Most Underfunded Private Pension Plans in the S&P 500 (Infographic)

Posted on August 2, 2017 // Leave a Comment

In addition to data on underfunded state pension funds, Bloomberg also has an infographic on private pensions: S&P 500’s Biggest Pension Plans Face $382 Billion Funding Gap. There are at least 20 large corporations that have put aside less than 70% of what they need to pay out their estimated pension obligations. This is even worse than many state governments, which at least have the ability to increase taxes. Here’s the full list along with their specific funding ratios:

pensionsp500

United Airlines was the largest private pension default in US history. I must admit, I don’t really understand the laws behind private pension obligations. In 2002, United Airlines filed for Chapter 11 bankruptcy. In 2005, a federal bankruptcy judge ruled that United Airlines could default their pension obligations and turn the management of pensions over to the Pension Benefit Guaranty Corporation (PBGC). According to this NYT article, the total shortfall was estimated to be $9.8 billion. Even after the PBGC put up $7.3 billion, this still resulted in a significant cut in promised benefits to many retired workers.

Here’s United’s stock price since emerging from bankruptcy in 2006 (via Google Finance):

ual2017

Yet today, I still see United Airlines on this list at 64% funded. I suppose these are Continental Airlines pensions due to their 2010 merger. American Airlines is also on this list at 58% funded (they also tried to dump their pensions back in 2012). I hope these airlines shores up their pension funds while their stock prices are reaching new highs.

The PBGC has never required taxpayer money and is normally funded by insurance premiums, but it could require a bailout if future pension defaults exhaust PBGC funds. I wonder what kind of future return figures are used in these estimates. If they are too optimistic, the situation could be worse than pictured above.

Filed Under: Investing, Taxes //

How Badly Underfunded is Your State’s Retirement Pension Fund? (Infographic)

Posted on July 12, 2017 // 5 Comments

The state of Illinois narrowly avoided having their S&P credit rating dropped to “Junk” status, but their current rating is already the lowest ever for any state. Their pension promises now total over $200 billion, but they are a bit short… $120 billion short. That’s only 40 cents saved for every $1 owed. Unfortunately, your state might not be doing that much better. Here is a Bloomberg graphic America’s Pension Bomb which shows the funding ratio for every state available:

pensionmap

This reminds me of a car wreck in slow-motion. Politicians get to make financial promises that can last 30-50 years, but they are only interested in being elected for the next 2-4 years. How will it end? Will states accept the pain now to fix things and get back on track? Or will they just keep kicking the can down the road until faced with huge tax hikes or maybe even a federal bailout?

If you are a municipal bond investor, Vanguard says not to worry: Despite Illinois’s financial troubles, muni market looks strong. Well, it’s good to see that Illinois is only about 1% of their national, investment-grade muni bond funds. I’m not worried about a crisis in the next few years either, but I also don’t see any evidence that things are getting better. I was planning to diversify my muni bond holdings anyway as my income drops in early retirement. Perhaps it’s time to speed up that timetable.

Filed Under: Investing, Taxes //

H&R Block Desktop Tax Software Discounts: Free $20 Nike Gift Card

Posted on April 3, 2017 // 3 Comments

hrb2016Updated with new deal. If you are still looking for downloadable desktop tax software that doesn’t require your Social Security Number and financial details to be stored in the cloud, here’s a limited-time deal on H&R Block Tax Software 2016.

NewEgg has H&R Block Deluxe Federal + State for $29.99 plus a free $20 Nike Gift card. If you can actually use that $20 Nike gift card, your net cost would be close to $10. The lowest price ever so far for the same H&R Block software on Amazon was $19 during a flash sale.

H&R Block Deluxe includes guidance for stock gains and losses, home mortgage interest deduction, and other itemized deductions. Compare that against TurboTax Deluxe Download which makes you upgrade to TurboTax Premier to get guidance for stock sales and dividends.

Keep in mind that for these products 5 Federal e-Files are included but State e-File is extra ($19.95 for all I believe). I would personally just print the (usually shorter) state return out and snail mail it in if you don’t have a free State e-File option.

