Wise Money Decisions

I love numbers.  I love to tinker with anything that has numbers.  That’s why I can’t wait to start my taxes.  It’s the most wonderful time of the year. 

Most years I would have started by now.  This year I’ve waited a little longer than usual.  Here are the top five reasons I haven’t started my taxes:

REASON #1:  I owe money.  Financially it is advantageous to defer the payment as long as possible.  The latest I can pay without running the risk of penalties or interest is April 15^th - so that’s the day I pay. 

I don’t always wait until April 15^th.  Sometimes I go to the post office on April 14^th to beat the rush.

By the way, if you receive a tax refund you should adjust your withholding.  There is no reason to make an interest-free loan to the federal government.  Same with your state withholding.  Learning how withholding works is a wise money decision.

REASON #2:  I need to contribute the full amount to both my and my wife’s IRA.  I need to round up some money and move it between accounts.  That takes time.

I could file my taxes before I contribute the money.  You are allowed to file your taxes before making the IRA contribution.  As long as you make your IRA contribution by April 15^th, then the IRS doesn’t complain. 

However, if you file your taxes and later decide not to contribute to your IRA, you will need to file an amended return.  Rather than risk an amended return in case I change my mind, I wait to file my return until I’ve done the IRA contribution.

REASON #3:  Last year I did my taxes in January.  Several days later I received a 1099 for a brokerage account that showed numbers different than what I expected.  I had to redo my return. 

Two weeks later I received an amended 1099 showing different numbers.  I had to re-redo my return. 

Even though I love doing my taxes, I wasn’t crazy about doing them three times in one year.  I decided from then on I would wait until March to do my taxes.

You may wonder why the broker was sending me amended 1099 statements after the January 31 deadline.  I found out later it wasn’t anything to do with the broker, but instead was a result of holding some foreign investments.  Foreign companies and funds don’t always follow IRS rules about reporting tax information on a timely basis. 

The last few years I received several amended statements, but I haven’t received any this year.

REASON #4:  I started this blog a few weeks ago.  It takes a tremendous amount of time.  Time I otherwise could spend doing my taxes. 

I think it’s safe to say I’m the only blogger in the world that wishes he could spend a little less time blogging in order to spend a little more time doing taxes.

REASON #5:  Doing my taxes is like a week in Hawaii.  The anticipation is wonderful.  The trip is wonderful.  But it’s a little disappointing after it’s over.  There’s nothing to look forward to until next time.

By waiting to do my taxes, I extend the excitement of the anticipation and defer the disappointment of the aftermath.

Conclusion

There are several reasons I have waited to do my taxes.  Deferral is the main reason.  I defer the payment of any tax as much and as often as I can. 

Deferral only makes sense if you invest the money in the meantime.  If you put the money in a checking account instead of investing it, then there would be very little benefit of deferral.

If you don’t like doing your taxes, then I hope for your sake you finish them quickly (or better yet you’re already done). 

But if you’re crazy like me and you love doing your taxes, I hope you haven’t started yet so you have the whole wonderful process to enjoy.  Have a great couple of weeks before April 15^th!

A few days ago I received a mailer from American Express.  They want me to pay my taxes using my Blue Cash card.  Apparently American Express doesn’t read my blog, because just last week I discussed why it’s a bad idea to pay your taxes by credit card.

The mailer focuses on the cash rewards I will receive from using the card.  The mailer helpfully reminds me that I can use the cash to buy certain featured items.  See if you can guess the items from AMEX’s descriptions:

First item: “A getaway to get away”

Second item: “Get a new perspective”

Third item: “A dazzling showstopper”

(Click below on “Read the rest of this entry” for the answers)

Remember, most people should not pay their taxes using a credit card.  Unless you’re on some kind of promotion with your credit card, your cashback bonus plus the time value of money from deferring your payment will not make up for the 2.49% “convenience fee.” 

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The IRS has a page describing the benefits of paying your taxes by credit card.  They tout the:

• Convenience,
• Security,
• Proof of payment, and
• Ability to earn cash, miles, or other rewards if you have a rewards card.

