business and creating more jobs. Tax them more and more services are needed to help out those who can’t get jobs working for them. That requires more taxes and could start a vicious spiral.

I’m sure this post will still ruffle a few feathers the wrong way. If it bothers you that the rich still don’t pay enough taxes, I have a solution for you…. “Become Rich, then we’ll talk.”

One of the benefits I’ve found from using the 60% method to put together our family budget, is that I realized just how much I was having taken out of my paycheck for taxes. When I got my first job out of college I did a fairly decent job of keeping my taxes to almost no refund. I rarely owed or got back more than $100 or so for the first several years.

However, during that time, I was still managing to rack up some debt. You know how it happens. I was working in purchasing and spending thousands of dollars at work every day. Spending $50 on that new cool thing just didn’t seem that expensive.

So, after getting married a few years ago, I decided to keep my single deductions to help us save. At the time, my wife was also working, so we still only got refunds in the neighborhood of $500 - $1000. About 2 years ago though, my wife quite working full-time and I never really bothered to change. Not that I didn’t have the chance. She quite work when we moved for a new job I was taking and I have gone on to 2 others since then.

Anyway, when reviewing my budget, I noticed that approximately 30% of my gross income was paying for taxes every paycheck. Now, this year with deductions we should still fall just barely into the 15% bracket. Then there is about 7% more in Social Security and Medicare taxes. There’s about 3% or so going to State taxes as well. To top it off, the City of St. Louis also has a 1% income tax (it’s okay, my lower property taxes make up for it). Still that leaves me with only about 26% I will need to pay in taxes (will actually be less because of the 10% tax bracket though). Still, that leaves 4% of my gross pay that I’m stocking away to the government every 2 weeks (we had a nearly $4,500 refund last year).

Don’t forget, I was withholding at SINGLE and ZERO exemptions. I just re-did the IRS W-4 form and taking into account the multiple jobs I have, it suggested Married Filing Jointly with 3 exemptions. To see the impact of that, I found a nifty calculator over at Dinkytown. Their Payroll Deductions Calculator lets you compare two different sets of withholdings side by side to see how they will impact your take home pay. For me, the difference come up to around $300 per month.

I’m convinced I need to start reviewing this every year. When I take the time to review my Health care Flex account, I need to review my W-4 as well. I may go back and review my state I-9 as well if I get a refund from the state this year.

Now, the real question is going to be what to do with the extra money. For now, we aren’t really missing it much month to month. However, it is currently coming out of my Committed Expenses part of the budget which is overly burdened at this point. What I’m not funding yet in my budget is my short-term savings (which would have come in handy with replacing the car battery the other day). So, it’s also time to get a savings account set up and complete a new direct deposit form so that the additional money heads directly to the savings account. That means I will have directly moved money from my Committed Expenses budget into Short Term Savings.