Financial Literacy

13
May

1040 Postmortem: Making Sense of Your Taxes and Withholding

An estimated 65% of U.S. households paid less in federal income taxes in 2018, whereas 29% paid about the same and 6% paid more.

Source: Tax Policy Center, 2019

The Tax Cuts and Jobs Act (TCJA), which passed in December 2017, made fundamental changes to the U.S. tax code, and 2018 returns were the first time most taxpayers could see the practical impact of these changes.

In an April 2019 Gallup poll, 43% of Americans said they were unsure how the new tax law affected them personally. Surprisingly, 21% thought their federal income taxes went up in 2018, and 21% said they were about the same. Only 14% of respondents reported that their taxes went down, even though independent analyses and preliminary tax filing data suggested that about two-thirds of Americans would owe less in federal taxes in 2018.1-2

One reason for this apparent confusion might be because taxpayers tend to pay little attention to employer withholding, and any potential increase in take-home pay may have been less noticeable when divided into weekly (or biweekly) paychecks. It’s also possible that many respondents didn’t take the time to compare their tax burdens to the previous year and/or may not know how to do so. Despite a stated effort to simplify the federal withholding and tax filing process, the tax code is still complex, and many taxpayers don’t understand the details and terminology.

Stay on top of withholding

About 73% of 2018 tax returns showed a refund, averaging $2,725.3 The amount of your refund or the amount you owe with your return has little to do with your overall tax burden. These numbers reflect whether your withholding and/or estimated tax payments during the year were more or less than your final tax bill.

In theory, your withholding should equal your tax liability; otherwise you are loaning your money interest-free to the government. But IRS formulas tend to err on the high side, partly because people usually dislike owing a balance and are often happy to receive a tax refund.

Employers estimate your federal tax bill based on the number of exemptions claimed on your W-4 Form and on IRS calculation tables. The IRS rather quickly released 2018 calculation tables reflecting the new rates and rules. However, the agency did not replace the W-4 Form and worksheet, which are based on exemptions, deductions, and credits that were reduced or eliminated under the new tax law.

This resulted in smaller refunds or higher tax bills than expected for some taxpayers, especially dual-income households with more complicated situations. The Treasury estimated that 21% of taxpayers would be subject to underwithholding because of the TCJA, compared with 18% if the tax law provisions had not changed.4

If you owed a large amount of money for 2018, bumping up your withholding now could help avoid a similar fate next April. You might also reevaluate your withholding If you received a large refund. You could make larger retirement contributions instead or take home more of your pay and put it to better use.

It’s also a good idea to review your withholding whenever something changes in your life — such as a marriage, divorce, birth of a child, new job, or other significant change in your financial situation.

The IRS (irs.gov) has an up-to-date, online calculator that can help you determine the appropriate amount of withholding. You still need to complete and submit a current W-4 to your employer to make any adjustments. An all-new W-4 Form for the 2020 tax year is in the works but isn’t expected to be available to employers until later in 2019.

Measuring the impact

How you fared under the TCJA depends on a variety of factors, such as how much you earned, your filing status, the ages of your dependents, and where you live. Undertaking a thorough side-by side comparison of your 2017 and 2018 returns could help you identify changes that affected your bottom line. Be sure to note differences in your allowed deductions, taxable income, and total tax liability.

New marginal tax brackets are likely to mean that much of your income is taxed at lower rates. But other provisions may add to or reduce that benefit.

Standard deduction amounts for 2018 roughly doubled to $12,000 for single filers and $24,000 for married taxpayers filing jointly. However, personal exemptions ($4,050 in 2017) for yourself, your spouse, and your dependents are no longer available. The expanded child tax credit may offset the loss of exemptions for many taxpayers, but the math may not work out in your favor if you’re a family of four or more.

A number of tax deductions commonly used by high earners have also been modified, capped, or eliminated. For example, the itemized deduction for state and local taxes (SALT) is now limited to $10,000 ($5,000 if married filing separately). This provision caused tax increases for some taxpayers in high-tax states. On the other hand, the overall limit on itemized deductions that applied to higher-income taxpayers (commonly known as the “Pease limitation”) was repealed, and fewer taxpayers are subject to the alternative minimum tax.

You might also consult a tax professional who can explain the relevant changes and recommend potential strategies to help reduce your tax liability for 2019.

What if you owe money and can’t pay?

If you didn’t file your 2018 federal income tax return because it’s going to show a balance due, you should file your return immediately and pay as much as you can afford. This can help limit penalties and interest, and being up-to-date on filing is generally required to pursue a payment agreement with the IRS.

