A hearty welcome to “Grandma’s Wealth Wisdom” with your neighborly hosts, Brandon and Amanda Neely. This is the only podcast that helps you take charge of your cash flow and leverage your assets, simply and sustainably, the way Grandma used to.
Brandon: Hey, I'm Brandon, and welcome to our Grandma's Wealth Wisdom, where we help you break through to a smart, stable financial future, with the tried and true wisdom Grandma used.
Amanda: And Hey, I'm Amanda. This is Episode 76, which we've titled “How to Avoid an Upcoming Tax Increase.” Yes, we're talking about taxes again, but for a really good reason.
Brandon: In June 2020—remember June? Everybody kind of was stuck in their house. We're finally coming out a little bit—the headline read “The wealthy are prepping for tax increases with these three strategies.” [01:01.0]
A little context, of course, the COVID thing was happening and the wealthy were thinking about taxes going up. Interesting. The article on CNBC explained that “The wealthy are … working with their accountants to give away money or shift their income” and even change their residents state due to rising state and federal deficits and potential political changes.
Now, of course, we now know after that—and it's now what? March?—the political changes have changed, so now looking back, we are seeing this happen, so those guys were thinking smart. According to Robert Frank, the author, accountants’ and tax lawyers’ phones were ringing off the hook back then in June 2020, long before we're recording this episode in March. It's been nine months since and it seems more and more Americans, not just the wealthy now, are getting concerned about taxes. [02:07.8]
Amanda: So, we thought we'd make an episode about it, and we should make sure to mention that we're not tax experts and this episode will not get into the nitty-gritty of proposed or likely changes to tax codes and tax laws and all the things that people are speculating about right now. None of us has a crystal ball that I know of or a Guinness Book of World Records from 30 years in the future, so none of us--
Brandon: Now you're showing your age, Marty.
Amanda: Thanks, McFly. None of us can know for sure what taxes are going to be like next year, five years, or 30 years from now. But we do want to ask some questions that are kind of higher level looking down from a 30,000-foot view kind of perspective.
The first question: could each of us set up our individual financial strategies in such a way that, no matter what happens to taxes, we're going to be okay? Is it possible to be protected from overpaying taxes now and/or overpaying taxes later over one's lifetime? What would it look like to pay our fair share and not a penny more? [03:11.7]
Brandon: For a refresher go back to Episode 48. The title was “Taxes going up and what to do about it now.” For the three different tax buckets, we talked about paying now, paying later and paying never. Now, we published this on February 14, 2020, so we've been thinking about a potential tax increase for a while now.
Amanda: Let's jump into considerations for 2021 and we've got three points for today's episode. We got a little creative with these three points. They all have the word “equal” in them to help you remember them.
Brandon: The first thing that might be helpful when looking to pay your fair share and not a penny more is that not all taxes are created equal. There are different sorts of taxes for different sorts of things. [04:01.5]
For example, regular income taxes and capital gains taxes are different, at least on the federal level, but also in some states, but definitely not all, so that gets confusing. We learned that quickly in Illinois and we were confused like you are listening to us now.
Amanda: Yeah, Illinois does not treat capital gains taxes differently from regular income tax. We learned that when we sold our business and had to pay taxes on the money we made.
Anyway, if you do live in a state or you're thinking on federal level, one of the considerations for a change to the tax law is to treat them the same as regular income and capital gains as the same. But for now they're different in some states and on the federal level, and knowing what makes a capital gain versus a regular income tax can be really crucial, depending on what you're doing with your money and the tax implications of it. [04:58.0]
By way of an example, let's take Jess and Joe. They both have brokerage accounts where they can buy and sell individual stocks, ETFs, index funds, and so forth. Jess is actively buying and selling stocks throughout the year, so any gains that Jess gets on stocks held for less than a year are taxed as regular income. Joe, on the other hand, buys stocks and makes sure that they're held for at least a year and a day before selling that stock or ETF or index fund or whatever. Any gains that Joe gets on those stocks that are held for more than a year are taxed as capital gains.
