How Obama Might Affect Your Taxes And Personal Finances

November 6, 2008

Barack Obama was voted the new president elect yesterday. Very early in the campaign, the number one issue changed from the war in Iraq to the slumping economy. Obama has preached change throughout his campaign and the most pressing issue that requires change is the economy. Additionally, Democrats hold the majority in both houses of Congress and in combination with Obama will quickly try to turn the economy around in ways that may affect your mortgage, taxes and retirement plans.

Retirement Plans

Obama has entertained the idea of temporarily eliminating the annual required minimum distributions from IRAs if you are 70 or older. The idea is that you shouldn’t be forced to sell losing investments if you don’t need the income. Obama has also mentioned making the required withdrawals tax free for a short time.

He has proposed temporarily removing early withdrawal penalties on $10,000 of savings from 401ks and IRAs. The money would still be subject to federal and state income taxes.

A more permanent proposal may include matching 50% on the dollar for the first $1,000 of retirement contributions if your income is less than $75,000. I am all for any proposal that encourages retirement savings. He has also proposed requiring employers to set up automatic contributions to IRAs (if a 401k or similar retirement plan is not offered) for employees. The employees would then have the option to opt out. I have read that more employees participate in retirement savings programs if they are automatically enrolled and have to opt out.

2nd Stimulus

Prior to the major bailout plan, Obama proposed a 2nd stimulus plan, which would result in roughly $500 stimulus checks for individuals and $1,000 for families. The stimulus plan would also encompass help for small businesses and failing mortgages.

Tax Plan

Obama has proposed reinstating the 36% and 39.6% tax rates for individuals with income of $200,000 and joint filers with income of $250,000. He plans on keeping all other income tax rates the same as the Bush levels. Obama plans a similar tax increase for capital gains rates. He plans on increasing the top capital gains tax rate to 20%.

Obama’s plan does include tax cuts in a few areas for lower level income filers. He wants to eliminate income taxes for low income seniors. He wants to add or increase tax credits for Social Security taxes, college expenses and mortgages who don’t itemize. Obama has also mentioned offering a refund from taxes levied on oil companies, although with the gas prices on the decline, I don’t know how much steam this refund will gain.

Mortgages and Foreclosures

Obama has proposed including a 90-day moratorium on foreclosures for firms receiving help from the $700 bailout plan. This plan includes the ability to buy troubled mortgages and restructure them. Obama also favors providing bankruptcy judges the power to write down mortgage debt. There is an argument that allowing judges to modify loans could lead to higher mortgage rates for future home buyers.


The next year will be extremely interesting. While doing research on Obama’s website, I browsed through all of his ideas for creating jobs, improving infrastructure, furthering energy independence, etc. and I just don’t see how he can not raise taxes. All of these ideas for change and tax cuts sound wonderful. I’m all for energy independence and promoting research and science jobs, but I just don’t see it happening without increasing taxes. Even though I don’t know how Obama will make it happen, I suppose I’m willing to see what he can do. Anybody else have thoughts as to how Obama’s tax plans and economy rescue plans will affect main street?

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Estimated Taxes For The Self Employed And How To Avoid Them

September 26, 2008

I began tutoring in November of 2007 to supplement my income and boost savings towards my condo down payment. My 2007 income tax return only included two months of tutoring income, which was not long enough a period of time to worry about estimated taxes. In 2008 I will have a full year of self employed income, which will require me to make estimated tax payments, or will it?

Estimated Tax Payments

Estimated tax payments are required by the IRS if you expect yourself to owe the government more than $1,000 when you file your income tax return. Estimated tax payments are due using the following quarterly schedule:

  • 1st quarter due date – April 15
  • 2nd quarter due date – June 15
  • 3rd quarter due date – September 15
  • 4th quarter due date – January 15

Most of the time estimated tax payments are associated with self employed individuals. This is because self employed individuals don’t have taxes already withheld from their income. Under some circumstances a standard W-2 employee will have to worry about making estimated tax payments. This scenario occurs when an unusually large bonus is received,  irregular income is incurred from the sale of stocks or you manage to catch Barry Bonds’ record setting home run.