Filed Under: Deals & Offers, Taxes //

2017 IRS Federal Income Tax Brackets Breakdown Example (Married w/ 1 Child)

Posted on March 9, 2017 // 5 Comments

irsclip

In a continued attempt to better explain the 2017 federal income tax brackets, here is a graphical breakdown of a simple scenario for a married filing joint couple with 1 dependent. See also my previous examples for a single filer with no dependents and married filing joint with no dependents. I will try to explain the differences in terms such as gross income, taxable income, marginal tax rate, and effective tax rate.

Here is a chart of 2017 federal income tax rates for married joint filers, based on the official IRS tax tables:

2017tbrac_mfj

Simple example. Let’s say your combined gross income is $100,000 a year. You are a married couple with one child under 16, and both earn $50,000 gross income. You are both employees that receive W-2 income only (i.e. neither are self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $100,000 gross income. You each get a personal exemption of $4,050 in 2017, including your dependent child. That’s $4,050 x 3 = $12,150. You also get something called the standard deduction which is $12,700 for married filing joint in 2017. Since you don’t have a lot of itemized deductions, you fall back onto the standard deduction.

2017t_brackets_mfj1kid

The first 24,850 of your gross income is not taxable. Without doing anything special at all, your $100,000 in gross income is now only $75,150 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $18,650 of taxable income is subject to a 10% tax rate. Shave off 10% of $18,650 and put that on your tax bill ($1,865). The remaining $56,500 of taxable income is moved onto the next tax bracket.

The next $57,250 in taxable income is subject to a 15% tax rate. However, we only have $56,500 left. So we shave off 15% of $56,500 ($8,475) and add that to the existing $1,865. The total tax bill is now $10,340.

In this example, this 15% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 15%. Even with a six-figure income, a couple with at least one kid can still land in the 15% marginal tax bracket (pre-tax 401k or IRA contributions would reduce taxable income even more).

Federal Child Tax Credit. As this income doesn’t exceed the phaseout limits and your child is 16 or under, you also get the full $1,000 Child Tax Credit. A tax credit lowers your tax bill dollar-for-dollar as opposed to a deduction that only lowers your taxable income. Thus, your tax bill is reduced from $10,340 to $9,340.

2017t_compare_mfj1kid

Payroll taxes. These aren’t technically federal income taxes, but you must each pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,100 a year for Social Security and $725 a year for Medicare. You both earn $50,000 gross and don’t exceed the income caps. (Your respective employers pay the same amount.)

Overall effective tax rate. You paid $9,340 in federal income taxes on $100,000 of gross income, for an average or overall effective tax rate of 9.34%. Again, you also paid 7.65% in payroll taxes. Your average tax rate is lower than a couple without kids due to the combined effects of the additional personal exemption and the child tax credit. In this specific example, having a kid reduced your tax bill by $937.50 + $1,000 = $1937.50.

Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint with no kids).

2017taverage

Filed Under: Family, Taxes //

Vanguard ETF vs. Mutual Fund Admiral Shares

Posted on March 8, 2017 // 5 Comments

Building My Portfolio BlocksAllan Roth has a new ETF.com article called Why ETFs Won’t Replace Mutual Funds. Inside, he offers the following reasons why if you are buying Vanguard funds, he typically recommends the Admiral Shares mutual fund over the ETF.

Vanguard Mutual fund advantages

  1. Can buy fractional shares
  2. No premium or discount—all transactions are at net asset value
  3. No spreads between bid and ask
  4. Less cash drag, as dividends are reinvested more quickly
  5. Can do a tax-free exchange from mutual funds to ETFs, but not the reverse
  6. Can do automated dollar cost averaging

In the interest of fairness, I will offer up the following:

Vanguard ETF advantages

  • Lower minimum investment amounts. Usually one share is only about $100, and some brokers even offer fractional shares.
  • No purchase or redemption fees. No short-term trading fee. Vanguard has these on a few mutual funds, for example the Vanguard Global ex-US Real Estate Fund Admiral Share charges a 0.25% fee on both purchases and redemptions.
  • You can easily hold, buy, trade Vanguard ETFs at any brokerage firm. The cost to trade will be as with any stock. (Vanguard mutual funds and ETFs trade free with a Vanguard brokerage account.) You might prefer the customer service of another firm, or you might prefer the convenience of having everything together if you hold non-Vanguard investments. You might already have free trades anyway, for example with the Robinhood app.