Brandon: Why does that matter? It matters because capital gains are currently given preferred tax rates than regular income, depending on your filing status and total income. [05:50.4]
Amanda: Yeah, so continuing this example, let's say both Jess and Joe make $1,000 on their stocks. Jess’ $1,000 gain would be added onto regular income and could pay 22% or more, depending on the income level. Joe might be able to pay 0% or at most 15% because of holding onto those stocks for at least a year and a day. That could be a really big deal to what they pay in taxes year after year.
Brandon: The example we used is about stocks. We don't necessarily recommend either buying or holding stocks, but thought it would be a good example. We should say two more things before we move on to Point 2.
Amanda: Yeah, so remember this thing about not all taxes are created equal that capital gains taxes apply to other assets, too, like real estate collectibles and businesses. There's also special considerations for things like social security. It gets really complicated really quickly. We just thought that would be a good example to use because it's easy to picture, the stocks and the gains and how a slight change in how long you hold them can make a big difference taxwise. [07:01.4]
Brandon: Exactly. Secondly, research has shown that, in general, those who actively trade often get lower returns than those who are less active, which is interesting. This might be a case when the tax code is rewarding you for behavior that builds your ROI, your return on investment.
Amanda: But there are cases and some instances of actual people that I know where they have lost money in their brokerage account over the course of a year, like January 1 was more than December 31, and then they still get a tax document. They have to still pay taxes, even though they lost money overall. So, it's very important to be aware of some of these tax implications of the stock market, especially when you're actively trading. [07:53.0]
Grandma always said, “Eat your vegetables. Look both ways before crossing the road. And never risk your financial future on elements of the market you can’t control.” That Grandma, always good for some tried-and-true advice. And although some of her wisdom seems to have skipped a generation, you don't have to be left behind.
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Brandon: Now onto Point No. 2. Not all ways to pay your taxes are created equal. There are different ways to pay your taxes. That's interesting, right?
Amanda: Yeah, for example, you can have taxes withheld from your paycheck. You can make quarterly estimates. You can pay annually with your return. You can even pay late or on a payment plan. Oftentimes, people use a combination of these, especially business owners and side hustlers. There are some to actually paying yourself in different ways and in different time schedules, and paying taxes in different ways in different time schedules, depending on how you're paying yourself. [09:03.4]
Brandon: Amanda, why does it matter when you pay your taxes?
Amanda: It all comes down to what they call opportunity cost.
Brandon: Oh, big word there.
Amanda: When you send funds to the IRS or to your state, the IRS or your state get all the growth on those funds until they're spent. Yet when you wait and send them in as late as you can without penalty, you can pursue some growth on them in the meantime.
Brandon: Gotcha. So, if you're getting a refund each year, what if you took a look at how much you're paying and when to reduce, and instead get those funds growing for you throughout the year?
Amanda: Yeah, many people use paying extra in taxes as a forced savings strategy, so they have money each spring for home repairs or each summer for summer vacation or whatever it is. Our encouragement to you is that there could be other ways to do forced savings that might benefit you more. It's at least worth looking into it.
Brandon: Now, there are some pitfalls to avoid here. [10:02.0]
Amanda: Oh, yeah.
Brandon: What are they, Amanda?
Amanda: Yeah, some warnings here. If you're going to follow a strategy to pay your taxes as late as possible, so that you get some growth on your money in the meantime, the No. 1 guideline is this: do not be tempted to use the money in the meantime, and definitely don't use it in the meantime. Perhaps you put it somewhere it's hard to access, like a different bank account at a different bank, or within your properly designed, dividend-paying, high cash-value whole life insurance policy, where maybe it doesn't just grow in the meantime until you pay your taxes, but it grows through the rest of your life maybe. That's what you do.
Brandon: And that's a good idea.
Amanda: Just remember, this is the money you owe to the government, so it's not yours to spend freely. You're going to want to have it when it's due and this ties directly into the second pitfall to avoid here. [10:57.1]
Brandon: Yeah, the biggest pitfall to avoid is getting behind so much that you have to go on a payment plan with them, with the IRS. According to the IRS website, there are both penalties and interest involved when you get on an installment agreement. I haven't looked up all the states, but my guess is that the states have something similar.