In addition to paying the amount of taxes that hasn’t been paid, a penalty is assessed that is based on numerous factors and is paid along with the payment for the income tax return. An interest rate factor is used to determine the magnitude of the penalty. An interest rate factor is used because the government feels as though they missed out on income from interest. The last factor that weighs into the penalty is when the income should have been reported. If the taxes that are delinquent should have been paid in the first quarter’s estimated tax payment your penalty will be larger than if the taxes should have been paid in the third quarter’s estimated tax payment. IRS Form 2210 is used to calculate the fee.

Withholding from Wages

If you derive most of your income from standard employment, which withholds taxes from your wages (W-2), you may be able to avoid paying a penalty. As the end of the year approaches and you think you might be vulnerable to a penalty, you can ask your employer to withhold extra taxes on your last couple of pay stubs. To take advantage of this strategy you must talk with your employer and fill out a W-4 form. This is possible because wages from withholding are considered to be paid equally over all installments.

Safe Harbor Exception

The safe harbor exception stipulates that no estimated tax penalties will be incurred if the total tax payments (from estimated tax payments and withholding wages) for the year equal 100% of last year’s tax liability. This exception is possible if your AGI is less than $150,000. If your AGI is greater than $150,000 you will use a modified safe harbor exception. For AGIs greater than $150,000 the tax payments must equal a percentage greater than 100% of the previous year’s tax liability. To find this value read IRS publication 505.

Avoiding the Estimated Tax Penalty

Combining the safe harbor exception and the withholding extra wages trick you can successfully avoid paying estimated tax payments and the associated penalty. To do this make sure you withhold enough wages to stay under the $1,000 threshold or withhold enough wages to meet 100% of last year’s tax liability.

My Estimated Tax Payments

I have not been making estimated tax payments as I need the money for my down payment due in a week from tomorrow (WOOT). Additionally, I fully expect to fund a solo 401k with my self employed income, so I don’t expect my tax liability to increase at all. Also, I should have no problem qualifying for the safe harbor exception as my salary increased from my regular job and the wages withheld should have increased accordingly. I will be doing some quick calculations towards the end of the year to see if I do in fact qualify for the safe harbor exception and will file a W-4 if necessary. I encourage all of you self employed individuals to do the same.

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First-Time Home Buyer Tax Credit

September 23, 2008

Recently I visited my condo building for the grand opening weekend. I was not allowed to see my unit as the unit itself was not complete, but more importantly the third floor was not completed. The grand opening was the first time I was allowed to see the inside of my condo building, instead of just driving by and observing from the outside. The builder had six completed units, two of which were fully furnished models. I find it sort of humorous that 13 units have been sold and they chose to finish 6 units for models, but I do understand they have a business to run. Also, in the long run it is better for me if the entire building is sold and occupied. While at the grand opening I picked up a flier from the National Association of Realtors about the first-time home buyer tax credit.

First-Time Home Buyer Tax Credit

Good old G. W. signed a new housing bill into law on July 30, 2008. As a part of this bill, a temporary tax credit will be offered to first-time home buyers, which I will be when I purchase my condo. A credit valued at 10% of the cost of the home, not to exceed $7,500, is available with the purchase of a principal residence between the dates of April 9, 2008 and July 1, 2009. My closing date is October 3, 2008, which puts me right in the middle of this range.


The credit applies to any single-family residence that will be used as a principal residence, which includes condos (WOOT!). This credit only applies to first-time homeowners. To qualify as a first-time homeowner the purchaser and purchaser’s spouse may not have owned a principal residence within 3 years of the date of the purchase.

