Episode Transcript
[00:00:00] Speaker A: In last week's episode, we gave you tips to optimize taxes for the year that just passed. So this year, it's time to open up some tools that will benefit you and take advantage of the year that's yet to come. Let's get started.
[00:00:10] Speaker B: Let's get some money from New Money, New Problems. It's the New Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
Negotiating compensation, purchasing your first investment property. Helping your family with money. The hot highs and lows of entrepreneurship. New Money brings new problems that require new solutions. Join us as we work through them together.
I'm Brenton Harrison, and this is the New Money New Problems podcast.
[00:00:48] Speaker A: Hello, my name is Brenton Harrison of New Money, New Problems and your host for the New Money New Problems podcast. Hope that you all had a phenomenal week in Nashville. We are actually preparing for, uh, a pending or impending winter storm. So schools are closed, the city's closed. We have, like, one salt truck here. So if it does indeed snow tomorrow, we will probably be stuck in the house for a couple days. But it makes it a great day to nail down, hunker down, and get some work done. And as a result, we are recording this week's podcast episode. If you were with us last week, we gave you some tools and tips to look back at the year that just passed and take advantage of or make the most of your tax return in the limited time that you have. I've shared that ideally you're planning for taxes moving forward, but. But if that wasn't something that you were able to do in 2024, we at least wanted you to have some working knowledge of ways to maximize. What tools are there to be maximized. But this week, we're doing the thing that I actually feel is more beneficial, more instructive, and that is talking about what you have planned for the year ahead, how it impacts your taxes, and striking the balance between not letting the tax tail wag the dog, meaning that you are making decisions that benefit your taxes without keeping in consideration the balance of your finances, but also when those two goals merge and align, making sure you do things in a way that benefits your taxes whenever possible. So, as a quick summary of the tax filing process, you start with totaling your income from all sources. Any taxpayer can then utilize something called above the line deductions to reduce the amount of income on which they pay taxes. After doing so, they'll come to a number called their adjusted gross income, which is A very important number when it comes to the amount of deductions or credits that you have access to. They then, after they find their adjusted gross income, decide whether they're going to take the standard deduction that's available to to all taxpayers or itemize their own deductions, whichever benefits them the most, that will bring them to their actual taxable income. And the taxable income is what's applied to the federal tax brackets. So you may make $100,000 but only have $60,000 in taxable income. So that's the amount on which you'll pay taxes. After we calculate the taxes owed, you can then use tax credits to reduce the amount of taxes that you pay dollar for dollar. And that brings us to the actual number that will be paid at the end of the process. So let's start at the top of the ladder totaling up the income and figure out some ways that having a little pre planning can help us in 2025. And one of the first things that I would encourage you to do is to take your income before we consider any deductions and things of that nature and just figure out your marginal tax bracket. Your marginal tax bracket is the rate at which the highest portion of your earnings will be taxed. So for example, let's say if you're looking on screen, we're looking at the tax brackets for 2025, we're going to assume that we have a couple that makes 250,000 dol thousand dollars, ah, combined. If you're looking at the federal tax brackets, you'll see that in 2025 that makes their marginal tax rate 24%. And to me that's valuable to know because it gives you an idea of how valuable any deductions that we find might be. What does that mean? Well, let's say that this couple makes $250,000 and they decide to put $10,000 into their 401ks and their IRAs $10,000 in pre tax retirement contributions red on which they pay taxes by $10,000. Well, if we know that the highest portion of their income is taxed at 24% their marginal tax bracket, then we also know that by reducing their taxable income $10,000, they are saving $2,400 in taxes. It gives you an idea of just how powerful certain deductions may be. So that if you're deciding between making certain retirement contributions in terms of the amount, or if you're deciding between making a pre tax retirement contribution which helps reduce your taxable income versus a Roth Contribution, which does not. Those are the types of things that you can know by looking at your marginal tax bracket. You also want to project any bonuses that you typically earn and have an idea of the withholding for those bonuses as compared to your marginal tax rate. Going back to our example of a couple that makes $250,000 and have a 24% marginal tax bracket, it's really important that they know that, because for many people in this country, when they get bonuses, the amount that they have withheld from that bonus for taxes is preset by employer, and in most cases it is 22%. Now, let's imagine that you're somebody who's in the 32% tax bracket or the 37% tax bracket, and you have a bonus where they're only withholding 22%. That can be a much wider gap that you have to plan and project for when it comes to how you plan for your 2025 taxes. And another reason why you want to have an idea of about how much you'll earn is because it's instructive in filling out your W4. The W4 is the form that your employer asks you to fill out, predict or project how much taxes they should withhold from your paycheck to make sure that you don't owe a significant amount at the end of the year. And it's something where, based on the number of dependents in your household, based on the income in which you earn, it is a stab in the dark because your employer only knows how much you'll earn. They don't know the other activities that you're doing in your financial life that impact what you do or don't owe on your tax return. Which is why, in