Saturday, February 28, 2015

Keep the Money!

“Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver."

Ayn Rand

Welcome to The Golden Sense! Every year tax season comes and goes and with it so does your money. The tax code in the United States is one of the most complicated in the entire world. It is hard to know the exact length of the U.S. tax code but it is estimated to be between 2,000-3,000 pages in length. It's like 2½ times the length of Stephen King’s It—except you replace “scary clown” with “accounting methods.” It's so absurd I am just another person in a long line of people to criticize it. In all of its complexity, the U.S. tax code has some tricks in it that allow you to save money and put your financial life in the right direction.

I have many friends who do contractual work and don't receive the traditional W2 for their services. These people all work for themselves doing fitness training, construction, art, catering, etc. Instead of that W2, they receive what is called a 1099 at the end of every year. This is just a form that reports a type of income that you received during the year. Whether you receive a W2 or a 1099 you may end up owing taxes. However, the good news is that there are ways to reduce the final bill.

Typically, people who make varying degrees of income year over year must pay estimated taxes every quarter throughout the year. This can be calculated based on your prior year’s income. By paying estimated taxes you can avoid interest penalties on the upcoming tax year. I suggest to these people that they set up a savings account and deposit a percentage of their income into the account as the year goes by. This allows you to have the right amount of cash on hand when the time comes to pay the estimated tax.

April 15th is the tax filing deadline, and before this date arrives it is important to start thinking creatively. As you sit down and look at that blurry, complicated spreadsheet (called a tax form) you need to take a long look into deducting expenses for the services you provided. Everybody knows this is possible, but I encourage you to claim every deduction and exemption you're entitled to. This will help reduce your reported income and the final tax bill.

Sometimes, after the estimations and the deducted expenses, there is still money to pay in taxes! There is good news for people in this situation. There are a few financial tools that can be of great use to you. Consider setting up two types of retirement accounts. One is called a traditional Individual Retirement Account (IRA) and the other is a Roth Individual Retirement Account (Roth IRA).

Savvy investors by design, often end up with a blend of traditional IRA and Roth accounts. Having both of these accounts on hand can offer you a chance to "hedge" the big fat tax man. IRA's and Roth IRA's aren't just for people with 1099, they are can be of great use to almost everyone.

An IRA is a financial account that allows you contribute pre-tax money. The money can then be invested, and grow tax free until the time of withdrawal. Of course, there are many rules that go along with this type of account that I won’t get into here. The importance to those who still owe taxes is that with an IRA they can deduct their contribution amount from their tax bill. Contributions can still be made to the prior year before the April 15th deadline. By knowing your final tax bill, you will know exactly how much you will want to further deduct in taxes. This will allow you to contribute the right amount to your IRA (depending on the amount and your situation of course). This is a win-win strategy. Instead of writing a check to the IRS, you will be writing a check to your own retirement account!

If you open a Roth IRA, this account will help when you reach retirement age. A Roth IRA is a financial account to which you can contribute funds that are 'after tax'. That money will grow tax free and there will be no taxes due upon withdrawal. This will help you have access to non-taxable money when you reach retirement age.

Arranging one’s affairs for tax optimization is normal. By having both accounts it will allow you to positively adjust your taxes both now and in the future. Without proper planning, a tax bill can sneak up on you and hit you with a devastating blow.

The whole tax discussion can be boring....and I mean B-O-R-I-N-G! But the tax system is cruel. It preys on society's uninformed. When it comes to your financial affairs, it pays to be as knowledgeable as possible. The more you learn the better off you'll be.

Over and Out,

T. Norman