Expense ratio is a tie with Admiral Shares. I don’t know if it an official “written in stone” polcy, but Vanguard has a long history of keeping the expense ratios of ETFs and Admiral Shares mutual funds the exact same (mostly $10,000 minimum investment). The Investor Class usually has a slightly higher expense ratio (mostly $3,000 minimum).

Tax-efficiency is a tie. I will add in this reminder that in the case of Vanguard (and only Vanguard as far as I know), the ETF and mutual funds share the same underlying investments and thus the same level of tax-efficiency, utilizing the benefits of both where possible. From the Vanguard ETF FAQ:

Are there any tax advantages to owning a Vanguard ETF®?
Because Vanguard ETFs are shares of conventional Vanguard index funds, they can take full advantage of the tax-management strategies available to both conventional funds and ETFs.

Conventional index funds can offset taxable gains by selling securities that have declined in value at a loss. In addition, they tend to trade less frequently than actively managed funds, which means less taxable income gets passed on to shareholders. Vanguard ETFs can also use in-kind redemptions to remove stocks that have greatly increased in value (which trigger large capital gains) from their holdings.

My money. I hold most of my portfolio in Vanguard mutual funds (Admiral Shares). One reason is that I am old and have a good amount of capital gains in the mutual funds bought before ETFs gained traction. I also hold some Vanguard ETFs, mostly bought back when ETFs were cheaper because I didn’t have enough money to qualify for Admiral shares. (Prior to 2010, the minimum for Admiral funds was $100,000! These days the minimums are mostly a more reasonable $10,000.) These days, I don’t have a strong preference, but I slightly prefer the simplicity of buying mutual funds.

Vanguard ETF tool. If you really want to pick at the details, Vanguard offers their own ETF vs. mutual fund cost comparison calculator. It’s pretty good and even includes things like historical bid-ask spreads.

Bottom line. There are certainly differences between ETFs and mutual funds. It is worth comparing the advantages and disadvantages before making your decision. However, in terms of the big picture, we are talking about relatively small differences. Being low-cost, transparent, and diversified are more important features. Given that both have their relative advantages, both ETFs and mutual funds will be around for a long time.

Filed Under: Investing, Retirement, Taxes //

2017 IRS Federal Income Tax Brackets Breakdown Example (Married No Kids)

Posted on March 6, 2017 // 6 Comments

In a continued attempt to better understand the 2017 federal income tax brackets, here is a graphical breakdown of a simple scenario for a married filing joint couple with no dependents. Again, I’ll try to explore the differences in terms such as gross income, taxable income, marginal tax rate, and effective tax rate. See also:

2017 federal income tax rates for married joint filers.

2017tbrac_mfj

Simple example. Let’s say your combined gross income is $120,000 a year. You are a married couple with no dependents and both earn $60,000 gross income. You are both employees that receive W-2 income only (i.e. neither are self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $120,000 gross income. You each get a personal exemption of $4,050 in 2017. You also get something called the standard deduction which is $12,700 for married filing joint in 2017. Since you don’t have a lot of itemized deductions, you use this standard deduction.

2017t_brackets_mfj

The first 20,800 of your gross income is not taxable. Without doing anything special at all, your $120,000 in gross income is now only $99,200 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $18,650 of taxable income is subject to a 10% tax rate. Shave off 10% of $18,650 and put that on your tax bill ($1,865). The remaining $80,550 of taxable is moved onto the next tax bracket.

The next $57,250 in taxable income is subject to a 15% tax rate. Shave off 15% of $57,250 ($8587.50) and add that to the existing $1865. The tax bill is now $10,452.50. The remaining $23,300 of taxable is moved onto the next tax bracket.

The next $77,200 in taxable income is subject to a 25% tax rate. However, we only have $23,300 left. So we shave off 25% of $23,300 ($5825) and add that to the existing $10,452.50. The total tax bill is now $16,277.50.

In this example, this 25% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 25%.

2017t_compare_mfj

Payroll taxes. These aren’t technically federal income taxes, but you must each pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,720 a year for Social Security and $870 a year for Medicare. You both earn $60,000 gross and don’t exceed the income caps. (Your respective employers pay the same amount.)

Overall effective tax rate. You paid $16,278 in federal income taxes on $120,000 of income, for an average or overall effective tax rate of 13.6%. Again, you also paid 7.65% in payroll taxes. You see that two married people earning $60k each pay the same percentage in tax as a single filer earning $60k.

