I cannot say this enough: EVERYONE must have an emergency fund! It is, short of food, shelter and clothing, the most important financial goal you should have. I would put it up there with budgeting as the greatest unlearned financial lesson of our time. Three to six months of expenses, in a reasonably accesible place (bank account). The choice between 3 and 6 months depends on the reliability of your job. Despite recent history, a government job or being in the military usually means 3 months. Unstable or new job means 6 months.
The good news is that it's not 3 to 6 months of income, it's 3 to 6 months of expenses. Add up all your monthly bills that you have to pay (you can cancel cable but not electricity), add in reasonable amounts for food, gas and other expenses (leave out eating out), and you have a good monthly amount. Multiply by the number of months and you have your goal. If you have slack in your budget such that you can get there in 6 months or less, just do it and ignore the rest of this article. If your budget is tight, keep reading.
I give this advice to at least a hundred people a year, and at least 98 tell me there is simply no money in their budget to make it happen. This is, to say it politely, bulls**t. The tighter your budget, the more important an emergency fund is, because you can't afford an emergency! And one WILL happen. Here's a good hierarchy for how to make an emergency fund work without a good, flexible budget.
1. If you have no emergency fund, stop your 401K contributions, cancel your cable, cancel your Netflix, sell expensive, unecessary crap you have around the house, eat beans and rice every day, buy NOTHING that is not essential to survival, NEVER eat or drink anything you didn't make at home, and save all that money until you have one month of expenses.
2. Once you have one month, you can eat an inexpensive variety of food, at home, but not out on town. You can also buy small amounts of non-essentials (like an occasional coffee at Starbucks). Once you have 3 months expenses, you can slowly reintroduce expenses into your life. Now comes the hard part:
3. Write a budget. Really - you HAVE to have one. Rich people have budgets, it's how they stay rich. You need one more. You just figured out the minimum you need to live in basic comfort (what you spent a month to get 3 months saved up.) Start there and compare it to your income. Add back retirement savings, cable, Netflix, some extravagances like eating out, and other items based on your priority. Add an amount for continuous emergency fund funding. Ideally this should be at least 5% of your total desired emergency fund. This way, when an emergency happens, you have a way to rebuild it. Use this money to get to your goal if it is more than 3 months.
4. If you're lucky enough not to have an emergency for a while, use the excess above your target to occasionally buy yourself something cool (like some of the stuff you sold to get an emergency fund). This is your reward for good financial planning.
DO NOT IGNORE THIS!!
Emergencies happen - be prepared!
This is my favorite book on personal finance:
Monday, October 21, 2013
Saturday, October 5, 2013
Don't Pay Capital Gains Taxes if You Don't Have To!
If you like the blog, buy my book: Everyday Taxes only $5.99 for Kindle!
I've been mulling over a post about this for quite a while. If you've read this blog before you probably know that I like numbers and specific directions. That is the problem with this post. I've come to the conclusion that it is simply too difficult to cover all the different scenarios that would allow this in a way that people could apply it to their particular tax situations. Because of that, I've decided to write a more general post that suggests when you should consider selling appreciated stock in order to avoid Capital Gains taxes. I will then give advice on how to get accurate numbers in your situation to determine how much to sell.
First and foremost, if you are not in the 15% tax bracket or below, stop reading. This won't work for you.
If you are, then you can cash in appreciated stock or mutual funds at a 0% tax rate so long as the gains do not put your taxable income above the 15% tax bracket. You can then immediately buy the same stock back (if you want) and the new price will be what is later used to figure gain when you sell it again. You can do this every year and effectively eliminate gains from potential taxation!
Here is a list of things to consider when determining if it's worth contacting your tax guy for help on this:
Much of the above involves over simplifications but it gives you a starting point to see if you might be close.
If the above apply to you, wait until Mid November, and contact your tax guy. Provide him with copies of your recent pay-stubs from all your jobs, as well as amounts of any other taxable income you have or expect to receive before the end of the year (interest, dividends, capital gains, etc.) He should be able to calculate how much gain you can have and still pay 0 taxes on it. Don't worry if it's not perfect, even if you go over a little, only the portion above the 15% tax rate gets taxed, and this at a favorable rate. Once you have this number, review your unrealized gains and losses information from your brokerage account and determine what to sell to stay below the number he provided.
You can do this every year you are in the 15% tax bracket!
Let's look at a simplified example:
You're Married, have $48,000 in wages and $2000 of interest and dividends. You have no kids and take the standard deduction. This means your Adjusted Gross Income is $50,000 and you get to subtract $20,000 from this to get taxable income ($12,200 standard deduction and $3900 for each exemption (you and your wife - you'd get $3900 for each kid if you had them)). So your taxable income is $30,000. This means you can have another $42,500 of income before you hit the 25% tax bracket.