If you owe $50,000 or less, you may even be able to apply for a short-term extension (up to 120 days) or a longer payment agreement online. Interest and penalties continue to accrue on unpaid amounts.

1) Gallup, April 12, 2019

2) The New York Times, April 14, 2019

3) Internal Revenue Service, April 12, 2019

4) U.S. Government Accountability Office, 2018

29
Apr

Teaching Your College-Age Child about Money

When your child first started school, you doled out the change for milk and a snack on a daily basis. But now that your kindergartner has grown up, it’s time for you to make sure that your child has enough financial knowledge to manage money at college.

Lesson 1: Budgeting 101

Perhaps your child already understands the basics of budgeting from having to handle an allowance or wages from a part-time job during high school. But now that your child is in college, he or she may need to draft a “real world” budget, especially if he or she lives off-campus and is responsible for paying for rent and utilities. Here are some ways you can help your child plan and stick to a realistic budget:

  • Help your child figure out what income there will be (money from home, financial aid, a part-time job) and when it will be coming in (at the beginning of each semester, once a month, or every week).
  • Make sure your child understands the difference between needs and wants. For instance, when considering expenses, point out that buying groceries is a need and eating out is a want. Your child should understand how important it is to cover the needs first.
  • Determine together how you and your child will split responsibility for expenses. For instance, you may decide that you’ll pay for your child’s trips home, but that your child will need to pay for art supplies or other miscellaneous expenses.
  • Warn your child not to spend too much too soon, particularly when money that has to last all semester arrives at the beginning of a term. Too many evenings out in September eating surf and turf could lead to a December of too many evenings in eating cold cereal.
  • Acknowledge that college isn’t all about studying, but explain that splurging this week will mean scrimping next week. While you should include entertainment expenses in the budget, encourage your child to stick closely to the limit you agree upon.
  • Show your child how to track expenses by saving receipts and keeping an expense log. Knowing where the money is going will help your child stay on track. Reallocation of resources may sometimes be necessary, but help your child understand that spending more in one area means spending less in another.
  • Encourage your child to plan ahead for big expenses (the annual auto insurance bill or the trip over spring break) by instead setting aside money for them on a regular basis.
  • Caution your child to monitor spending patterns to avoid excessive spending, and ask him or her to come to you for advice at the first sign of financial trouble.

You should also help your child understand that a budget should remain flexible; as financial goals change, a budget must change to accommodate them. Still, your child’s ultimate goal is to make sure that what goes out is always less than what comes in.

Lesson 2: Opening a bank account

For the sake of convenience, your child may want to open a checking account near the college; doing so may also reduce transaction fees (e.g. automated teller machine (ATM) fees). Ideally, a checking account should require no minimum balance and allow unlimited free checking; short of that, look for an account with these features:

  • A simple fee structure
  • ATM or debit card access to the account
  • Online or telephone access to account information
  • Overdraft protection

To avoid bouncing checks, it’s essential to keep accurate records, especially of ATM or debit card usage. Show your child how to balance a checkbook on a regular (monthly) basis. Most checking account statements provide instructions on how to do this.

Encourage your child to open a savings account too, especially if he or she has a part-time job during the school year or summer. Your child should save any income that doesn’t have to be put towards college expenses. After all, there is life after college, and while it may seem inconceivable to a college freshman, he or she may one day want to buy a new car or a home.

Lesson 3: Getting credit

If your child is age 21 or older, he or she may be able to independently obtain a credit card. But if your child is younger, the credit card company will require you, or another adult, to cosign the credit card application, unless your child can prove that he or she has the financial resources to repay the credit card debt. A credit card can provide security in a financial emergency and, if used properly, can help your child build a good credit history. But the temptation to use a credit card can be seductive, and it’s not uncommon for students to find themselves over their heads in debt before they’ve declared their majors. Unfortunately, a poor credit history can make it difficult for your child to rent an apartment, get a car loan, or even find a job for years after earning a degree. And if you’ve cosigned your child’s credit card application, you’ll be on the hook for your child’s unpaid credit card debt, and your own credit history could suffer.

