- The truth about Tax Refunds – A refund signifies a yearly interest free loan to the IRS. Conversely, if a taxpayer owes the IRS, the IRS charges interest on the amount owed not paid by the due date. (Although the IRS recently started paying interest if a refund is owed and not released to the taxpayer by April 15th or the due date.) The optimal situation is to break even, meaning only a minimal amount should be owed or refunded – between $30 to $100. If a taxpayer receives a refund they must wait, depending on when they file their taxes over a year for the use of their money. Instead change your withholding with your employer (Form W-4), have less money deducted from your paychecks. I understand some taxpayers use their refund as a type of savings account-to use for vacation or to buy a car. A better use would be to open a 3, 6, 12 -month Certificate of Deposit and earn interest. With today’s automation, bank accounts can be set to automatically deposit a preset amount of money from each paycheck to an interest earning account. Compounding interest is the ideal savings account (see Passive Income).
- Credit Unions – I recommend a credit union account over bank account. Credit Unions fees are lower. They offer a variety of compound interest savings accounts, low interest auto loans, mortgages, business and personal loans, and lines of credit.
3. Credit – Use it like cash. I never had a credit card until I started my own business. I have two. One card is for the business to automatically track my monthly expenses by linking to my QuickBooks Online account thus eliminating manual record-keeping. I hold the other credit card for emergencies or personal travel expenses. I kept both in good standing to boost my credit score. Ideally, I never want to pay interest only earn interest so I usually pay my business credit card off each month or pay four times the minimum payment. For personal expenses, if I do not have the cash to pay for something outright, I do not buy it.
4. Line of credit to quickly pay off mortgage or car loan – Scenario: You have a business or a source of recurring income (e.g. W-2, 1099- NEC). Open a personal line of credit for say $10,000. Use the line of credit for expenses but also to make monthly mortgage payments. For example, if your mortgage payment is $1300 a month. Use your regular bank account to make this payment and also the line of credit to make additional payments monthly. Make sure you specify that these payments are for the principal amount not the mortgage interest. Use your monthly revenue from your business to pay yourself or use your recurring income to pay down the line of credit monthly. Rinse, repeat. Several clients have used this method to pay off their mortgages in five to ten years.
5. Interest– avoid paying it.
*Note – although I do not like to pay interest, most credit cards come with extensive perks, such as fraud protection (quite useful when visiting another country and purchasing items online), price protection, and extended warranties. “Credit cards with travel benefits often include such perks as rental car insurance, roadside assistance and lost or delayed baggage insurance, among many others.” Just pay off the balance or most of it every month and leave some uncharged balance for emergencies.
6. Stop listening to advice from nonaccountants about situations affecting your financial health Statements clients have said to me:
“ I heard on FB I should not have a QuickBooks account until my business makes $100,000″. QBs is ideal for small to midsized firms.
“My mortgage lender said we would receive a huge tax deduction if we buy a house now so we rushed to close before the year ended.” Mortgage interest is deductible and beneficial if accumulated for a year or at least six-months and there are other itemized deductions.
“I went to a seminar held by three lawyers who told me to form my business as a C-corporation for asset protection.” One, C-corporations are better suited for big businesses. Two, you must pay yourself as a W-2 employee meaning you must pay on time, quarterly payroll taxes or risk being assessed a $10,000 penalty. Three, you must hold an annual meeting of the Board of Directors and record the monthly/annual meeting. Four, if your business is a start-up, record-keeping, tax preparation, and a variety of other issues are simpler if your business is formed as a sole-proprietorship. Five, until recently many CPAs have little experience with C-corporation tax preparation and many are unfamiliar with the correct way to prepare the tax return (e.g., shareholder loan interest expense -AFR rate, Section 1244 losses).
“I went to a real estate seminar and they do all the paperwork for you to open a business. They formed an S-corporation/Partnership and had me write a promissory note to myself so the business would pay me back.” Small corporations or S-corporations function similarly to C-corporations except the income or loss flows through to the personal tax return (1040) as does partnership income. Thus raising your income and moving it to a higher tax bracket if the business is profitable or lowering your income if the businesses has a loss for the year. Again, a shareholder must pay themselves a reasonable salary as a W-2 employee. An interest earning loan must be set-up to ensure repayment of a promissory note. Also, S-corps and partnerships are flow-through entities meaning a shareholder/owner cannot file their personal tax return until the business return is filed first.
7. Hire a bookkeeper – Scenario: you just started a business. You took an accounting class in college. You want to save money. You have a QBs account. There are negative numbers on the financial statements. “Being cheap is very expensive” the less organized your books the more time it takes an accountant to prepare the financial statements thus charging more (see Things Your CPA Will Not Tell You). Even if it is just once a year hire a bookkeeper (certified) to clean up your books before filing taxes and most importantly reconcile the end-of-year account balances to match the tax return.
8. End of year contributions – If you have a traditional IRA or Health Savings Account (HSA) and have not contributed before filing your taxes, contribute the maximum amount. Traditional IRA and HSA contributions are deductible.
9. Simplified Employer Pension (SEP) IRA – if you are a sole-proprietor or entrepreneur and receive at least $650 of compensation from your business, open a SEP IRA before filing your taxes to reduce taxable income.
10. Cancellation of Debt (COD) – ” My credit card company forgave my $3,500 debt and gave me this form (1099-C) I do not know what it is.” The IRS considers COD income that must be reported when filing taxes.
11. IRA withdrawals – ” I quit my job and cashed in my IRA. I am younger than 59 1/2 but I already paid the taxes.” The IRS will assess a 10% penalty when the taxes are filed.
12. One strategy to consider if you make large contributions to charity consider donating appreciated long-term held securities (i.e., stocks, bonds, options, futures). You would get a charitable deduction for the fair market value of the securities and not have to report the capital gain/loss income.
13. Another strategy to consider with a low mortgage and minimal medical expenses and $10,000 in charitable contributions consider using the standard deduction going forward and loading up this year’s contributions with the next few year’s or put into a donor advised fund (or if over 70 ½ to use part of your RMD for charity).
13. Donation Guidelines – People are always shocked by the difference between their valuation of an donated item and the IRS’.
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