my opinion, unless you have a very, very straightforward tax return, and I've shared why, and even those cases, I encourage you to use a tax professional. I often ask my high income earners to consult with their CPA or their enrolled agent to get their help based on the other activities they're doing in their taxable environment to know how much should be withheld from their paycheck. As an example, we have people who, from an income perspective would have a marginal tax bracket in the 30s and higher, but maybe they're exceedingly charitable or they have other losses that are taking somewhere in their tax return, and when you factor in those losses, they have have a, uh, lower tax bracket than you would expect given their earnings. And conversely, the opposite can be true where you have somebody who just doesn't predict the fact that their spouse is earning a significant amount of money and may not have the same, uh, level of withholdings, or you have a bonus that you weren't expecting and they get to the end of the year and they owe significant amounts and they're wondering what happened. It's all because of a lack of planning when it comes to the amount that you're going to earn and the amount that's being withheld from your paycheck on a bi weekly basis. And if you're a business owner or an independent contractor, we're not leaving you out. As a matter of fact, you might need to do more projection than even a W2 employee. Because when you are an independent contractor or a business owner, you're responsible for more things. Not only do you have to pay your taxes on a quarterly basis to make estimated payments, you also have to pay your payroll taxes at an extent that W2 workers don't have to pay. You also want to have some projection of income and how much you will need to pull from that business. Because at a larger scale, when it comes to your planning and the structure of your business, there are people where they might start as an LLC because that's the most beneficial thing for them at the time that they start their business. But as the business and their income progresses and maybe they don't need to take as much out of that business on a year to year basis, they may shift to a structure like an S Corp where they're allowed to differentiate between what is actually a salary versus what is distributions from the business that are taxed at different levels. So having a pre meeting with a tax professional will give you the ability to talk to them and plan out what you're thinking for the year ahead, or looking at what happened in the year past and saying, does my business structure still suit me? Are there changes that I can make for the year ahead that will benefit me? And the reason you want to do this now is because in the event that you're in the scenario like I discussed, where maybe you had an LLC in the past and S Corp makes more sense moving forward, that's not a decision that you can make in December for the tax year 2025, you would have to have done that with more advanced notice if it's something that you plan to do for the current tax year. So now that we've talked about how our income could impact our tax strategy for the year ahead, I want to go to the next level in the tax preparation process which is utilizing your above the line deductions. And this is not like a fact, this is personal preference. Maybe it's because I'm a business owner and when most small business owners file their taxes, prepare for their taxes, at least in my experience, they don't decide how much they're going to contribute to retirement until the end of the process, really towards the end of the tax year, uh, in most cases. But if you're a W2 employee, that's not really possible. You have to determine how much you're going to put in your 401k, 403. But what I would say is in the tax projection process, I would tell you to look at the above the line deductions that you're going to utilize, excluding your retirement contributions, which we'll address at the end of this process. The reason I say that is because based on some of the other things we talk about in terms of what impacts your taxes, I would want to know what my taxable income is going to look like before I decide whether I'm going to do a certain amount in a 401 versus a Roth 401k or a SEP IRA versus a Solo 401k as an example. So I start with the other above the line deductions. How much are you going to contribute to your health savings account? Are you going to instead do a flex spending account? Are you going to put money into a dependent flex spending account? If you're self employed and we're doing some type of projection for your net business income, what are you going to pay when it comes to your self employment taxes? All of those things give you an idea of what you have available as an above the line deduction to reduce your taxable income down to your adjusted gross income or modified adjusted gross income. And to me, I like to take those tools that you have available in the process and get a little further along and then once we're further along decide, okay, I'm going to max out my IRA this year, or I think that I'm okay in terms of how I'm projected in terms of the taxes that I owe. So since I'm not trying to save on taxes, maybe I do feel more comfortable putting those funds into a Roth IRA as a basic example. So if you're following along, we've projected our income, then we've projected the amount of above the line deductions absent retirement contributions that we'll have to reduce our taxable income down to the level of our adjusted gross income or modified adjusted gross income. And this is an area where I would tell you to stop based on whether you have or do not have a really particularly awful form of debt. And that form of debt is federal student loan debt. As you know, we have a separate podcast from a separate business entity called Escape Student Loan Debt where we talk about this more in detail. But on this podcast we have covered that. If you have federal student loan debt of a certain amount, it's highly likely that you're going to pay on that debt using an income driven repayment plan. These plans base their payment each year in part on your adjusted gross income. And there's a lot of strategy that needs to be done based on not just how much you owe, how much you earn, but also how much your spouse earns when it comes to what your tax return looks like. And