What is a Tax Credit

Since this is a tax credit, it might be a good idea to explain what a tax credit is. Tax credits reduce income tax liability on a dollar for dollar basis, which is different than a tax deduction. A tax deduction reduces the taxable income so the value of the deduction is dependent on your tax bracket. For example, if you qualify for the full $7,500 tax credit and you owe $5,000 in taxes at the end of the year, the government will send you a check for $2,500. The government will send this $2,500 refund check because this credit is considered “refundable”.

Income Restrictions

There are income restrictions for the tax credit. Single filers are eligible for the full tax credit if their income is $75,000 or less. Joint filers are eligible for the full tax credit if their income is $150,000 or less. There are phase out rules with regards to exceeding the income restrictions. The tax credit for a single filer will begin to phase out above $75,000 and will completely phase out at $95,000. The tax credit for a joint filer will begin to phase out at $150,000 and will completely phase out at $170,000.

Principal Residence

The purchase must be used as a principal residence in order to receive the tax credit. A principal residence is defined as the home of an individual for more than 50% of his time. The credit applies to principal residences for single-family detached housing, condos or townhouses.

Temporary Tax Credit and Repayment

The tax credit is called temporary, because it must be paid back. Repayment will be done over a span of 15 years starting two years after the tax credit is claimed. Interest will not be charged on the amount of the tax credit, effectively making this tax credit more of an interest free loan. I will claim the tax credit in my 2008 income tax return and will begin paying 6.67% of the amount of the tax credit on my 2010 income tax return.

Selling the Home

I have a temporary plan of living in my condo for about 5 years. This is well short of the 17 year repayment plan outlined in the bill (15 years of repayments and 2 years of no payments). If there is an outstanding amount from the tax credit when the home is sold, the amount that has not been repaid will be due in the income tax return from the year of the sale. If the capital gains from the sale do not cover the amount remaining from the tax credit, a portion of the liability is forgiven. For example, if you still owe $5,000 of the tax credit and sell your home for a gain of $3,000, the remaining $2,000 is forgiven.

Applying for the Credit

The tax credit is simply claimed on the tax return of either 2008 or 2009. Even if your purchase will be in 2009, you may claim the tax credit in 2008, which would make the credit available for the down payment.

Personal Thoughts

I have heard numerous people claiming this tax credit will allow people to purchase a home who otherwise couldn’t afford a home, which is exactly how the subprime mortgage mess started. For most people this credit can not be used as part of a down payment, which does not allow people to qualify for homes they can’t afford.

I haven’t decided how I will use the tax credit. To save for my 20% down payment I have skipped retirement savings so far for 2008. I still plan on fully maximizing my Roth IRA and solo 401k. This tax credit could go a long way towards helping me catch up on my retirement contributions for 2008. If I decide that I can fund my retirement accounts without the help of this tax credit, I might use the money as a one time payment towards principal to advance quickly through my amortization schedule. Finally, the money can go a long ways towards furnishing my condo appropriately. I am grateful for this money even if it is only a 0% interest loan. I will never find an interest free deal and turn it away!

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Adjusting Cost Basis to Reduce Taxes

September 22, 2008

I’ve recently posted about capital gains/losses and tax loss harvesting. Both of these topics depend on the underlying concept of cost basis. The cost basis is the original value of the asset, which in most cases is the purchase price plus commission paid to the broker. The cost basis should be adjusted for splits, dividends and capital gains distributions. Adjusting the cost basis is useful for minimizing capital gains and therefore taxes.

Determining the Cost Basis

Say I bought 100 shares of Target stock today at $49.80 a share. The transaction would cost $4,980 for the Target shares and $5.00 (rounded up from $4.95 purchased through TradeKing) for a total cost basis of $4,985.

Cost Basis After a Split

If the same 100 shares of Target underwent a 2 for 1 stock split, I would now own 200 shares of Target. The total cost basis would still remain at $4,985, however, the cost basis per share is different, which is important to know when you sell the shares. Since the total cost basis is unchanged, you just divide the cost basis by the new total number of shares, which is 200. The cost basis per share is now $24.925, which is down from $49.85.