So now lets assume you were an investing genius, and a stock you bought two years ago for $10,000 is now worth $110,000 (can I get some investing tips from you?) This means you have $100,000 in unrealized gains that will eventually be taxable income if the stock stays up in price and you don't give it away or do something else weird with it. Who wants to pay tax on $100,000?
So in this scenario, you can sell a portion of it, such that your profit would be $40000 (don't push it too close to the line) and you would pay $0 in taxes on it. Buy it back right away and your basis (what you paid for it) is now $50000. Your potential taxable gain is down to $60,000! If your situation stays the same for two more years, you could do it over and over until you had no gain to pay taxes on!
Obviously this is complicated, and I have over-simplified it. Talk to both your investment adviser AND your tax guy before you do it. But if all the bulleted points above apply to you - make the call!
I've been mulling over a post about this for quite a while. If you've read this blog before you probably know that I like numbers and specific directions. That is the problem with this post. I've come to the conclusion that it is simply too difficult to cover all the different scenarios that would allow this in a way that people could apply it to their particular tax situations. Because of that, I've decided to write a more general post that suggests when you should consider selling appreciated stock in order to avoid Capital Gains taxes. I will then give advice on how to get accurate numbers in your situation to determine how much to sell.
First and foremost, if you are not in the 15% tax bracket or below, stop reading. This won't work for you.
If you are, then you can cash in appreciated stock or mutual funds at a 0% tax rate so long as the gains do not put your taxable income above the 15% tax bracket. You can then immediately buy the same stock back (if you want) and the new price will be what is later used to figure gain when you sell it again. You can do this every year and effectively eliminate gains from potential taxation!
Here is a list of things to consider when determining if it's worth contacting your tax guy for help on this:
- For 2013, your taxable income should be several thousand dollars below: $36250 if filing Single, $72500 if filing Married Filing Jointly, $48600 if filing Head of Household (taxable income is basically your income after all adjustments for deductions and exemptions)
- You have unrealized gains in taxable brokerage accounts or mutual funds that you have held for more than a year (in most cases this means you have stocks or mutual funds that are worth more than you originally paid for them)
- You're not under age 19 (24 if in school)
- You're not receiving Earned Income Credit on your tax return
- You're not receiving Social Security payments (if this is most of your income you might still benefit)
- Buying and Selling stocks or mutual funds in your taxable accounts doesn't cost too much in commissions
Much of the above involves over simplifications but it gives you a starting point to see if you might be close.
If the above apply to you, wait until Mid November, and contact your tax guy. Provide him with copies of your recent pay-stubs from all your jobs, as well as amounts of any other taxable income you have or expect to receive before the end of the year (interest, dividends, capital gains, etc.) He should be able to calculate how much gain you can have and still pay 0 taxes on it. Don't worry if it's not perfect, even if you go over a little, only the portion above the 15% tax rate gets taxed, and this at a favorable rate. Once you have this number, review your unrealized gains and losses information from your brokerage account and determine what to sell to stay below the number he provided.
You can do this every year you are in the 15% tax bracket!
Let's look at a simplified example:
You're Married, have $48,000 in wages and $2000 of interest and dividends. You have no kids and take the standard deduction. This means your Adjusted Gross Income is $50,000 and you get to subtract $20,000 from this to get taxable income ($12,200 standard deduction and $3900 for each exemption (you and your wife - you'd get $3900 for each kid if you had them)). So your taxable income is $30,000. This means you can have another $42,500 of income before you hit the 25% tax bracket.
So now lets assume you were an investing genius, and a stock you bought two years ago for $10,000 is now worth $110,000 (can I get some investing tips from you?) This means you have $100,000 in unrealized gains that will eventually be taxable income if the stock stays up in price and you don't give it away or do something else weird with it. Who wants to pay tax on $100,000?
So in this scenario, you can sell a portion of it, such that your profit would be $40000 (don't push it too close to the line) and you would pay $0 in taxes on it. Buy it back right away and your basis (what you paid for it) is now $50000. Your potential taxable gain is down to $60,000! If your situation stays the same for two more years, you could do it over and over until you had no gain to pay taxes on!
Obviously this is complicated, and I have over-simplified it. Talk to both your investment adviser AND your tax guy before you do it. But if all the bulleted points above apply to you - make the call!
Friday, October 4, 2013
Government Shutdown and the IRS
So the government is shutdown, but you have tax issues to deal with the IRS about. What should you do? The IRS has issued information on that very topic, and I have provided a link below.