The “marriage penalty” usually occurs when two individuals both with either low- or high-incomes marry. The “marriage bonus” usually comes about when the incomes are quite different. For example, a single person earning $120k in gross income would pay an extra $7,000 in income tax vs. married earning $120k.

Married earning $60k gross annually. Alternatively, a married couple earning $60k gross would pay roughly $3,000 less in income tax vs. single earning $60k (and only reach the 15% marginal tax bracket). Here’s that visualization:

2017t_brackets_mfj60

Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint).

2017taverage

Filed Under: Taxes //

2017 IRS Federal Income Tax Brackets Breakdown Example (Single)

Posted on March 5, 2017 // 7 Comments

Income taxes can be hard to visualize with just a table of numbers. Below, I try to explain the 2017 tax brackets and exemptions system with graphics and simple example of a single worker. What is the difference between gross income, taxable income, marginal tax rate, and effective tax rate? Also see:

2017 federal income tax rates for single filers.

2017tbrac

Simple example. Let’s say your gross income is $60,000 a year. You are single with no dependents. You are an employee that receives W-2 income only (i.e. you are not self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $60,000 gross income. You get something called a personal exemption which is $4,050 in 2017. You also get something called the standard deduction which is $6,350 for singles in 2017. Since you don’t have a lot of itemized deductions, you use this standard deduction.

2017t_brackets

The first 10,400 of your gross income is not taxable. Without doing anything special at all, your $60,000 in gross income is now only $49,600 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $9,325 of taxable income is subject to a 10% tax rate. Shave off 10% of $9,325 and put that on your tax bill ($932.50). The remaining $40,275 of taxable is moved onto the next tax bracket.

The next $28,625 in taxable income is subject to a 15% tax rate. Shave off 15% of $28,625 ($4293.75) and add that to the existing $932.50. The tax bill is now $5,226.25. The remaining $11,650 of taxable is moved onto the next tax bracket.

The next $53,949 in taxable income is subject to a 25% tax rate. However, we only have $11,650 left. So we shave off 25% of $11,700 ($2,912.50) and add that to the existing 5,226.25. The total tax bill is now $8,138.75.

In this example, this 25% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 25%.

2017t_compare

Payroll taxes. These aren’t technically federal income taxes, but you must pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,720 a year for Social Security and $870 a year for Medicare. (Your employer pays the same amount.)

Overall effective tax rate. You paid $8139 in federal income taxes on $60,000 of income, for an average or overall effective tax rate of 13.6%. Again, you also paid 7.65% in payroll taxes. Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint).

2017taverage

Filed Under: Taxes //

IRS Estimated Taxes Due Dates 2017

Posted on January 12, 2017 // 22 Comments

irsclipIf you have significant self-employment or other income outside of your W-2 paycheck that is not subject to witholding (interest, rents, dividends, alimony), you may need to send the IRS some money before the usual tax-filing time. This is my annual reminder to either slide in a last-minute payment for 2016 if needed, or plan ahead for four equal installments in 2017.

Here are the due dates for paying quarterly estimated taxes in 2017; one last one for 2016 tax year and four quarterly installments for 2017 tax year. This is for federal taxes only, state and local tax due dates may be different.

IRS Estimated Tax Payment Calendar for Individuals

Tax Year / Quarter Due Date
2016 Fourth Quarter January 17, 2017* (Tuesday)
2017 First Quarter April 18, 2017 (Tuesday)
2017 Second Quarter June 15, 2017 (Thursday)
2017 Third Quarter September 15, 2017 (Friday)
2017 Fourth Quarter January 16, 2018 * (Tuesday)

 
* You do not have to make the payment due January 17, 2017, if you file your 2016 tax return by January 31, 2017, and pay the entire balance due with your return. You do not have to make the payment due January 16, 2018, if you file your 2016 tax return by January 31, 2018, and pay the entire balance due with your return.

Who needs to pay estimated taxes?
In general, you must pay estimated tax for 2017 if both of the following apply:

  1. You expect to owe at least $1,000 in tax for 2017, after subtracting your withholding and refundable credits.
  2. You expect your withholding and credits to be less than the smaller of
    • 90% of the tax to be shown on your 2017 tax return, or
    • 100% of the tax shown on your 2016 tax return. Your 2016 tax return must cover all 12 months.