Cost Basis After Reinvesting Dividends

Most larger cap stocks pay dividends out to shareholders. Say the 100 shares of Target stock produced a dividend of $200, which was reinvested at $50.00 a share. The total cost basis is now $4,985 plus the reinvested dividend value of $200, which amounts to $5,185. The cost basis per share is now $5,185/104 or $49.86.

Cost Basis After Capital Gains Distributions

Mutual funds often provide part of the return on investment in the form of capital gains distributions. These capital gains distributions are often reinvested in the fund. The cost basis for capital gains distributions is calculated in the same way as dividends. The cost basis is equal to the original cost basis plus any reinvested dividends plus and reinvested capital gains distributions.

Methods for Determining Cost Basis Upon Sale of Shares

In the above examples the cost basis was determined by adding the original cost basis with dividends and capital gains distributions and determining what essentially is an average cost basis per share. There are other methods for determining the costs basis when selling shares of securities.

  • Average Cost Basis – As discussed above it is obtained by taking the total investments made and dividing it by the total number of shares held.
  • First In, First Out (FIFO) – FIFO dictates that the first share purchased is the first share sold. The cost basis is maintained for each share from the purchase to the sale.
  • Average Cost Double Category Basis – This method requires the shares to be split into two categories: short-term and long-term. A cost basis is determined for each category and shares from either category may be sold depending on the most favorable tax situation.

Step-Up In Basis

I received shares of Target stock from my Grandparents when I graduated high school. The cost basis for these shares is determined to be the market value of the asset at the time of inheritance. This step-up in basis is significant when calculating capital gains because the market value at the time of inheritance is almost always greater than the market value at the time of purchase.


Understanding how to calculate cost basis is important for minimizing taxes. A personal example of the benefit is the Target Stock that was probably purchased when Target was selling below $10.00 a share and was gifted to me when it was selling around $38.00 a share. Stepping-up my cost basis from below $10.00 to around $38.00 will significantly lower my capital gains taxes when I decide to sell my shares. Also, adjusting the cost basis when reinvesting dividends and capital gains distributions reduces taxes. In the example above, if the 104 shares of Target stock are sold for $55.00 a share, the capital gains will be calculated to be $535 ($5,720 – $5,185) if the dividend reinvestment is included in the cost basis, instead of $735 ($5,720 – $5,185) if the dividend reinvestment is not included. The $200 in reduced taxes is worth it for me to pay attention to the cost basis.

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Tax Loss Harvesting To Reduce Income Taxes

September 22, 2008

Recently I posted about capital gains and losses and the tax implications. Understanding how the IRS views short-term and long-term capital gains and losses is important for minimizing taxes. To minimize taxes on investment income it’s important to know when a capital gain becomes a long-term gain instead of a short-term gain. Short-term gains are taxed at normal income tax rates, whereas long-term rates are taxed at a much lower rate. Another method of reducing taxes on investment income is to harvest your losses.

Tax Loss Harvesting

Tax loss harvesting is the art of using capital losses to offset capital gains for tax purposes. Harvesting is most often done to reduce the impact of taxes on short-term capital gains, which are taxed at higher rates than long-term capital gains. Not only can you offset capital gains, but you can deduct up to $3,000 from your ordinary income in any given year. If you still have capital losses and all of your capital gains are offset and $3,000 is deducted from your ordinary income, the rest of your capital losses can be carried over to subsequent years.

The Process

Add up your short-term gains and losses for the tax year and offset the gains with the losses. Do the same with your long-term gains and losses. Finally, compare the short-term gains/losses with long-term gains/losses. For example, if you have a net short-term loss of $6,000 and a net long-term gain of $2,500, you end up with a net loss of $3,500 ($6,000 – $2,500). $3,000 of the net loss can be deducted from ordinary income. The remaining $500 can be carried over to the following year’s income tax report.