My summary:
My summary:
- Continue filing tax returns, electronically and on paper that you are required to (specifically the 10/15 extended deadline still applies)
- Continue making any required tax payments and estimated payments
- Tax returns may not be processed, but will be considered timely filed under the usual rules (e-filing will likely get a return processed, but no refund issued)
- Refunds will not be paid until a CR authorizes it
- Transcripts through the automated process are still available
- 3rd parties can't get copies of your transcript (this may cause problems if you are applying for a mortgage)
- Automated phone systems are operating
- IRS website is operating but may not have all functions available
- IRS representatives may not be available in person or over the phone
Tuesday, October 1, 2013
Cancelled Debt and Insolvency
If you like the blog, buy my book: Everyday Taxes 2016 both the kindle and print versions have detailed information on this topic, and links to an excel spreadsheet version of the INSOLVENCY WORKSHEET. This is available only to book buyers. The book is a must for everyone, regardless of how they do their taxes.
So you got a 1099C, or were informed by someone you owe money to that they're canceling some of your debt. Maybe you were foreclosed on, had your car repossessed, or negotiated a settlement to pay a credit card less than what you owe. If you haven't gotten a 1099C yet, you will. Now is the time to get prepared. I wrote an earlier post on cancellation of debt in general, which you should read before continuing: http://www.supertaxgenius.blogspot.com/2012/03/i-got-1099c-now-what.html
I'll wait...take your time...
Okay, so now let's talk about how to find out if you're insolvent. First look at the 1099C, box 1 and note the date. If you don't have the 1099C, use the date the debt was forgiven (you can call the lender to figure this out.) You will use this date and figure out, as of that date, how much your assets were, and how much your liabilities were. Your assets are everything you own, your liabilities are everything you owe.
We'll start with liabilities first. Start with the debt that was canceled, the debt they canceled counts as a liability, so that's your first number. Go to your credit cards, mortgages, car loans and any other money that you owe. Print out the first statement after the date in question. Now review the statement and determine what you owed as of our date. You can do this by highlighting the beginning balance and any charges or payments up to our date. Add the balance and charges, subtract any payments, and write this number on the statement. Repeat for all of your debts, and then add them up to get a total amount of liabilities. SAVE each of the statements! The IRS can ask you to prove how insolvent you were.
Now assets. Start with your bank accounts, brokerage statements, investments etc. Print out each statement and highlight the value on the date in question. For checking accounts, they usually keep a running total. For brokerages, they may only give you a monthly balance. If you can, go online and get the actual balance on our date. Print the screen with this balance and keep it with the statement for that account. If you can't get an exact amount, use the balance closest to our date. Make sure to do this for your retirement plan at work (401K, 403B, TSP, etc.), as well as any Individual Retirement Accounts.
Now it gets harder. For any vehicles you have, go to kbb.com or edmunds.com and determine the value of them. You can use some judgment to get the best value (lower is better) but be reasonable. If your car is truly a piece of s**t and you are using that to drop the value, take pictures to justify this assessment. It's also not a bad idea to take a picture of the odometer reading. Print the value you choose and highlight the value and attach it to any pictures you took.
Now you have to value everything else you own. This is difficult. Big, valuable items, take pictures and try to get a value off the internet - print any pages with values you use. For your general household, pictures and video can be useful to prove you don't have fancy, expensive furniture. Talk to a few people who know about values and try to get a good estimate. I wouldn't do an appraisal unless you're really unsure, just make sure your values aren't ridiculous.
For your house (or houses) get a real estate agent to run comps and give you a written value estimate for them. Save this paperwork.
Now the kicker. This is updated due to recent litigation (Jan 2017): If you are receiving a pension such as state or federal retirement, union retirement, or private pension or annuity, you must figure out the value of your payments as a lump sum based on your life expectancy, IF you are able, based on the requirements of the plan and/or state law, to withdraw or borrow against the full value of the plan. If you have no choice but to get the monthly payments, it is not an asset. This is hard to figure out, and the number is usually an insolvency killer. (I did several checks of my military retirement (which would no longer be included as an asset) from various sources and found values between $800,000 and $1.7 million.) If you're close with everything else, this will probably prevent you being insolvent and is probably not worth the effort.
Now take all your liabilities and add them up. Do the same with your assets. Subtract assets from liabilities and if you get a positive number, you're insolvent! This generally means you can avoid paying taxes on your cancelled debt up to the amount of your insolvency.
A couple words of warning:
1) Save all the paperwork.
2) Make sure to include the value of anything they repossessed in the asset column.
3) If the debt cancelled was in your name (or your spouses) and not in the other's name, you have to calculate insolvency for the individual, not both of you (in this case include the full amount of anything in only the debtor's name, and split everything in both of your names.)
4) If the numbers are close, make sure you have your ducks in a row. If you lowballed the value of your household, or forgot to include your $3000 engagement ring, things can get ugly, and you could owe money back. Conversely, if your liabilities are enormous, and you have tens of thousands of dollars of insolvency above your canceled debt, you can probably relax and not be quite as anal about household contents values (still do all the cars, house, big toys and bank accounts just like we said.)
