Did you recently start your own business and need to learn how to calculate your self employment tax to file your tax return?

If you are an individual who is self employed, you have many advantages over people who are employed by companies. Of course, you get to set your own hours and rates, which is something many other employees cannot do. However, at the same time, you will be required to pay your own self employment taxes, which can be somewhat complicated if you have never done so before. But don’t worry; once you walk through it, it’s pretty painless. Let’s walk through how to calculate self employment tax.

Self Employment Taxes

People who are self-employed differ from those employed by an outside company in that they do not have a portion of their salary deducted from their pay. Therefore, there is no withholding of money toward taxes or for Social Security or Medicare. If you work for an outside company, the company pays half and the individual pays half of the Social Security and Medicare taxes. However, when you are self-employed, you must pay the entire amount of Social Security and Medicare taxes yourself. This is known as self-employment tax.

Self employment tax is separate from and in addition to state and federal income tax rates. Self-employment tax must be paid in addition to your regular income taxes. Self employment tax is applicable at any age, and you are still responsible for paying self employment tax, even if you are already receiving Social Security benefits.

Self Employment Tax Rate

The self employment tax rate for 2014 is 15.3%. (12.4% for Social Security tax and 2.9% for Medicare tax). Since 2013 there is also an additional 0.9% Medicare Surtax that applies to earnings over the threshold for high earners.

How to Calculate Self Employment Tax

Calculating your self-employment tax is not as difficult as it may seem. Once your net earnings from self-employment are at least $400 (or church employee income of at least $108.28), you are responsible for paying self-employment taxes and filing a tax return. Here is how to calculate the self employment tax:

  1. Determine your net income. The net income for your business is income minus any of your expenses related to your work. For instance, if you have purchased a laptop and printer for your business, you are entitled to tally up the costs of them and other work related expenses and deduct them from your income. For a list of common expenses see Tax Deductions for the Self Employed.
  2. Calculate Net Earnings from Self Employment. To do this, multiply the net income by 92.35 percent.
  3. Calculate Self Employment Tax. Next, for any income less than the social security wage base (2014: $117,000 and 2015: $118,500) multiply the amount by 15.3%. For any amount over the wage base, multiply by 2.9%. Add the two figures together to arrive at your self employment tax.

Self Employment Tax Calculator

If you don’t want to calculate your self employment tax by hand, you can use the tax calculator to calculate it automatically. In addition, if you are using tax software like TurboTax, the software will also calculate your self employment tax automatically.

Self Employment Tax Form to Use

When you are ready to file your taxes, you will need the Schedule SE for self-employment taxes. The self employment tax form is in addition to your regular Form 1040 and business Schedule C for profit or loss; they are all due on the same tax deadline.

Self Employment Tax Deduction

In addition to paying the self employment tax, you also get a personal tax deduction for paying it! You can deduct half of the self employment tax, which will lower your adjusted gross income, and lower your income tax.

More Self Employed Topics





Usually filing taxes for the kids is an afterthought. Only after people scramble to finish filing in time for the tax deadline do they realize they didn’t even think about the kids. Let’s put in on the radar earlier this year. Will you remember to file taxes for your kids?

If your kids earn interest and dividends, or have a job, check out the requirements for filing taxes.

2014 Kids Tax Filing Requirements

If you claim your child as a dependent on your return, the kids need to file taxes if ANY of the following are true for tax year 2014 (due in 2015):

  • Earned income, from a job for example, is more than $6,200.
  • Unearned income, including dividends or interest, is more than $1000.
  • Self employment net earnings are more than $400.
  • Earned and unearned total income is more than the larger of $1000 or earned income plus $350.

Also, if interest, dividends and other investment income are more than $2,000 in 2014, you’re going to get hit with the kiddie tax (which means you’ll pay your tax rate on part of your child’s income).

Filing a Child’s Tax Return

You can file your child’s taxes for free at TurboTax.

If you want, you can also attach it to your return if the income is less than $10,000 and only from interest or dividends. This option is available to children under age 19 (or a full time student under 24) using Form 8814.

A word of caution though, qualified dividends or capital gains may be taxed at a higher rate if you attach it to your return instead of filing the child’s return separately.

More Filing Requirements

There are other circumstances when children must file a tax return. For more information see Publication 929, Tax Rules for Children and Dependents.

For more information when others must file, see minimum income to file taxes.

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How much money do you have to make to file taxes? What is the minimum income to file taxes?

Let’s take a look at the requirements for the minimum income to file taxes in 2014 (and due in 2015).

2014 Minimum Income Requirements

The IRS recently released the minimum income to file taxes in 2014.

For the 2014 tax year, you will need to file taxes if your gross income meets the minimum income for your filing status and age. Here are the minimum income limits for the 2014 tax year.

How Much Money Do You Have to Make to File Taxes 2014

 
Filing Status Minimum Gross Income
(under 65)
Minimum Gross Income (65+)
Single $10,150 $11,700
Head of Household $13,050 $14,600
Married Filing Jointly $20,300 $21,500 (one spouse)
$22,700 (both spouses)
Married Filing Separately $3,950 $3,950
Widow with Dependent Child $16,350 $17,550

This table does not apply to dependents. See When Do Kids Need to File Taxes? for minimum income to file taxes for children.

Once you find out if you meet the minimum income to file taxes, you can determine your tax rate using the current tax brackets.