Wash-Sale Rule

The wash-sale rule stipulates that a security is disallowed for a loss deduction if a substantially identical security is purchased within 30 days before or after the sale of the security used for the loss deduction. This rule was introduced to prevent the sale of securities just for avoiding taxes.

A substantially identical security is defined as a security from the same company. Purchasing securities in the same sector is not considered substantially identical. For example, buying shares of Best Buy does not prevent you from deducting losses from Circuit City securities. It is not always black and white as to the definition of a substantially identical security. Selling shares of a Vanguard index fund and buying shares of a Fidelity index fund that tracks the same index is a hazy area.

Taking Advantage of Tax Loss Harvesting

Towards the end of the year it’s important to start planning how to minimize your income taxes. Part of the plan has to include analyzing stocks and funds that have the potential to be sold for a loss to offset gains.

If you have securities that are currently valued at a loss, but think they are still good securities to own, you can buy the securities 31 days before or after you sell the securities for a loss. This way you can use the loss to offset gains or ordinary income and still maintain shares for future profit.

Another option when selling securities at losses is to purchase a similar security in the same sector. For example, if you had a securities in the financial sector that were hammered from the sub-prime mortgage mess, you can sell the securities for a loss and purchase other securities in the financial sector. This is appealing a sector suffered significant losses and you think the sector is set to rebound. This strategy allows you to maintain your asset allocation despite selling off losers.


With the stipulation that losses may be carried over to subsequent years, there is almost no reason to not sell losses and take advantage of tax loss harvesting. One reason not to take advantage of this strategy is if you think the exact security you are selling will rebound before you will be able to repurchase. Tax loss harvesting is a significant concept for individuals that do heavy investing in taxable accounts. As soon as I maximize my tax sheltered accounts, I will start investing in taxable accounts and will keep in mind the strategies of tax loss harvesting.

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Capital Gains, Losses and 2008 Tax Rates

September 15, 2008

For a couple of reasons I recently started reading up on capital gains taxes. I’m purchasing a condo in the next few weeks with the goal of selling it in a few years and realizing a capital gain. Also, I have a goal of earning a sufficiently high income to fully max out my retirement accounts and still have enough left over to invest in taxable accounts. Investing in taxable accounts requires a thorough knowledge of the effects of capital gains taxes in order to minimize taxes.

Capital Asset

A capital asset is defined as everything you own and use for personal purposes, pleasure or investment. The following are examples of capital assets:

  • stocks and bonds held in a personal account
  • household possessions
  • the real estate you live in
  • your car for pleasure and commuting
  • hobby collections
  • gems and jewelry
  • gold, silver and precious metals

Capital assets are subject to capital gains taxes when sold. For the most part all capital gains are subject to capital gains taxes, but not all capital losses are subject to deductions.

Capital Gain Versus Capital Loss

A capital gain is realized when a capital asset is sold at a price greater than the cost basis. The cost basis is most often, but not always, the original purchase price of the asset. A capital loss is realized when a capital asset is sold at a price less than the cost basis. Some capital assets can not be realized as capital losses for tax purposes, such as a car.

Long Term Versus Short Term Gains and Losses

Long term gains/losses are classified as held for more than a year. Short term gains/losses are classified as held for a year or less. The holding period for an investment is considered to begin on the day after the purchase and ends on the day of the sale. For example, if you purchase a stock on February 20, 2008 you will have to wait until February 21, 2009 to sell if you the gain to be considered long term. February 21, 2008 is considered the first day of the holding period and February 21, 2009 is one year later. It is important to understand the difference between a long term and short term capital gain as they are taxed at different rates.

Short Term Capital Gains Tax Rates

Short term capital gains are taxed at the ordinary income tax rates, which vary depending on income level and filing status. The figure below outlines the short term tax rates for 2008.

Long Term Capital Gains Tax Rates

Long term capital gains are taxed at varying levels according to the short term gains tax rate and the asset class. The figure below outlines the long term tax rates for 2008.