5) Insolvency affects tax attributes for future tax years. This is way beyond the scope of a blog post, but you should seek professional assistance to determine the effect, especially if you have a business, investments, or rental property.
Don't forget the BOOK with the excel spreadsheet link!
Good Luck!
So you got a 1099C, or were informed by someone you owe money to that they're canceling some of your debt. Maybe you were foreclosed on, had your car repossessed, or negotiated a settlement to pay a credit card less than what you owe. If you haven't gotten a 1099C yet, you will. Now is the time to get prepared. I wrote an earlier post on cancellation of debt in general, which you should read before continuing: http://www.supertaxgenius.blogspot.com/2012/03/i-got-1099c-now-what.html
I'll wait...take your time...
Okay, so now let's talk about how to find out if you're insolvent. First look at the 1099C, box 1 and note the date. If you don't have the 1099C, use the date the debt was forgiven (you can call the lender to figure this out.) You will use this date and figure out, as of that date, how much your assets were, and how much your liabilities were. Your assets are everything you own, your liabilities are everything you owe.
We'll start with liabilities first. Start with the debt that was canceled, the debt they canceled counts as a liability, so that's your first number. Go to your credit cards, mortgages, car loans and any other money that you owe. Print out the first statement after the date in question. Now review the statement and determine what you owed as of our date. You can do this by highlighting the beginning balance and any charges or payments up to our date. Add the balance and charges, subtract any payments, and write this number on the statement. Repeat for all of your debts, and then add them up to get a total amount of liabilities. SAVE each of the statements! The IRS can ask you to prove how insolvent you were.
Now assets. Start with your bank accounts, brokerage statements, investments etc. Print out each statement and highlight the value on the date in question. For checking accounts, they usually keep a running total. For brokerages, they may only give you a monthly balance. If you can, go online and get the actual balance on our date. Print the screen with this balance and keep it with the statement for that account. If you can't get an exact amount, use the balance closest to our date. Make sure to do this for your retirement plan at work (401K, 403B, TSP, etc.), as well as any Individual Retirement Accounts.
Now it gets harder. For any vehicles you have, go to kbb.com or edmunds.com and determine the value of them. You can use some judgment to get the best value (lower is better) but be reasonable. If your car is truly a piece of s**t and you are using that to drop the value, take pictures to justify this assessment. It's also not a bad idea to take a picture of the odometer reading. Print the value you choose and highlight the value and attach it to any pictures you took.
Now you have to value everything else you own. This is difficult. Big, valuable items, take pictures and try to get a value off the internet - print any pages with values you use. For your general household, pictures and video can be useful to prove you don't have fancy, expensive furniture. Talk to a few people who know about values and try to get a good estimate. I wouldn't do an appraisal unless you're really unsure, just make sure your values aren't ridiculous.
For your house (or houses) get a real estate agent to run comps and give you a written value estimate for them. Save this paperwork.
Now the kicker. This is updated due to recent litigation (Jan 2017): If you are receiving a pension such as state or federal retirement, union retirement, or private pension or annuity, you must figure out the value of your payments as a lump sum based on your life expectancy, IF you are able, based on the requirements of the plan and/or state law, to withdraw or borrow against the full value of the plan. If you have no choice but to get the monthly payments, it is not an asset. This is hard to figure out, and the number is usually an insolvency killer. (I did several checks of my military retirement (which would no longer be included as an asset) from various sources and found values between $800,000 and $1.7 million.) If you're close with everything else, this will probably prevent you being insolvent and is probably not worth the effort.
Now take all your liabilities and add them up. Do the same with your assets. Subtract assets from liabilities and if you get a positive number, you're insolvent! This generally means you can avoid paying taxes on your cancelled debt up to the amount of your insolvency.
A couple words of warning:
1) Save all the paperwork.
2) Make sure to include the value of anything they repossessed in the asset column.
3) If the debt cancelled was in your name (or your spouses) and not in the other's name, you have to calculate insolvency for the individual, not both of you (in this case include the full amount of anything in only the debtor's name, and split everything in both of your names.)
4) If the numbers are close, make sure you have your ducks in a row. If you lowballed the value of your household, or forgot to include your $3000 engagement ring, things can get ugly, and you could owe money back. Conversely, if your liabilities are enormous, and you have tens of thousands of dollars of insolvency above your canceled debt, you can probably relax and not be quite as anal about household contents values (still do all the cars, house, big toys and bank accounts just like we said.)
5) Insolvency affects tax attributes for future tax years. This is way beyond the scope of a blog post, but you should seek professional assistance to determine the effect, especially if you have a business, investments, or rental property.
Don't forget the BOOK with the excel spreadsheet link!
Good Luck!
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