adjusted gross income is one of the tools that gives you the best opportunity to make some decisions that impact that number in a major way. As an example, if you're looking on screen, you're seeing the Escape Student Loan Debt Guide to Income Driven Repayment Plans. We'll put a link for you to download this guide in the show notes if you are interested. And let's go back to our couple that makes $250,000 and we're going to assume that they're adjust adjusted gross income is $225,000. Let's give them a couple kids, so it's a family of four. And we're going to assume that their student loan balance is $350,000. If that sounds astronomical, I can assure you based on people with which we work, it is not. And if you look at those variables, you will see if you look to the right, if they're paying under the new income based repayment plan, the monthly payment that they would have to make every single month is $1,485 a month. If they're paying under the old income based repayment, it's $2,227.50 a month. But now let's do some strategy and let's assume that one of the partners in this relationship is a stay at home parent. So it's a family of four. It's $225,000 of adjusted gross income. But only one person is earning the income on a day to day basis. Technically the stay at home parent is earning their keep. But you understand what I mean. If we're going to put this person in a state, we're going to for this example, assume that they're in the state of California. Why am um, I using California? Because California is a community property state if it's not a community property state. If it's not a community property state, let's say that it's Tennessee and these spouses decide to file their taxes separately, then the person who makes 225,000 will get a tax return that says 225,000 and the person who stayed at home will get a tax return that says they made $0 in a community property state. However, it works differently. In a community property state, instead of each having a tax return with their respective income, they take the total household income and they split it down the middle. So even though one person earned $225,000 of adjusted gross income, if they file separately with their spouse, they would each get a tax return that has $112,500 of income in it. So let's lower our adjusted gross to 112,500 and we are going to see that instead of the 1400amonth that they were paying under the new IBR plan before, and I think the 2200amonth that they were paying on old IBR, it drops those down to $922 and $614, respectively. Now, the flip side to this is in most cases, if you file your taxes married filing separately as compared to married filing jointly, it costs you more in taxes. Which is why, if you're considering this, you need to work with a tax professional. Because what you want to make sure of is that the amount that you're saving in student loan payments is higher than the amount that it's costing you in additional taxes. This is the benefit of tax projection, not just for your student loans. It's also the benefit of using a tax professional to do those projections.
[00:15:06] Speaker C: This is the New Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen. We'll be right back.
[00:15:24] Speaker B: Are you wondering what new money problems you might be overlooking in your financial life? If so, we've got great news.
We've crafted the New MONEY New Problems gap finder to identify potential weaknesses in your finances in areas ranging from budgeting to investments, insurance, and even the threat your extended family's finances could pose to your household. Please head to newmoney newproblems.com Gapfinder to complete it today. Again, that's newmoney newproblems.com gapfinder to take the assessment.
[00:16:03] Speaker C: You're listening to the New Money New Problems podcast. Subscribe now at newmoney new problems.com welcome back.
[00:16:14] Speaker A: Welcome back. We're continuing our journey down the tax filing process. We have total up our income. We've projected the amount of above the line tax deductions we'll have at our disposal. Now it's time to make the decision on itemizing versus taking the standard deduction. Another term for itemized deductions are below the line deductions. And if you're looking on screen, you're looking at a screenshot of, uh, some of the ones we talked about last week. So let's talk about some ways that we can optimize this so that if we are trying to make that decision, we give ourselves the best chance of having deductions that exceed what's available with the standard deduction. For example, when it comes to charitable deductions, the obvious way that you can benefit your itemized deductions in this area would be to make those charitable deductions. But it doesn't necessarily have to be you going out and finding a charity that you're going to give money to on a monthly basis. You could do a concept called bunching deductions, where instead of spreading out your deductions over the course of several years, if you're thinking that this year you're going to take the stand standard deduction, maybe you don't make as many charitable contributions this year and you take everything that you were going to contribute and you add it onto next year's plans. Charitable contributions, that increases the total that you have in the tax year 20, 26, which might put you in a position where you're giving to charity and benefiting from a tax perspective by itemizing your deductions. So the concept of bunching deductions is essentially saying, if I'm not going to itemize this year, let me take that amount, add it on to a future year, and in that year I increase odds, uh, of benefiting from itemizing. Another way that people will do this if they're trying to get some benefit from charitable contributions every single year, but they do not necessarily have a nonprofit or a cause in mind that they want to contribute to in the here and now is what's called a donor advised fund. We'll do an episode on this, uh, down the line. But the concept of a donor advised fund is it's an account that you can open up now, you can contribute money to that account and you can take a tax deduction in the year in which you contribute, even if you do not have those funds dispersed to a charity in that same year. So, for example I can put money in a donor advised fund, that money can be invested in the market, and if I contribute in the year 