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Author: BadlandZ Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121189  
Subject: Minimizing My Tax Damages Date: 4/24/2001 8:50 PM
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I am looking for some advice on how to pay a little less in taxes next year. Unfortunatly, it doesn't seem to be a simple matter, so this is going to be a little long. Please bare with me:

Obviously I'm a bit naive about taxes, at 30 years old, I got HAMMERED this year. Last year I only made $12k/year as a grad student, and had no idea how to plan. Now my wife and I are both out of school with jobs, and apparently we have made some kind of hideous mistake. I'm in a hole I can't seem to get out of, and taxes seem to be doing it to me. My wife and I make a good living, but we have some rather large debts. The debts are manageable, but the taxes seem to be getting a bit out of hand!

My income is $70k/year, hers is $51k/year, which is good. Our debts are pretty huge though, I own about $34k in student loans, she owes about $28k in student loans, and we owe about $40k outside of that (two new cars we bought when the 10+ year old cars we had finally died, both at about the same time last summer). Although the debts are big, we HAD a plan to pay them off… and were making great progress. Then came the deadly 2000 1040 form, which said, "Pay up another $8,000 for 2000!" (That's state and federal, and apparently there is a form with tables we were supposes to fill out on the back of the W4's because we are a two-income household. Surprisingly, none of my co-workers seemed to even know about this.)

$62k in student loans, and apparently we are over some kind of threshold for income so we can't deduct any student loan payments. There goes our first idea of how to gain some much-needed deductions. I'm still sort of pissed off about that.

So, we had to pay for 2000, but come 2001 I want to be a bit more prepared. 401k's are where we are starting, I'm going to try to hit the $10,500 limit for the year on mine, and my wife won't make it because her company limits her contributions to 15%.

Then I think we need to put $2000/each into an IRA. Although I would prefer a ROTH IRA, I think taxes are going to make us choose the deductible option.

Still, doing the math, it looks like even after doing that, I have to come up with about $3000 next year (at the current tax rates). It seems like I do have to modify my W4 to include an "extra withholding" to make it. But, even without taking the extra withhold out, it's tough to make rent, car payments, student loan payments, and buy groceries. It's going to be really tight when we try to start living on $25k/year less that we put into IRA's and 401k's. I know it will pay off in the long run to put money away now, but it isn't going to be easy.

Next, maybe mortgage interest deduction? Rent is high around here, $1000/month to rent a little place in a pretty rough neighborhood. Since we have to pay rent anyway, I am thinking maybe we should just bite the bullet and buy a house. With little to put down, a huge debt load, and living in New Jersey, that probably means we will be lucky if we can get a loan to get into a $100k house somewhere. I know nothing about mortgages, buying a house, or what this will take, so any advice on that would be great also. But, that's probably the next thing I need to do to help manage my taxes, right?

Is there anything obviously wrong with my plan?

Does anyone have any ideas I may have overlooked?
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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50562 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/24/2001 11:44 PM
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Badlanz,

What I am about to suggest may seem illogical, but it may be best for you at this time.

Your real issue isn't how to reduce taxes, but how to get your income to go further. Your most immediate concern is the reduction of your large debt load.

If your employers do not provide matching funds for your 401(K) plans then I would stop contributing to them. If they do provide matching funds, only contribute as much as you need to get the maximum match. I would also not contribute to any IRA plan. 401(K)s and IRAs are great for building retirement assets, but for every pre-tax dollar you contribute to one of these plans, you will only get back $.28-.41 in reduced taxes ($.28 in income tax, $.00-.08 in social security/medicare, $.00-.05 in NJ state income tax). Retirement plans cost you real money now for the promise of future benefits.

Ira





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Author: BadlandZ Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50563 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/25/2001 12:05 AM
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I think I agree, somewhat.

But... There's the whole "tax-bracket" coupled with the fact I had to put in an extra $8,000 this year above what my withholdings were that has me convinced I'm screwing something up pretty big. Our combine income will be over $120k this year easy, possibly $130+ if bonuses and extras weight in... And if I could get that under $100 with deductions, it would seem to make the projected $6k I'll owe drop to a couple hundred bucks.

I'll just have to sit down and do the math to confirm if your right, it sounds fairly logical, and you very well could be.

As for 401k's, both of our employers match 50% up to 6% (so if we put in 6%, they put in 3%). I really don't want to drop below that.

As for debt, your ABSOLUTELY RIGHT! As of January 1st 2001, I had paid off ALL of our credit cards, and was doubling payments on a few of the smaller student loans to get rid of them. Then I realized I had to come up with the $8k by May 15th, and that all went to hell... Now the credit cards are back up to a total of $6k because we had to put stuff on them (gas, groceries, etc) in order to get the $8k saved up for taxes. I'd have been better off NOT paying my taxes, because the IRS charges LESS than credit cards. But, no matter, my #1 priority now is to pay those cards back off, ASAP, even if it means eating Mac&Cheese or Raman Noodles for a while (I can do it.. grad school teaches you how to live on a shoestring by necessity).

But, as of now, it looks like buying a house might be a necessity. For a couple reasons. Our landlords are getting a divorce, and selling the place we live in now, so we will be out in a few months. We have 2 dogs, and as much as my wallet and mind tell me to get rid of them and rent a cheap little place for a while, my heart won't let me do it.