If you forget to pay (like I’ve done before), then you should make a payment as soon as possible even though it is late. This will minimize any penalty assessed.

How do I pay? When does the payment count?

  • By check. Fill out the appropriate IRS Form 1040-ES voucher (last page of the PDF) and snail mail to the indicated address. The date of the U.S. postmark is considered the date of payment. No fees besides postage.
  • By online bank transfer. You can store your bank account information and pay via electronic funds transfer at EFTPS.gov or call 1-800-555-4477. It takes a little while to set up an online account initially, so you’ll need to plan ahead. For a one-time payment, you can also use IRS Direct Pay which does not require a sign-up but it also doesn’t store your bank account information for future payments. Both are free (no convenience fees). The date of payment will be noted online.
  • By debit or credit card. Here is page of IRS-approved payment processors. Pay by phone or online. Fees will apply, but the payment will count as paid as soon as you charge the card. You may also earn rewards on your credit card.

The following credit cards currently have the ability to offer rewards equal or greater than 1.87%, meaning you could theortically make money by paying your taxes with them. Please read my card-specific reviews for details.

How much should you pay in estimated taxes? You’ll need to come up with an expected gross income and then estimate your taxes, deductions, and credits for the year. The PDF of Form 1040-ES includes a paper worksheet to calculate how much in quarterly estimated taxes you should pay. You can also try online tax calculators like this one from H&R Block to estimate your 2016 tax liability, and divide by four quarters.

Filed Under: Entrepreneurial, Self-Employment, Taxes //

Free Estate Planning Guide and Workbook from American Red Cross

Posted on January 8, 2017 // 5 Comments

arc_estateIf one of your New Year’s Resolutions is to create an estate plan for you and your loved ones, here’s a good starter kit. The American Red Cross has a free Estate Planning Guide and Workbook which comes in both electronic fillable PDF form or a paper workbook format if you give them your address. It is roughly 50 pages and includes blanks to store your asset and beneficiary information, make future edits when needed, and print multiple copies to share with your attorney and family members. The guide will help you to:

  • Understand estate planning and the importance of having a will.
  • Gather the information they need to prepare to draft or update your will.
  • Discover ways to minimize taxes and liabilities for your families.
  • Explore the benefits of making charitable gifts in your estate plans.

Here’s a snapshot of the Table of Contents:

  • Why Everyone Needs a Will
  • When to Revise Your Will
  • Get a Head Start on Writing or Updating Your Will
  • Three Pillars of Every Estate Plan
  • Will Planning Workbook
  • Charitable Giving Through Your Will or Other Gift Plan
  • Including the Red Cross in Your Will
  • Making a Gift Outside Your Will
  • Gifts that Benefit You and Keep the Red Cross Strong

The American Red Cross also offers another free PDF resource called Disasters and Financial Planning: A Guide for Preparedness and Recovery.

Filed Under: Deals & Offers, Family, Taxes //

ETF Tax-Loss Harvesting: 70% Overlap Rule of Thumb for Substantially Identical

Posted on December 26, 2016 // 2 Comments

calc_10keyTax-loss harvesting (TLH) is a common practice used to improve after-tax returns by realizing losses to either offset realized capital gains or to defer capital gains into the future. Many robo-advisors including Betterment and Wealthfront offer automated tax-loss harvesting as a feature. As nearly all of them hold ETFs, they accomplish this by selling the primary ETF for each asset class and replacing it temporarily with an alternative, secondary ETF. DIY investors can perform a similar maneuver as well.

The IRS wash sale rule states that you can’t deduct a loss by selling a security and immediately replacing it with something “substantially identical”. Instead, harvesters buy an ETF that is slightly different. It’s a grey area, as there is no solid definition of what “substantially identical” means. However, this recent Barron’s article (paywall, use Google News) offered up a rough rule of thumb that I hadn’t seen before (bolding mine):

Although the wash-sale rule remains ambiguous, there may be an alternative standard that investors can use for guidance. In the 1980s, the IRS created the “straddle rules” to address a loophole in hedged long-short portfolios. For tax-loss purposes, the portfolios on the long side couldn’t be “substantially similar” to those on the short, which the IRS defined as having over 70% overlap. “Some people use the straddle-rules definition as a surrogate to apply to the wash-sale rule,” says Eric Fox, a principal at Deloitte Tax. “If two ETFs don’t have more than 70% overlap and they’re not substantially similar, how could they ever be considered substantially identical?” That should give loss harvesters some confidence.

