July 01, 2014

The Lightning Round: Take 3

Credit: FreeDigitalPhotos.net

Thanks to all of you for the many questions I received. Some of you even submitted more than one! You asked the questions, and now it’s time for me to share my answers to five of them...

1. I recently sold my house and have the profits sitting in a money market account. I'm relatively young,  have no more debt to pay off, already contribute to my work retirement account, have my rainy day fund, and would still like to put this profit toward my future as well. Is having this money sitting in a money market account the best “bang for my buck" or is there a better way to invest it?
- Anonymous                   

First of all, congratulations on selling your house for a profit! Real estate is not always a profitable investment, but it is certainly nice when it works out. Let me get this straight - you’re debt-free, you’re contributing to your 401(k), and you have set aside enough cash to form an adequate rainy day fund? Well done! You are certainly on a path towards financial success!

There are a lot of things you could do with the excess cash you have in your money market account that would provide you a bigger “bang for your buck.” Unfortunately, given current interest rates, the difference between burying your excess cash in your backyard and leaving it in your money market account earning interest is just not that much. I don’t know the ins and outs of your financial situation, but for someone in your shoes I’d usually suggest you redeploy some of that excess cash and put it to work for you. I’d suggest you consider increasing contributions to your 401(k) plan, opening and contributing to a Roth IRA, or opening and funding a diversified brokerage account. For simplicity’s sake, I’d probably lean towards increasing your 401(k) contributions. For 2014, you can contribute up to $17,500 per year (and if you’re age 50 or older, you can contribute up to $23,000 per year), and any additional contributions you make could be a nice boost to your long-term retirement savings. If you’re contributing to a Traditional 401(k) (not a Roth 401(k)), these additional contributions could also lower your 2014 tax bill, which makes increasing your contribution amount kind of a win-win. Two other things to consider, though: 1) Your 401(k) investment returns could provide you a much bigger “bang for your buck” than you would get in a cash account, but you could also see the value of your money go down in the short-term or during market downturns. 2) My guess is that your money market account balance will go down over time to help you sustain your current lifestyle if you decide to contribute more to your 401(k) going forward because your take-home pay will decrease to facilitate that change. I say that because I don’t want you to be surprised or concerned. By contributing more to your 401(k) going forward, you are essentially slowly and surely reducing your cash on hand and putting your excess cash to work. Just remember, if your money market account gets lower than you would like, you can adjust your 401(k) contributions back down to a level that will allow you to normally sustain your desired cash balance.  

Please let me know if you would like to discuss further.

2. Can you explain, in layman's terms, what supplemental income needs to be reported come tax season and how to do so? For example, I sell Thirty-One on the side and it's not a lot of money, so I'm curious if I even need to report it, and if so, how?
- Amanda                         

When it comes to miscellaneous supplemental income tax law implications in layman’s terms you’re asking a lot (just kidding), but I’m happy to try to translate. Your question is a great one and addresses a common misconception held by many taxpayers. Per the IRS, taxpayers “must also report other income such as: cash earned from side jobs, barter exchange for goods and services, awards, prizes, contest winning, and gambling proceeds…. It is a common misconception that if a taxpayer does not receive a form 1099-MISC or if the income is under $600 per payer, the income is not taxable. There is no minimum amount that a taxpayer may exclude from gross income.”

If you have income outside of basic things like your wages, salary, interest, and dividends, it really is best to talk with your CPA, and if you don’t have one, find one. That’s because supplemental income is tricky. I think you’ll agree that based on the IRS wording above, it’s pretty clear that supplemental income must be reported, but what is not always clear and most of the time cannot be put in layman’s terms is where to actually report the income. In some cases it might belong on Form 1040 itself, in some cases it might belong on Schedule C, in some cases in might belong on Schedule E, and in some cases, it might also need a Schedule SE (Self-Employment Tax) filled out, too. There could also be an opportunity to reduce the amount of your supplemental income you will be taxed on by specifically listing any expenses (such as travel expenses or postage expenses) you personally incurred by generating that supplemental income, but of course these expenses might belong on Schedule A, but then again, they could belong on Schedule C or Schedule E depending on how you actually generated the supplemental income. I’m about to answer your question, but for non-Thirty-One supplemental income earners I wanted to make two points: 1) See why the tax law really needs to be reformed and simplified? 2) If you have supplemental income, you probably need more than do-it-yourself tax software to make sure you get it right and report the supplemental income in the most tax-efficient (and legal) way possible.

