Not only is April 15 the Due Date for Income Tax filing but April was also designated Financial Literacy Month by George W. Bush in 2003. In 2022, Gov. Ron DeSantis of Florida added financial literacy to Florida’s required curriculum. 35 States now require a course in Personal Finance to graduate, and 28 require a course in Economics. More States need to sign on, but it’s a good start.
This Blog has recently been featuring introductory lessons on Personal Finance and Income Tax, and today’s topic is an important concept called Adjusted Gross Income, or simply AGI. Reasons abound for understanding AGI, as well as its redheaded uncle, Modified AGI, or MAGI, to determine what happens on your Form 1040, U.S. Individual Tax Return, and the effect on your overall tax bill.
In a prior Blog, we covered the term “Gross Income.” The most prevalent components of Gross Income are Wages, Salaries, Tips, Interest, Dividends, Business Income from non-W-2 employers, Retirement Account Distributions, Social Security Benefits, Pensions, Annuities, and Capital Gains. These are listed as Gross Income on Page 1 of Form 1040.
Schedule 1, Part I lists other Additions to Income, including rent, gambling, jury duty pay, etc. If you have any of these, Uncle Sam wants to know.
Schedule 1, Part II, contains Adjustments to Income that reduce your income for taxation purposes. Arriving at Adjusted Gross Income, or AGI, requires combining Additional Income with Total Adjustments, and then adding to, or subtracting from, Total Income.
For most taxpayers, MAGI is the same as their AGI. Computing MAGI simply adds any tax-free interest income to your AGI.
Eligibility for certain tax-related deductions and credits is dependent on a taxpayer’s AGI (or MAGI), including the Earned Income Tax Credit (EITC) and certain Child Credits. Deductibility of Student Loan Interest is lost above a certain level of AGI, as are certain other Educational Tax Breaks.
One of the most important and useful applications of AGI and MAGI is in determining eligibility for certain Retirement Plan contributions and deductions. For IRA savers, attention needs to be paid to MAGI to determine eligibility for Roth IRA contributions, as well as the deductibility of Traditional IRA contributions.
Social Security recipients use a slightly different calculation to determine MAGI. This formula includes only half of Social Security benefits to Gross Income and then follows a formula for determining the taxable component.
Understanding the process puts you in control. Next week, we will cover Deductions to be applied to compute Taxable Income.
Van Wie Financial is fee-only. For a reason.
Throughout March, we have been highlighting the need for people to learn more about money while they are young. April, which has now arrived, is designated National Financial Literacy Month. Hardly surprising, as Personal Income Tax Filing Deadline Day occurs in mid-April. While anyone can request an Automatic Extension of time to file, any amounts owed from the prior year are due and payable on Tax Filing Day, regardless of filing status.
How many of you could come up with a reliable estimate of what you owe? As a “workaround,” many people simply have excess Tax Withholding deducted from their paychecks. While avoiding penalties for underpayment of taxes, these people are essentially making annual interest-free loans to the U.S. Treasury. They justify that nonsense as an informal savings plan and use the refund for vacations or whatever luxury they designate.
Given the importance of Income Tax Returns, we are continually concerned about taxpayers’ lack of understanding of how the tax system affects them. Paying the lowest legal tax bill should be everyone’s objective. That requires an understanding of the Tax Code. We start by asking people how much they paid in taxes. Often, we hear, “I didn’t pay anything, I got money back.”
Common sense dictates that we understand at least our own Tax Returns. Overpaying income tax is distasteful, and underpaying is illegal. Given that, instead of simply plugging in numbers to TurboTax or equivalent, filing the resultant Tax Return, and putting the whole concept “on the shelf” for another year, why not learn? Time spent could become very profitable, as well as educational. Here’s a very short course on Tax Return preparation.
Pertinent numbers on the annual required 1040 Income Tax Form begin with Total Income. Just like it sounds, Total Income (or Gross Income) is simply an aggregate of all forms of income received in a Tax Year (usually a calendar year). However, no one pays taxes on their Total Income. Reducing Total Income to Taxable Income is the essence of Tax Preparation.
The next step is to identify Adjustments to Income, which include such items as deductible contributions to Qualified Retirement Accounts, plus a few other items. The resultant Adjusted Gross Income, or AGI, is pivotal in qualifying (or disqualifying) the taxpayer for certain taxes and/or benefits. One derivative from AGI is Modified Adjusted Gross Income, or MAGI. We will explain the importance of MAGI in a later Blog.