Primary Residence

Primary residences have a special exclusion from capital gains taxes. Individuals can exclude up to $250,000 of capital gains on the sale of a primary residence. Married couples can exclude up to $500,000 of capital gains. The real estate must be used as the primary residence for two of the previous five years. The two years as primary residence don’t have to be sequential or the most recent two years. Unfortunately capital losses on the sale of a principal residence is not deductible.

Capital Losses

Without getting too detailed (I will try to do so in a future post), capital losses may be used to offset capital gains, this practice is commonly referred to as tax loss harvesting. If capital losses exceed capital gains the capital loss may be taken as a deduction with a cap of $3,000. If there is an excess of capital losses by more than $3,000 the losses can be carried over to the next year. Certain capital assets can not be deducted or used to offset capital gains. Real estate and personal property, such as cars can not be realized as capital losses.


A thorough knowledge of capital gains and losses is crucial for investing outside of tax sheltered accounts. Done appropriately capital loss harvesting can have a huge impact on your overall investment return. Additionally, since I am purchasing my condo as an investment property and as my primary residence, I am hoping to take advantage of the exclusion from capital gains after I sell my condo for a huge increase (crossing my fingers). If you are looking for more information on utilizing capital gains/losses to your advantage consider signing up for automatic updates via e-mail or RSS as I will be blogging about tax loss harvesting and cost basis in the near future.

Double the Taxes for Self Employed Income and Social Security Wage Limits

August 20, 2008

Ever since I started working as a summer intern, I have always been depressed to open up my check and see the amount of my salary that was going towards taxes. Currently, 29.2% of my salary goes straight to the government. The majority of my taxes are federal income taxes, with social security tax and state income tax coming in second and third. Medicare taxes are a distant fourth. The magnitude of the downsizing of my income due to taxes is even more readily apparent on my self-employed income.

Double the Taxation

As a part-time self-employed contractor, I am responsible for federal and state income taxes, as well as a double taxation on the Federal Insurance Contributions Act (FICA) taxes, social security and Medicare. The employer and employee are each responsible for paying half of the Medicare tax and social security tax. As a self-employed contractor, I am responsible for both the employer’s and employee’s portions of the Medicare tax and social security tax. This double taxation is the major reason why I set the goal to put all of my self-employed income into a solo 401k. I wanted to defer the taxes on my self-employed income, since it will be taxed at such a high rate due to this double taxation.

Breaking Down the Tax Rates

The combined tax rate for the FICA taxes is 7.65% for regular income and 15.30% for self-employed income in 2008. The social security portion of the FICA tax is 6.20% for regular income and 12.40% for self-employed income in 2008. The Medicare portion of the FICA tax is 1.45% for regular income and 2.90% for self-employed income in 2008.

Social Security Wage Limit

The Medicare tax has no income caps, however, the social security tax has an income cap of $102,000 for 2008. This means, that if your combined income exceeds $102,000, the portion of your income above $102,000 is not subject to the social security tax. This is a very critical income cap to exceed if a portion of your income is self-employed as you are saving 12.40% of the taxes on your income, instead of just 6.20%. The wage limits for the social security cap increase yearly based on a Cost of Living Adjustment (COLA). The following table shows the increases in the wage limits over recent years.

As you can see, the wage limit has increased every year since at least 2000. The average increase in the wage limit is 3.7%, however, the average COLA is 2.8%. The difference in almost one full percentage point means that if you are getting annual salary increases that match the cost of living, you are falling further behind the wage limit and further away from decreasing your tax rate on your self-employed income.


Currently, my salary does not exceed the wage limit, and I don’t make enough self-employed income to fret too much over this ever increasing wage limit. I have thought about trying to extend my self-employed income as a tutor, however, I am about a year away from trying to do that. The wage limit is definitely something I’m shooting for as it is critical to self-employed individuals and I’m hoping I have significant self-employed income in my future.