2025, I get a tax deduction for that charitable contribution in 2025. Now let's say that two years later in 2027 is a charitable cause that catches my eye and I decide that I want to make a $3,000 distribution from my donor advised fund to that charity in the year 2027. Well, I got my tax deduction in 2025, even though the funds weren't distributed until two calendar years later. Next up we have state and local taxes. And while there may not be as much that you can do in terms of how much you pay in state income tax, when it comes to property taxes, if you do not have your taxes escrowed into your mortgage payment and you've decided to pay them on your own, you may prepay your property taxes so that you can take advantage of the itemized deduction. Now next up, medical expenses. And this is one where it's kind of similar to the process that you go through, uh, when you're talking about federal student loans. Medical expenses are things that are tax deductible to the extent that they exceed 7.5% of your adjusted gross income. Now for a high income earning couple, it may take a lot of medical expenses to exceed 7.5% of adjusted gross income. But let's say that you're planning to have a child this year, or you're planning a major surgery in this year, or any other medical expense for one of you in the household that you know is going to be costly. And if you filed your taxes jointly, it still would not exceed 7.5% of that adjusted gross income. But if you filed your taxes separately, that's a different and lower bar that may allow you to benefit from those expenses in a tangible way. Now it would still have to be, in my opinion, some pretty substantial medical expenses. But again, if these are pre planned things where you can project ahead and you're working with the tax professional, you can have them run the numbers and maybe if you have other scenarios that might benefit you to file separately, these are the types of areas where some pre planning can save you some significant funds in the long run. Now, after you've calculated your possible below the line deductions, you now have a decent idea of whether you're going to itemize or take the standard deduction. And regardless of the option you choose, the amount that's left over at the end of that process is your actual taxable income. That's the amount that's going to be applied to the progressive tax brackets that we've discussed. So you can, even though there are going to be things that change throughout the course of the year, at least do some rough projections based on that taxable income of the amount that you will actually owe in taxes. And this to me is where you start the process of determining how much you're going to put into things like your 401k and what type of retirement contribution you're going to make. We've talked about this earlier in the episode, but if I go through this process and it turns out that I'm going to pay way more in taxes than I expected, then it may definitely benefit me to not only contribute to a pre tax retirement account, but to do so at a significant level so that I can reduce my taxable income come dollar for dollar. Conversely, if I get through this projection and it looks like I'm going to be okay, cash flow is very strong. I'm not really concerned about my tax bill and I may be in a situation where I can not only consider things like Roth contributions if I have a, uh, low enough income where I contribute to that directly, but even if I'm over that amount, I may as a high income earner consider things like backdoor Roth contributions or even doing a Roth conversion of a current IRA or 401k and converting it to a Roth IRA. Those are complex processes, but with pre planning you can start to build that process into your yearly strategies so that you can shift money that currently is in a position where in retirement when you take withdrawals, it'd be subject to income taxes to funds that are free from income taxes in your retirement years, if that's the right strategy for you. And lastly, tax credits. The major tax credits that you're going to come across depending on your income are things like the amount that you're spending towards your children's college or your education. Or if you have minor children that are under the age of 13, the amount that you spend in terms of the expenses that it takes to keep them occupied while you're going to earn an income for things like the Child Independent Care credit. In my opinion, most of the things that you're going to spend in this area are things that you are, uh, already going to spend. It's just a matter of making sure that you keep proper records. Because the mistake that I often see people make is you've paid expenses that are eligible to increase the credit that's due to you, but because you didn't keep track of them, you don't have receipts. You can claim them if you want to, but if there were an audit that will require you to substantiate those expenses, you wouldn't be able to do so. So it's not as much a matter of optimization as it is a matter of record keeping to know you can make sure that you can take advantage of all those expenses in terms of recouping them in the form of tax credits at the end of the taxable year. Year. So that was a lot. I know that last week's episode and this week's episode are dense, and again, I'm okay with that because I will tell you that my ulterior motive is to make sure that if your situation is advanced enough where several of these things are applicable to you, that you would just go ahead and hire a tax professional. It is January. I will tell you that many tax professionals who do tax projections for the year ahead are already closed to people who are filing for the year that just passed. But this is a golden opportunity to establish a relationship with the tax professional that will give you some projections for what's going to come in the year that's in front of you. I would encourage you to do so. I would encourage you to not take on the mantle of doing these things on your own. Because while it may seem like you're saving money on the front end, I can assure you that filing your taxes incorrectly can lead to significantly more costs on the back end. We'll be back next week with a new episode, and I look forward to seeing you then.
[00:24:17] Speaker B: From New Money, New Problems this was the New Money, New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