From there, another income reduction is applied, using the higher of the statutory Standard Deduction (most people use this) or Itemized Deductions. Again, we’ll address these later. For now, the structure of Tax Return preparation begins with understanding taxes for fun and profit. OK, profit anyway.
Van Wie Financial is fee-only. For a reason.
Despite an earnest effort by California and the current Administration in Washington, D.C., many Americans choose to become self-employed. Two groups are particularly fond of the independent route: young workers and the post-retirement group. For the older group, self-employment offers a route to staying sharp and involved, but for the young, it represents a lifestyle choice.
Last week, we discussed the downside of “gig work,” including the steep tax burden imposed on independent contractors. Paying “both sides” of the mandatory payroll tax withholding means that 15.3% of the first $168,600 in annual earnings belongs to the Social Security (FICA) and Medicare “trust funds.” Since there is no Payroll Withholding for the 1099 crowd, a quarterly check has to be written and filed with Form 1040-ES.
Unfortunately, that is not the extent of the taxes owed, but today, we want to focus on the good news for independents looking to fund retirement. Congress has assisted self-employed people by creating savings opportunities not available to W-2 employees. Let’s start low and rise to the savings opportunities.
IRAs (Individual Retirement Accounts) are available to all Americans who have earned income to cover the contribution. The income can be from a spouse if applicable, but either way, IRA limits are pathetically small. We speculate that Congress imposes low limits because so many W-2 employees have 401(k) Plans available, however lame that reasoning sounds.
For successful independents looking to reduce current taxes, while simultaneously financing a substantial future retirement, it is difficult to beat the Personal 401(k) Plan. Also known as the Indy(k) or Solo(k), these accounts offer incredible tax savings, flexibility, and tax-deferred asset growth. It is important to note that a worker may include a current spouse in the Plan while doing work for the employed spouse, but cannot have any other employees at any time.
Current Personal(k) limits are $23,000 for an individual, plus an additional $7,500 for workers ages 50 and up. Additionally, profitable personal businesses may add Company contributions from profits. This stands in contrast to statutory IRA limits, which are currently $7,000, plus $1,000 for ages 50 and up.
Gig workers are required to pay out-of-pocket for many items considered routine benefits by their W-2 friends, who only pay half of FICA and Medicare. Other perks include insurance premiums (Health, Life, Disability, etc.), and Income Tax Withholding. Possibilities for larger tax-deferred retirement savings can make up for many unique demands on self-employed earnings.
Only after making a valid comparison between expenses for self-employment vs. W-2 job benefits can a sound decision be made. Too frequently, contractors will not demand a high enough hourly rate to justify their expenses.
Van Wie Financial is fee-only. For a reason.
Increasingly, young Americans are opting to join the “gig economy,” rather than working as captive employees for a single employer. Independent workers are variously called self-employed (my favorite term), consultants, contractors, freelancers, and a host of other non-employee descriptors. For them, flexibility with their time and location drives them to operate as “1099 employees,” meaning they get an annual Form 1099 instead of a W-2. Many receive multiple 1099s each year, having performed services for multiple employers.
Self-employment requires discipline, as well as a basic understanding of the Tax Code. 1099 workers generally earn a substantial hourly rate for time worked, but they are responsible for their own interactions with the U.S. Treasury. Financial obligations on 1099 earnings are significant, and failure to meet every requirement leads to costly consequences.
In our day jobs as Certified Financial Plannersâ, we have interviewed independent contractors from all walks of life. Many earn very substantial incomes, but some are not attuned to their total financial obligation under the U.S. Tax Code. Some find out that they are not as well off as they thought because Uncle Sam lays claim to a large portion of their gross earnings.
Too often, the decision to freelance is made without sufficient information, setting up the worker for financial trouble. Here are some potential problems:
- Instead of 7.65% being deducted from their paycheck for mandatory Social Security and Medicare, self-employed workers must pay 15.3% of earnings “out of pocket” for these items.
- Contractors are required to pay quarterly Estimated Tax Payments to the U.S. Treasury on Form 1040-ES.
- Contractors generally receive no fringe benefits from their gig employers and are therefore responsible for their own insurance coverages and retirement savings plans.
- No Employer Matching Contributions are available for Retirement Accounts of contractors, but as a trade-off, individual contribution limits are higher.
This week, Americans are facing changes in the law, potentially limiting gig workers’ opportunities. We will report in depth next week, once the dust has settled.
Only after a thorough understanding of the costs involved in gig work can a self-employed worker evaluate what a reasonable rate of compensation is for the skill needed and the type of work.