So, I dug and dug for Thirty-One-specific tax guidance and was able to find buried on page 16 of their Consultant Guidebook some surprisingly helpful advice:

“Yes, you’re required to report your commissions and other earnings from your Thirty-One business as income in your tax filings each year. Your other earnings include your Overrides, free products, hostess and other business credits, etc. For tax purposes, you are “self-employed” and it’s important that you keep complete and accurate records of your business income and expenses.
There are some tax benefits for self-employed individuals that may allow you to deduct certain business expenses. We strongly recommend that you talk with your own tax advisor to learn how the tax laws apply to your Thirty-One business.
As a Consultant, you’re a self-employed, independent contractor of Thirty-One. You’re not an employee of Thirty-One and we won’t issue you a Form W-2.
The U.S. Internal Revenue Service (“IRS”) requires us to issue a Form 1099 to every Consultant who earns $600 or more during the previous calendar year. By January 31st of each year, we’ll issue you a Form 1099 for the previous calendar year. Your Form 1099 will include all of your earnings from your Thirty-One business, including your commissions and the other earnings described above.
You’ll have to report the income from your Thirty-One business on Schedule C of your federal income tax return. Because you are self-employed, you may be able to deduct certain business expenses like the use of your vehicle or home office. You can discuss this with your tax advisor and/or contact the IRS for more information at www.irs.gov or (800) 829-1040.
Also, if your state and/or city collect income tax, you may need to file income tax forms with them too.”

I hope this is what you were looking for. To recap in layman’s terms: you have to report the income, you are deemed to be self-employed, you are deemed to be an independent contractor, and Thirty-One will send you a 1099 by 1/31/15 for Tax Year 2014 to get you started. As always, I’m happy to help you specifically address your tax situation offline, but I really think you’re going to want the services of a paid tax preparer as well!

3. For the life of me, I do not understand the ad valorem tax. I've read a few government documents on it, but none of them are explicitly clear. Can you please explain for us new-to-Georgia folks? 
- Amanda                         

Sure, I’ll be happy to. Don’t you love it when people explain things in a way that’s so complicated no one can understand it?

On March 1, 2013, Georgia changed the way it taxes motor vehicles. For people who have cars that were purchased before March 1, 2013, nothing changed: you renew your tag right before your birthday and you get to pay an annual ad valorem tax (sometimes nicknamed the “birthday tax”) as part of that process. (An ad valorem tax is a tax based on value.) For people who have bought cars (or will buy cars) since March 1, 2013, the rules have changed: you no longer have to worry about paying an annual ad valorem tax when you renew your tag, but you do have to pay a title ad valorem tax all at once when you buy a new motor vehicle. The title ad valorem tax is calculated based on the fair market value of your new vehicle (less any trade-in value you may have gotten from your old car and less any discounts or rebates you may have received from the dealer) times 6.75%. I know the new title ad valorem tax has the words “ad valorem” in it just like the old tax, but try to ignore that and just think of the new tax as a sales tax of sorts. The new tax is essentially tax pain all at once as opposed to slow tax pain by a lash every time you have a birthday.

A couple of additional “nuggets:”
     - The title ad valorem tax also applies to purchases of used vehicles.
     - If you’re a Georgia resident and you buy your car out of state, you’ll still get to pay the Georgia title ad valorem tax even if you've already paid another state's tax.
     - If you transfer the title of a vehicle within your family, you will trigger a reduced title ad valorem tax.
     - The title ad valorem tax rate is scheduled to increase to 7% in 2015.