I was surprised by the conservativeness of this rule of thumb. Most of the TLH articles I have read by both human and software-based advisors implement more aggressive strategies than the 70% maximum overlap suggested above. A traditional advisor quoted in the Barron’s article admitted swapping between the Vanguard Total International Stock ETF (VXUS) and the Vanguard FTSE All-World ex-US ETF (VEU). VXUS and VEU have a 76% overlap by weight, according to this ETFResearchCenter.com Overlap Tool:

etf_tax1

Perhaps more importantly, these two ETFs have a near 100% performance correlation. Here’s a chart of the two ETFs over the last 12 months, per Morningstar (click to enlarge):

etf_tax2

Meanwhile, this Wealthfront whitepaper shows their ETF tax-loss pairings and their correlations. Out of the 7 pairs, 4 have correlations of 97%+ and all of them are over 70%.

etf_tax3

Commentary. There are few firm answers here. If robo-advisors marketing aggressive ETF tax-loss harvesting gather a lot of assets, I suspect the IRS will eventually provide additional guidance. I imagine the worst-case scenario as the IRS classifying past trades as violating the wash sale rule, nullifying your tax losses and possibly imposing additional penalties. I guess current practitioners don’t see a big risk of that happening. They essentially see a nearly free lunch by substituting these similar ETFs. Still, when you market something publicly as 99% correlated, aren’t you basically admitting that they are “substantially identical”?

Filed Under: Investing, Taxes //

Credit Karma Tax 2019: $0 Federal and $0 State Tax Filing w/ No Last-Minute Charges

Posted on December 12, 2016 // 22 Comments

cktax0Tax season is officially here and the IRS is accepting E-files. For you early birds, Credit Karma Tax is now on its 4th year of offering 100% free Federal AND State tax preparation software with free e-File and no income restrictions. You can have itemized deductions, business income, self-employment tax, and/or capital gains and losses. They now also have a Max Refund Guarantee, Accurate Calculations Guarantee, and Audit Defense include if you get audited.

My favorite feature of this product is that there is no “upgrade” version, so there are no upsells and no last-minute fees. Your bill will always be $0 Federal, $0 State. I hate the feeling when you have spent hours (days?!) typing in all that data and you expect a certain price, but then at the very end they want to charge you a little bit more. You are just too tired to do it all over again, so you accept, but it leaves a bad taste in your mouth.

cktax1

Is this legit? What’s the catch? Yes, they are legit. Credit Karma purchased AFJC Corporation, which was a private-label software provider and previously supplied the online tax software for Jackson Hewitt. They’ve been running this offer since 2016.

The “catch” is that you must also sign up for the main CreditKarma.com site, which takes your personal information and provides you access to your credit scores and reports from two of the three major consumer credit bureaus. They make money by also using that personal information to show you customized advertisements for things like credit cards, banking, and insurance products.

What’s included.

  • Free Federal filing with free e-File for 90%+ of filers with no income restrictions.
  • Free State filing for 40 states + Washington DC. (Some states don’t have income tax).
  • No upsells, no upgrades, no “premium version”.
  • You can print and snail mail if you choose not to e-File.

Here are some popular forms included by Credit Karma Tax that other “Free” editions probably don’t cover:

  • Schedule C – Profit or Loss from Business (Sole Proprietorship)
  • Schedule D – Capital Gains and Losses (Stock Sales)
  • Schedule E – Supplemental Income and Loss (Rental property)
  • Schedule SE – Self-employment tax

What’s NOT included. Credit Karma will NOT support the following forms this year:

  • Multiple state filings
  • Part-year state filing
  • Foreign earned income
  • State returns for married filing separately in community property states*
  • State filing without a federal filing

No business tax returns. Credit Karma Tax supports Sole Proprietorships and income reportable on a Schedule C/E/SE, but does NOT yet support business tax returns for an S corporation, C corporation, partnership or multi-member LLC.