Amanda: Yeah, I've definitely met some people who are on payment plans and it was one of the debts they wanted gone first and as soon as possible due to the high interest and the high monthly payment requirement, too.
Brandon: Finally, Point No. 3, savings on taxes is not equal to a strategy. Let me say that again. Savings on taxes is not equal to a strategy. As they say in the financial sector, don't the tax tail wag the dog.
Amanda: Yeah, so would you give up a 25% return on an investment to save 22% on taxes? Would you live life without any fun experiences, because if you took more income to pay for those experiences, you'd have to pay more in taxes? [12:10.5]
Brandon: For us, personally, we're taking the approach that a solid financial strategy is more important to us than trying to times tax rates and guess whether they will be lower or higher in the future.
Amanda: Yeah, but if you do press us, our personal opinion is that, for us, taxes are likely going to be higher in the future for a few reasons.
One, we haven't reached our peak earning years, which typically people reach in their fifties. Neither one of us is in our fifties yet. We plan to earn more in the future. Secondly, we don't plan to live in poverty as seniors.
We want to still have a nice income when we're old. Thirdly, we have these lower income years as we are building our business. We have some really good tax deductions right now known as a kiddo, a child, and so we're not interested in lowering our tax burden now. [13:01.7]
In fact, we're more interested in paying as much tax as possible for now, and then we get to some of those peak earning years when we don't have some of the tax deductions we have now, things like that. That's so we can look at tax-deferred strategies as our income increases over certain tax thresholds, which will probably change by the time we get there anyway.
Brandon: Yep. You will likely have a different strategy depending on your life stage, your passions, your career trajectory, the number of kids you have, and so on and so forth.
Amanda: But here's something I think a lot of people can relate to from various different life stages and career trajectories and all that. Here's the question: would you rather reduce your taxes in the short term or would you rather have a financial strategy that both saves taxes over the long-term and maybe even gives you enough money to pay taxes, no matter the future of the tax code? [13:58.5]
Brandon: Likely the person that does your taxes is thinking of the former, how to save your taxes this year. Of course, right? A good financial professional should be looking at the long-term and helping you develop a strategy around the variables of your unique situation. Yes, possibly to save taxes, but perhaps more importantly, to give you financial freedom, no matter what cut the IRS takes.
Amanda: Isn't that truly financial freedom anyway, that you're not worried about how much taxes you're going to have to pay and that that's keeping you from the kinds of experiences and things you want to see happen? That sounds like financial freedom when you don’t have to worry about taxes so much.
But let's recap the three points of today's episode.
No. 1: not all taxes are created equal.
No. 2: not all ways to pay your taxes are created equal.
And No. 3: saving on taxes is not equal to a strategy. [15:02.8]
Which of these is the one you want to dive in deeper and figure out how to apply to your situation? And, more importantly, who is going to help you ask the right questions and point you to the right resources to improve how you pay for taxes?
Brandon: Of course, we'd love to be of service in whatever way we can, sharing resources or giving you some thoughts to consider, and you can schedule a call with us at Grandma'sWealthWisdom.com. We're happy to help in whatever ways that we can.
Amanda: Yeah, so go schedule a call with us right now, and then be sure you've hit the subscribe button so that you don't miss a very fun episode next time. We’ve titled it “Grandma + Frugal. It's not what you think.”
Brandon: That sounds more…I don't know, fun episode being frugal.
Amanda: We're going to talk about a different way to define frugal, no clipping coupons or cutting back required. We're going to even share one question that saved us a lot of money in 2020.
Brandon: Until next time, keep building your wealth simply and sustainably, so you can break through to a smart, stable financial future. [16:11.0]
The topics presented in this podcast are for general information only and not for the purpose of providing legal, accounting or investment advice. On such matters, please consult a professional who knows your specific situation.
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