Van Wie Financial is fee-only. For a reason.
Americans are woefully uninformed about money, economics, and taxes. No good can come from this, so we at Van Wie Financial are dedicated to improving that situation. Some argue that taxes are boring, complex, and difficult to understand, but others love to talk about (and dream about) money. Too many people are seemingly content to complain when their money runs low, or worse yet, runs out.
Common wisdom says that the quickest way to make more money is to save more money. Step 1 in learning about money is to analyze your own spending to see where you might make cuts. Most young people believe that the process begins with your “take-home pay.” After all, that’s what you have available to spend between paydays, right?
By the time you receive your payday spending money, your earnings have been reduced, and often sharply. Examine your most recent Form W-2. For starters, there is mandatory withholding, often called payroll tax.” It is really not a tax, but rather a compulsory insurance premium. The Social Security tax component (also called FICA) pays into your account at Social Security, and the Medicare tax component similarly goes to your future Medicare benefits. With these items, your earnings have already been reduced by 7.65%, up to the current earnings limit of $168,600 for FICA, though Medicare withholding applies to 100% of earnings. Your employer paid an equal amount on your behalf.
Moving along on your W-2, there are boxes for Federal Tax Withheld, and in some states, State Tax Withheld, over and above the Payroll Taxes. Income above a modest Standard Deduction is taxed at the Federal level. Some of your earnings are sent to the U.S. Treasury every paycheck, because the government wants their share at the same time you get yours. Remember, we haven’t even discussed any Fringe Benefits you receive as part of your employment, some of which may require partial payments from you. You may see deductions for Health and/or Life Insurance, Dependent Care, and a host of others.
Only after these sums are gone do we find voluntary paycheck reductions for you, most popularly 401(k) deferrals from current pay. This amount will vary, and you are in control. How do you decide the optimal level of contributions? That requires some analysis of the Tax Code and its application to your situation.
What better way to save money than to understand your “paycheck?” With electronic payroll, you may have to hunt for the electronic pay stub, though your employer will direct you to it if necessary. You may be surprised to see how much you are really paid, and how little is left over for you.
Didn’t get a W-2, but a 1099 instead? We’ll cover that next week.
Van Wie Financial is fee-only. For a reason.
Today, we are exploring real estate for younger Americans. Homeownership is a lofty goal, and has long been considered a central tenet of the “American Dream.” Many people believe that America is in the midst of a real estate affordability crisis, suppressing the ability of younger Americans to realize their own American Dreams. If current trends continue for a very few years, half of all homes are projected to be owned by people ages 60 and up.
A common dilemma we encounter in our day jobs as Certified Financial Planners® involves young adults (both single and married) who are in full pursuit of their own American Dream. Unfortunately, the early years of adulting present a variety of competing demands on a meager starting salary. Food, clothing, and shelter are the three necessities unable to be put aside for later. Add in marriage, family, student loan repayment, starting a retirement savings plan, and suddenly purchasing a home seems nearly prohibitive. But is it?
Whether or not affordability presents an insurmountable obstacle is debatable. We believe that perception is based partially based on “recency bias,” meaning that last year’s 3% mortgages are fresh in people’s minds, but are no longer available. This notion belies decades of history, as America’s housing inventory and ownership base thrived before today’s home prices and mortgage interest rates. Baby Boomers in the 1980s were paying double-digit mortgage rates, yet managed to purchase and/or build homes. Interest rates will continue to change over time, and savvy homeowners will have the ability to refinance at lower rates when the time is right.
In the intense competition for young people’s cash, the use of homeownership dollars competes with rental dollars to cover the necessity of shelter. With the recent escalation of rents nationwide, a significant portion of household budgets is already deployed to the category of shelter. Elimination of rental dollar drain from budgets frees up significant cash for costs of ownership, with the promise of home equity. From a cash flow standpoint, this renders ownership more affordable than it may seem. The biggest hurdle for many young people is amassing a down payment. For some, parents are willing to help, and in fact, more parents than ever before are assisting a purchase in order to eliminate the “kids living at home” phenomenon.
Creative financing options, especially those with limited down payment requirements, are also becoming more available. Current credit restrictions have loosened significantly, bringing an increased number of young people back into the market. Housing inventory in post-COVID America is returning to normal. Young people who have not previously qualified as buyers should shop around, as conditions have changed significantly.
Van Wie Financial is fee-only. For a reason.