Since it's SOO hard to find a place to rent with large pets, a mortgage is a tax deduction, and I'd rather put money towards something rather than passing it off to someone else in the form of rent... I think we should buy a house. It'd cost us over $1,200/month to find a comparable place that allowed pets, IF we could find it. I'm hoping that I can get a mortgage on a little place, and have a payment <$1000/month.

That is... If I can even qualify in the position I am in right now.

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Author: buc99 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50566 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/25/2001 4:44 AM
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I wanted to alert you that you would not be able to deduct an IRA contribution at your income since you both have 401k's.

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Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50567 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/25/2001 7:08 AM
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But... There's the whole "tax-bracket" coupled with the fact I had to put in an extra $8,000 this year above what my withholdings were that has me convinced I'm screwing something up pretty big. Our combine income will be over $120k this year easy, possibly $130+ if bonuses and extras weight in...

First, get two copies of Form W-4 (make sure you have both pages) and work out how many allowances you should be claiming for withholding. That will address the $8,000 shortfall. You will get less money each paycheck, but no surprises on April 15 (almost no surprises, you've missed 1/3 of the year already).

And if I could get that under $100 with deductions, it would seem to make the projected $6k I'll owe drop to a couple hundred bucks.

What you are proposing is to spend $20-30K (deductions don't just "appear", they represent actual cash expenditures) to reduce your taxes by $6K. Instead, take the $20K, use $6K for taxes, and $14K to reduce your debt load.

As for 401k's, both of our employers match 50% up to 6% (so if we put in 6%, they put in 3%). I really don't want to drop below that.

Agreed. Even though it costs you real money to contribute to your 401(k), it would be foolish (not Foolish) to give up a 50% return on your money. Contribute 6% each.

But, as of now, it looks like buying a house might be a necessity. For a couple reasons. Our landlords are getting a divorce, and selling the place we live in now, so we will be out in a few months. We have 2 dogs, and as much as my wallet and mind tell me to get rid of them and rent a cheap little place for a while, my heart won't let me do it.

Since it's SOO hard to find a place to rent with large pets, a mortgage is a tax deduction, and I'd rather put money towards something rather than passing it off to someone else in the form of rent... I think we should buy a house. It'd cost us over $1,200/month to find a comparable place that allowed pets, IF we could find it. I'm hoping that I can get a mortgage on a little place, and have a payment <$1000/month.


You will have to run some numbers on this. You will have to compare your projected home ownership costs to your rent. Don't forget to reduce your mortgage by the tax benefit on the interest portion of the payment. Add in real estate taxes (reduced by tax benefit), utility costs, and 2-3% of purchase price for annual repairs and maintenance.
You also didn't mention if you have a downpayment available.

Ira


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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50570 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/25/2001 9:07 AM
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Badlandz,

My wife and I went through the same kind of sudden grad student to professional transition about 20 years ago (at much lower income and debt levels, but same idea). I strongly concur with Ira's advice. I hope you understand (many people don't) that your tax bracket only refers to your marginal tax rate, so it's not like increasing your deductions cuts down the rate paid on most of your income. That fact is, as Ira says, anything you do to increase your deductions decreases your available income. For people who have adequate cash flow and long term savings goals, retirement deductions and mortgage deductions are wonderful. But your problem is short term cash flow, and you have plenty of time to work towards your retirement savings. You should certainly take advantage of the retirement match, but until you get your cash flow in order, any additional contribution will probably work to your disadvantage (i.e., until you have enough surplus beyond your debt payments).

A big question is what interest rates you are paying on student loans and car payments. If your interest rates are lower than the return you can get from the bank (some loans are, but definitely not credit cards), you shouldn't hurry to pay off those loans. If not, pay them off as quickly as possible, focussing on the ones with the highest rates. (Think in terms of interest you'd get from Money Market or CD: stay away from the stock market with money you may need to access.)

As Ira said, owning a house is expensive, despite the tax advantages. A lot depends on where you live as to whether or not you can get a "starter house," and sometimes "starter houses" are hard to sell when, in a few years, you can afford to move into something that fits your income. Living, as I do, in the boring Midwest, you could buy an acceptable house (if you have the downpayment) and have less than $1000/month in payments, with the tax savings being enough to cover repairs and utilities, but not a lot of fancy new furniture. Unfortunately, in most places, housing is more expensive.

I seriously doubt you'll have to go back to living like grad students. What you need to do is work out a careful budget and live well within it. Very roughly speaking, I would think, after taxes (correcting your deductions) and 6% for retirement, you should still have about $70,000 for paying off loans and living. Even if you're paying $20, 000 for debt, you still have $50, 000. We spend less than that now, socking the rest of our income away for retirement, and we live a perfectly good upper middle class lifestyle.

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Author: njashmore Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 50584 of 121189
Subject: Re: Minimizing My Tax Damages Date: 4/25/2001 4:19 PM
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We also get bonuses. I think that might be where your problem is. My husband and I both claim married with NO dependents. The companies pay the bonuses at a 20 or 22% rate rather than our normal deduct. So every quarter we analyze the money going in and drop in extra for the quarter as needed.

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