Tell me more about how Credit Karma makes money. Quoted from their site:

When you visit Credit Karma, we show you offers and recommendations (like credit cards or loans) that could save you money. If you take one of these offers, the bank or lender usually pays us. We never charge you a dime. And we never sell your info to marketers.

For example, if they know you have a 4% rate mortgage, they could sell you a 3.5% refinance mortgage. If they know you are older and have a paid-off home (i.e. you pay property taxes but no claim no mortgage interest), they could sell you a reverse mortgage. If they know your income, they can estimate the amount of life insurance you need. You could actually like this customization, be creeped out completely, or simply plan to ignore the ads.

Try before you commit. Nearly all the online tax prep software only bills you when you are ready to file. If you’re not sold on a single product, why not sign up and do this and a competitor side-by-side in two different browser tabs. It’s a bit more work, but not a lot if you’re doing it simultaneously. That way, you can double-check the calculations. Ideally, you should get the same refund/due amount for both and then you can file for free!

Bottom line. Credit Karma Tax will give you free Federal and State tax returns. There is no other version, so you will never be hit with a last-minute upcharge. In exchange, you let them show you ads based on your financial data. In terms of technical accuracy, I expect that they are roughly equal to the other major providers. However, you may value the convenience factors offered by competitors (easily import last year’s data, unlimited phone support, automatic import of 1099-B tax lot data).

Filed Under: Deals & Offers, Taxes //

Mortgages, Imputed Rent, and Early Retirement

Posted on May 3, 2016 // 15 Comments

mcman286In a Quora question What do economists think about buying vs renting a house?, in addition to the previously-mentioned answer by Alex Tabarrok of Marginal Revolution, there was another well-ranked answer by Erik Brynjolfsson, professor at MIT Sloan. One of his three points was about the value of imputed rent (read the other ones as well):

Second, there’s a huge tax benefit to housing which comes from the hidden “dividend” it pays. I’m not talking (just) about the (too) generous mortgage deduction, but rather the fact that you don’t have to pay taxes on the implicit rent you earn on your house since its paid to yourself. A house generates enormous rental value each month — like a dividend. If you rent it to yourself, you take the money out of one pocket and pay it to the other one, and the IRS doesn’t tax that. In contrast, if you earn money some other way and then use that money to pay rent, you probably also have to pay taxes. That can add up.

From the Wikipedia entry on imputed rent:

Consider a model: two people, A and B, each of whom owns property. If A lives in B’s property, and B lives in A’s, two financial transactions take place: each pays rent to the other. But if A and B are both owner-occupiers, no money changes hands even though the same economic relationships exists; there are still two owners and two occupiers, but the transactions between them no longer go through the market. The amount that would have changed hands had the owner and occupier been different persons is called the imputed rent.

In other words, as a homeowner you could be considered both the landlord and the renter. Let’s say you would rent your house for $1,600 a month. If you were in the 25% marginal tax bracket, you have to earn $2,133 a month pre-tax to cover that rent (and pay $533 in income tax).

As part of my “rough model” of early retirement, I recommend setting your mortgage payoff date to coincide with your retirement date (for those that choose to buy a home). Part of the reason for that is that you won’t have to generate that extra income to pay your mortgage anymore. This could lower your marginal tax bracket into the next lower bracket, and also the tax rate on your capital gains.

For example, $1,600 in monthly rent equates to nearly $20,000 a year in after-tax expense, or nearly $26,000 in gross income at the 25% tax bracket. Here are the 2016 federal income tax rates (source):

2016taxschwab

Ideally, I would target my household expenses to stay in the 15% tax bracket for married joint filers in retirement. Being able to reduce my taxable income by over $25,000 would definitely help someone stay in the 15% tax bracket range. Also, if you are the in 15% ordinary income tax bracket, your tax rate on qualified dividends and long-term capital gains becomes zero!

Now, the idea of imputed income could be extended further. When I cook at home, I save the money from eating out an Applebee’s. Let’s say a dinner out costs $40 for the family. To reach $40 after-tax, I’d have to generate $53 of income at a 25% tax rate. Same with childcare, housekeeping, laundry, yard maintenance, etc. But housing is an area with significant impact, usually the biggest item in a household budget.

Filed Under: Real Estate, Retirement, Taxes //
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