Typical Americans have three primal fears: death, public speaking, and running out of money. Once again, a recent survey concluded that a majority of Americans fear running out of money more than they fear death or public speaking. This has been confirmed numerous times over several decades. Why should no money be scarier than death itself? Perhaps, I speculate, because we have no control over mortality, but our money is more manageable.
Why, then, don’t more people seek assistance from professional advisors and financial planners? Many believe that paying a professional money manager, rather than playing the Home Game, may result in a net cost to their retirement assets. This fallacy has been endlessly contradicted. Investment results generally improve when competent professionals are involved. In fact, a recent study from SmartAsset.com found that people who work with a competent financial advisor could wind up with about 15% more income in retirement.
Given the stature of “moneyless phobia,” the advisor solution should be ingrained throughout society. Find a competent advisor, implement the suggestions he or she co-develops with you, and your financial future will be improved. Yet, this concept is not widespread, with only about 35% of Americans utilizing professional financial advisors. Fully 62% of Americans admit that their financial planning needs improvement, so why wait?
This is not to say that every financial advisor will produce great results. Finding the right fit is vital to an investor, and fortunately, many resources are available to aid your search. Fortunately, the American public is taking the word fiduciary to heart, and with good reason. Simple in concept, the term fiduciary packs a wallop for investors. Working with a fiduciary advisor means that you will never have to worry about which side of the table you each represent. It’s always about you, and your needs come first. Fiduciary advisors put you first. Full stop.
Also important to long-term success with an advisor is sticking to fee-only professionals. Other business models allow the advisor to be compensated (in whole or in part) by commissions, creating at least the potential for conflicts of interest. Search for a fee-only (not fee-based) advisor, operating as a Registered Investment Advisor (RIA). This may sound like self-promotion, but it is truthful.
As fee-only, CFP®, fiduciary planners, Van Wie Financial understands the financial fears of most Americans. We firmly believe that education is the key to successful investing. Therefore, we are constantly educating our clients, as well as our radio listeners, as to what constitutes good investing practice.
We can’t help anyone resolve their fear of public speaking, and none of us can increase your life span. We can and will help investors succeed financially.
Van Wie Financial is fee-only. For a reason.
No longer willing to spend my time uncovering every bad idea concocted by Congress, Media, Politicians, and others who hope to become noticed, I have narrowed the search to only the worst of the recent batch. At least for a while, until I get rejuvenated. It takes too much time and effort to find and refute each and every dumb thing these days, so I am being selective.
Our “Best of the Worst” stupidity entry is a proposal to bolster Social Security–itself a good idea. Before getting into the weeds, I refer our readers back to my past 2 Blogs, available on strivuswealth.com. Both fall into the general category of faulty “Tax the Rich” problem-solving, as does our current highlighted proposal.
Today’s Hall of Fame entry is presented by two ostensible researchers, who propose to save Social Security by reducing or eliminating tax breaks for contributions to Qualified Retirement Accounts. You know, those pesky and discriminatory 401(k) Plans, 403(b)s, IRAs, and the like? Higher-income Americans seem to enjoy greater benefits from contributions than do their lower-earning counterparts. Maybe they make more and larger contributions?
There is Dumb, there is Really Dumb, there is Government Dumb, and then there is Hall of Fame Dumb, like this proposal. From its very enactment in 1935, Social Security was intended to be an insurance system, providing a supplemental retirement income plan for those who needed it the most at the time of retirement.
As with any insurance program, it stands alone and independent financially, taking in premiums, and doling out benefits. Social Security inflows include mandatory FICA withholding, income tax collected on benefits paid out, and an occasional one-time boost to adjust for a change made by Congress. A classic example of Congressional program expansion was adding Disability Benefits to Social Security, and the Trust Fund had to be bolstered until collections covered initial and ongoing disability claims.
Today’s winners have thoughtfully(?) set out a plan to – wait for it — Tax the Rich. Since only the top half of American Workers pay income taxes, using General Revenues to bolster Social Security amounts to simply letting “The Rich” pay yet another gigantic portion of the American lifestyle, the Social Security System. Lower-income earners get off unscathed.
Regardless of how much wealth is controlled by “The Rich,” it is a pittance compared to the rate of government spending. Confiscating 100% of assets held by the uber-wealthy would fund the government for a few weeks, after which those spent assets would earn no more income or tax revenue.
Hall of Fame Dumb.
Van Wie Financial is fee-only. For a reason.