Paying your federal taxes by credit card comes with a price  -  2.49% to be exact.  It’s called a “convenience fee” although I don’t find the fee to be convenient.  The card issuer charges the fee because by law the issuer is not allowed to charge the IRS a fee.  

I usually jump at the chance when I learn of an opportunity to pay one of my regular bills by credit card because my card pays 1.5% cash back.  However, when there is a convenience fee you need to consider the numbers.

If You’re Getting a Refund, You’re Also Getting an Assignment

Before we look at credit cards, first I want to talk to those of you that don’t owe taxes.  If you are employed and you don’t owe taxes on your 2007 tax return, your employer is over-withholding from your paycheck.  If you are self-employed and you don’t owe taxes, you are over-paying your estimated taxes.

If your refund is big, say more than $1,000, I’m giving you the assignment to learn about withholding and adjust the amount withheld from your paycheck (if you’re employed) or the amount of your estimated taxes (if you’re self-employed) so that you won’t receive a refund next year.  No matter how hard I rack my brain I just can’t think of a good reason to give Uncle Sam an interest-free loan. 

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Yesterday I provided an overview of the three ways to make money: labor, capital and gift.  I discussed the first way, labor.  Today I will discuss the remaining two ways: capital, and gifts.

What is Capital

Once you’ve made some money from your labor, you can invest and make money from capital.  The most common way is opening a savings account at a bank.  Other ways:  invest in stocks or funds, real estate, collectibles (art, stamps, baseball cards), or start a business.   Starting a business requires a combination of labor and capital.  Some businesses require high amounts of both, while other businesses may require more labor and less capital.

What’s Good with Capital

Generally, making money from capital requires less effort than labor.  It usually takes less time to manage your capital.  Your capital works even while you’re not.  For example, I own stocks of Japanese companies.  It’s nice to think they’re on the other side of the world making money for me while I’m asleep at night. 

Capital is taxed less than labor.  Not only is the tax rate lower, but there are also more tax planning opportunities to reduce your tax bill.  As mentioned above, I’ll post soon on the taxation of labor vs. capital.

How To Make More Money on Capital

Capital is scalable.  If you want twice the return, you can invest twice as much capital.  Or you can find ways to invest your money at a higher return.

Downsides of Capital

With all the advantages of capital, what downside could there be?  Just one.  It takes a lot of capital to make significant amounts of money.  Let’s take the stock market as an example.  Even if you find ways to achieve an average annual after-tax return of 15% per year in the stock market (not an easy feat), you need to invest about $600,000 bucks to generate enough return to live a middle class life in Silicon Valley!  (based on 2006 median income of $85,446)

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Last time I discussed my goal to be in a position to retire after a 20 year career.  To reach my goal I need to accumulate a large amount of money.  There are many ways to make money: jobs, savings accounts, stocks, mutual funds, real estate, start a business, receive an inheritance, etc.   I find it useful to categorize the different ways that money is made as follows:

• Labor
• Capital
• Gifts & Inheritance

Each of us makes money from all three categories.  For most people, the vast majority of their money comes from labor and a much smaller amount comes from the other two categories.  Over the next couple days I’m going to discuss the pros and cons of each category.  I will start with labor because it is the most familiar for most people.  For now let me arrange the categories into a table with some defining characteristics:

What is Labor

When I was 10 years old I did a paper route.  I got paid six cents a paper.  That’s labor.  A few years later a math professor hired me as a math guinea pig.  He wanted me to do all of the math problems in a textbook he was writing.  That’s labor.  Not to mention the most boring summer job ever. 

These days I provide legal services.  That’s labor.  I help people invest their money.  Also labor.

What’s Good with Labor

Most people earn most of their money from labor.  Labor is the only way to make money when you start out in the world.  There’s a low barrier to entry.  Even if your only skill is digging holes in the ground, you can find someone willing to pay for it.  As you develop skills your labor becomes more valuable.  A doctor makes more than a ditch digger, for example. 

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