Here are some tips to help your child learn to use credit responsibly:

  • Advise your child to get a credit card with a low credit limit to keep credit card balances down.
  • Explain to your child that a credit card isn’t an income supplement; what gets charged is what’s owed (and then some, given the high interest rates). If your child continually has trouble meeting expenses, he or she should review and revise the budget instead of pulling out the plastic.
  • Teach your child to review each credit card bill and make the payment by the due date. Otherwise, late fees may be charged, the interest rate may go up if the account falls 60 days past due, and your child’s credit history (or yours, if you’ve cosigned) may be damaged.
  • If your child can’t pay the bill in full each month, encourage him or her to pay as much as possible. An undergraduate student making only the minimum payments due each month on a credit card could finish a post-doctorate program before paying off the balance.
  • Make sure your child notifies the card issuer of any address changes so that he or she will continue to receive statements.
  • Tell your child that when it comes to creditors, students don’t get summers off! Your child will need to continue to make payments every month, and if there’s a credit card balance carried over from the school year, your child may want to use summer earnings to pay it off in order to start the next school year with a clean slate.

Finally, remind your child that life after college often involves student loan payments and maybe even car or mortgage payments. The less debt your child graduates with, the better off he or she will be. When it comes to the plastic variety, extra credit is the last thing a college student wants to accumulate!

23
Apr

Bypassing Probate

You may have heard about the horrors of probate, but in truth, probate has gotten an undeservedly bad reputation, especially in recent years. If you bypass probate, your estate will go to your beneficiaries without any court proceeding, and you may save a certain amount of time and expenses. However, there is usually little reason for most people to avoid probate today. States continue to revise their probate laws, making them more consumer friendly, particularly for small estates. For most modestly sized estates, the probate process now costs little. In fact, there are some good reasons to distribute your property by will. Decisions are binding and have legal finality once your will is probated. Creditors who fail to file claims against your estate within a specific amount of time — usually six months after receiving notice — are out of luck.

However, some major drawbacks to probate do exist, including the time it can take. The process averages six to nine months to complete but may take up to two years or more for some complex estates, tying up the assets that your family may need immediately. Also, for a larger estate, the cost may be as high as 5 percent of the estate’s value.

If you feel that the size and complexity of your estate warrant exploring alternatives to probate, you may want to consider one or more of the following:

Transfer your assets to a revocable living trust

A trust is like a basket that holds your assets. A revocable living trust (also known as an inter vivos trust) is flexible enough to include almost any asset that you own. While you are living, you can act as the trustee and can add or remove property as you see fit. You can also terminate or amend the trust at any time. When you die, your successor trustee distributes the trust assets to the trust beneficiaries, according to the trust agreement. Trusts require a significant amount of paperwork, are costly to create and maintain, and usually require a lawyer to draw up the trust documents. Also, a revocable living trust does not shield your estate from your creditors, creditors of your estate, or estate taxes.

Own property as joint tenancy with rights of survivorship

Assets owned as joint tenancy with rights of survivorship pass automatically to the surviving joint owner(s) at your death. To establish joint ownership, you may need to record new real estate deeds, titles for your car or boat, stock and bond certificates, statements of account for mutual funds, registration cards for your bank accounts, and other assets. This costs little and usually does not require a lawyer. Some drawbacks are that the joint owner has immediate access to your property, and your joint owner’s creditors may reach the jointly held property.

Designate beneficiaries

Assets pass outside of probate if you establish payable-on-death provisions for your savings accounts and CDs. Ask your agent to set up transfer-on-death provisions for brokerage accounts containing stocks, bonds, or mutual funds. Your retirement accounts, such as profit-sharing plans, 401(k)s, and IRAs can also pass along to designated beneficiaries. Finally, life insurance death proceeds will avoid probate, provided you name a beneficiary other than your estate.

Make lifetime gifts

Another way to avoid probate is to simply give away your property to your beneficiaries while you are living. Carefully planned gifting can also free those assets from gift and estate taxes. The following are usually nontaxable gifts:

  • Gifts to your spouse
  • Gifts to qualified charities
  • Gifts totaling $15,000 (in 2019) or less per person, per year ($30,000 in 2019 if you and your spouse can split the gifts)
  • Tuition payments on behalf of an individual directly to an educational institution
  • Medical care expenses paid directly to the provider on behalf of an individual

Other ways to bypass or minimize probate

If your estate is small enough to meet state guidelines, your beneficiaries can simply claim your assets by presenting a notarized affidavit. About half of the states set a limit of $10,000 to $20,000 of the qualified estate value; most of the other states allow as much as $100,000. You can generally deduct estate expenses from your qualified estate value, such as taxes, debts, loans, or family allowance payments, plus the value of any other assets that pass outside probate (e.g., a home jointly owned with a spouse). Real estate is usually disqualified from claims by affidavit. Therefore, your estate may qualify even if it is fairly large. Expect the process to take 30 to 45 days. Another method is for your executor to file for summary, or simplified probate. This streamlined process is generally a paper filing only, requiring no attorney. States vary widely regarding the allowable size of an estate for simplified probate.