Social Security is failing, due to an imbalance between the inflow of funds relative to mandatory outflows for monthly benefits. Simple logic dictates that step one in curing an insolvency problem would NOT involve reducing incoming dollars. Yet, a current proposed Bill does exactly that. Or so it seems.
Most Americans are unaware that Social Security funding currently consists of several components. Everyone who ever had a job knows about mandatory Payroll Withholding, but that is just the beginning. Income Tax on benefits paid out are also turned over to the Social Security Administration. Occasionally, direct deposits are made by Congress, usually due to large, mandated changes in Social Security rules. Above minimum income limits monthly benefits are partially (either 50% or 85%) taxed at marginal income tax rates. These funds are all allocated to Social Security, separated from General Revenues, which are primarily individual and corporate Income Taxes.
Dubbed “You Earned It, You Keep It,” the current proposal would seemingly eliminate one primary source of Trust Fund revenue by eliminating income tax on all monthly benefits paid out. Originally promised by the designers of the Social Security System, it seems logical. But look under the hood.
Saving a gigantic system by starving it for revenue seems superfluous. Is that really what “You Earned It” means? Unsurprisingly, no. It is merely a smokescreen designed to sell the proposal to Americans who are being kept in the dark. Reading beneath the headlines, we find that revenue loss from the taxation of benefits is quietly replaced from General Revenues. The lower-income half of Americans do not pay into the General Fund. The result? Tax the Rich.
But that’s not all. To justify the claim of extending the solvency of the current system, mandatory payroll taxes (FICA Withholding) would be applied to all earned income. The 2024 income limit is $168,800, after which no more FICA Withholding applies. Again, Tax the Rich.
Nowhere in the “You Earned It” proposal is there any mention of raising the eligibility age for younger workers. Increasing longevity of recipients is the cause of the impending shortfall. This very situation was present in the early 1980s, when President Reagan and Congress raised the Full Retirement Age from 65 to 67, phased in gradually over decades. That simple process increased Social Security solvency by about 75 years while giving young workers ample planning time.
With an eye to long-term solutions, we can see from “You Earned It” that we must be diligent, as Congress is willing to sneak in provisions that would simply apply the worn-out pursuit of letting The Rich pay for everything. It won’t work, because it can’t ever work. When will they learn?
Van Wie Financial is fee-only. For a reason.
Today’s self-described “Progressives” seem to have adopted the universal answer, “Tax the Rich.” It doesn’t matter what the question might be; the answer lies in a burning desire to punish successful Americans through taxation, in the name of solving societal problems. Constantly tilting at the windmills of increased government revenue, these people live in a political Utopia we call the “Big Lie.”
To illustrate The Big Lie, we can examine President Biden’s recent claim that “The Rich” only pay an 8% tax rate, far less than the rest of us. An old adage says that there are 3 kinds of lies: White Lies, Damn Lies, and Statistics. In today’s world, a fourth type of lie, and perhaps the most insidious, is the Lie of Omission. The Big Lie is a combination platter, based on the Progressive notion that when a lie is repeated often enough, it is true.
Many politically liberal activists have long favored and frequently introduced, the concept of a Wealth Tax. So far, it has not been implemented, partly because it would be virtually impossible to administer, but also as it is not likely to pass Constitutional muster. Progressive activists remain steadfast in their attempts to fleece our hated Billionaires, who ironically fund a large portion of political campaigns for those very politicians.
The fundamental precept of a Wealth Tax is to levy a tax on appreciated, but unsold, assets. In our Blog of December 13, 2023, we referred to the Wealth Tax concept as, “Taxation Without Monetization.” Taxes are generally derived from the proceeds of income-generating transactions, whether earning income or selling assets. When payment is made, we call the income “realized,” meaning received. The worker, or the seller, keeps the post-tax proceeds of the transaction after the government collects its legal percentage from the realized cash flow.
American taxpayers understand that one of the most favorable tax rates on realized income is the Long-Term Capital Gains Tax (LTCG), which is applied to the realized (monetized) gain on assets held at least one year. For most Americans, that rate is 15%, but it rises to 20% for higher-income Americans. “The Rich” pay an additional tax of 3.8% on investment income, brought to them by ObamaCare, and designed to further fund Medicare.
Throughout modern American history, tax rates have fluctuated wildly. From government records, we find that when tax rates were raised, revenue shortfalls resulted. When authorities react to reduced tax receipts, they lower tax rates. Following each tax rate decrease, revenues to the government rise. Such a simple and demonstratable principle, yet the Big Lie never dies.
Van Wie Financial is fee-only. For a reason.