I hope that’s clear as mud. If it’s not, please let me know. Here are two other links that might help you: 1) a Georgia Department of Revenue Title Ad Valorem Tax Calculator and 2) a FAQs page about the new rules.

4. I have an opportunity to move to a state that I would prefer not to live in for a really good job opportunity. What should I be thinking about financially as I weigh the pros and cons? 
- Anonymous                    

Nice question, and one I’ve never been asked. Whatever you decide, congratulations on earning the opportunity to take the job!

If the job opportunity was something you were really excited about in a state you were really excited about, I don’t think I’d try to be a wet blanket on your job opportunity as long as it was financially lucrative. I believe there are more currencies in life than just money, such as time, happiness, and fulfillment, so I wouldn’t want financial implications to unnecessarily sway your decision. That being said, since the situation you are describing is "only" a really good job opportunity in a state that you are less than excited about, I can definitely see digging into the financial implications a little bit more.

I’d advise you to consider your new state tax rate versus your current state tax rate. I’d look into what your new property tax rates would be, and maybe even more importantly, how much a suitable home would cost you in your new state versus your current state. I’d look into potential cost of living differences in terms of utilities, transportation, and groceries. Once you factor in the cost of the physical move with these cost adjustments, versus any change you would experience if you took the job in terms of compensation and benefits (don’t forget benefits like 401(k) matching, paid time off, health insurance, etc.), I think you may be better able to gauge whether taking the job would be financially good for you or not.

If you’d like more specific assistance, I’d be happy to try to help you. I have also come across this nifty, little tool developed by the National Center for Policy Analysis that attempts to help you determine how much you will gain or lose by moving to another state, and I’d suggest you check it out. I’m not trying to dismiss your question in any way, but unless it really comes down to financially making it or financial ruin (which you should be able to figure out pretty quickly), I’d spend more energy on considering how your potential move could affect your family and friends, what amenities you might gain or lose, how stable your potential new employer is, and what your growth potential in your new role could be.

5. Do you recommend taxable bonds or municipal bonds for your clients?

That’s a very good question and is a question that all investors should ask their financial advisors or brokers and CPAs. (Actually, financial advisors or brokers should be discussing this with their clients and their clients’ CPAs, but that’s a different story.)

As I respond to so many “general” questions, I must also respond to this one: it depends. Bond investors are typically looking for investments with high yields and less volatility than the stock market. They basically have two general bond types to choose from: taxable bonds and municipal bonds. Taxable bonds are typically issued by corporations and offer a higher interest rate, but an investor will have to pay federal and state taxes on their gains. Municipal bonds are typically issued by state and local governments and offer a lower interest rate, but an investor will not have to pay federal taxes on their gains. If the municipal bond is from the state or a locality in the state that the investor resides in, the investor may very well not have to pay any state taxes on their gains either!

So, in summary, I recommend both taxable bonds and municipal bonds to the clients I work with, and in some cases, a combination. If someone is in a 25% tax bracket, they’d much rather have a 5% municipal bond than a 6% taxable bond that would only yield 4.5% after taxes. If someone is in a 10% tax bracket, they’d much rather have a 6% taxable bond that would yield 5.4% after taxes than a 5% municipal bond. My recommendations are client-specific, and under the right circumstances, could even be bond-specific. The one other general comment I can throw your way is that in light of municipal bonds usually having lower interest rates than taxable bonds, municipal bonds rarely ever make sense inside a tax-deferred investment account such as a 401(k) or IRA. A 401(k) or IRA is already pretty much exempt from income taxes until you take a withdrawal or distribution, so the potential after-tax “savings” of municipal bonds would really be of little to no value in these types of accounts.

I hope that helps!

Thanks again for all of the questions. The Lightning Round is a lot of fun for me, but please always feel free to reach out to me with your financial questions year round!


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