Social Security Income

Gross income doesn’t include social security benefits.

However, there is an exception to this rule if half of your social security benefits plus your other gross income is more than $25,000 ($32,000 if married filing jointly). Once that happens, you’ll need to file a 2014 tax return. Married filing separate also have different social security rules. For more information, see Do You Have to Pay Income Tax on Social Security?

Other Income Sources

There are special rules for self employment earnings and church earnings. You must file taxes if your:

  • Self employment net earnings are greater than $400.
  • Church earnings are greater than $108.28 and are exempt from employer Social Security and Medicare.

If you are self employed, you will also need to file and pay self employment tax.

New Health Care Responsibility

New this year is the filing requirement for health insurance. If you received advancements of the new health insurance premium tax credit to pay for health insurance, you will need to file a tax return. Here’s how to reconcile your payments and Claim the Health Insurance Premium Tax Credit. In addition, you will also report any penalties for no health insurance on your tax return.

More Tax Filing Requirements

Optional filing. Even if you are not required to file a tax return, you can choose to file one. You may want to file an optional tax return if you had any federal withholding or are entitled to tax credits, like the earned income tax credit or the new Health Insurance Premium Tax Credit and want to get a refund.

Other filing requirements. In addition to the income requirements, there are other circumstances when you must file a tax return. One example is if you sold your home. For all the requirements, see Publication 17.

When to file. If you earn enough money to file a tax return, you must file your tax return by the tax deadline. However, you cannot file before the first day to file taxes.

After you file. Once you file, you can see How Long Does it Take to Get Your Tax Refund Back?

2014 Tax Calculator

If you are under the minimum income to file taxes, and are unsure whether or not filing your taxes will benefit you, use our Tax Calculator to compute your tax liability and refund.

Tax Filing Online

Now that you know how much money you have to make to file taxes, go ahead and file your free federal and state taxes online with TurboTax!





We’re pretty familiar with the tax deadline on April 15. However, the first day to file taxes each year often depends on what Congress has done recently with any new laws that were implemented. This year is no different as congress signed new legislation at the end of December to extend various tax laws another year.

In addition to the last minute tax law changes, this this the first tax season that will include filing requirements for the new health insurance premium tax credit and the penalties for no health insurance. You’ll get new forms this year to claim the health insurance premium tax credit. I have a feeling these new forms and requirements will generate lots of questions this year!

When is the Earliest You Can File Taxes?

The IRS announced the first day to file 2014 year taxes in 2015 will be on January 20, 2015.

Is there a delay this year?

The IRS is currently predicting an on time start to filing season. Last year, there was an IRS Tax Delay after the government shutdown. While the IRS is planning an on-time start, at the same time the IRS Warns Of Delayed Refunds, Long Waits For Taxpayers & Possible Shutdown.

Will the tax deadline be extended if there are delays?

No. Delays to the start of tax season usually do not lengthen the tax filing season; the tax deadline will still be April 15, 2015. You can request a tax extension if you need additional time to file.

When is the earliest I can file my taxes by paper?

If you file your taxes on paper, can you file before the first day? No. Tax returns, including paper returns, will not be processed before January 20. E-filing will still be the faster option to get your tax refund. The earliest you can file your taxes is set for January 20 for all filing methods.

Why Would You Want to File Your Taxes Early?

If you are expecting a tax refund the sooner you file the sooner you’ll get your refund. You can use our 2014 Tax Calculator to project your tax refund.

Also, if you need your completed tax return to show your income for other financial decisions, you’ll be able to complete those transactions sooner. This is usually necessary for financial aid applications for college students or mortgage applications if you are self employed.

Why you might need to know the first day to file taxes.

If you are feuding with an ex-spouse over dependents, be prepared that he or she may plan to file the first day to try to claim dependents.

You should be aware that the first to file a tax return will be able to claim dependents. If you are entitled to claim a dependent, and someone else files first claiming them, when you file using the same SSN you’ll get an error message. This doesn’t mean that you won’t be able to claim them, but be prepared with documentation to prove you are the correct person to claim the dependent and your tax filing status.

Filing Your Taxes Early

What do you need to file on the first day?

Even if you want to file on the first day, you must have your paperwork, including your W2 Form from your employer before you can file. If you don’t receive your W2, you can file a substitute W2 using Form 4852, but only after February 14.

Can you enter your information earlier?

Yes, many tax preparation programs, including TurboTax, will let you begin working on your tax return before the first day to file. You can enter your information, but you will not be able to file your tax return until the first day to file.

Will your tax refund be delayed?

Normally, you can expect your tax refund in 21 days: How Long Does it Take to Get Your Tax Refund? If the IRS issues an update, I’ll let you know!

When do you plan to file your taxes?

More Tax Filing Questions





Almost anywhere you turn, you see news stories about the widening gap between the rich and the poor. As a result of this inequality, many prominent figures have come forth with their thoughts on how to fix things. Some want to raise taxes on the rich. Others want to raise wages for those working certain jobs.

Why the Rich Keep Getting Richer

What I don’t hear a lot of talk about though is why the gap really is widening. The reason is twofold: the rich invest their money and the government taxes income, not wealth. Let’s look at these two in more detail.

stock market

(Photo Credit: worradmu)

The Rich Invest

If you create an investment plan and hold a diversified portfolio for the long-term, you are going to experience an increase in the value of your investments. Just look at any historical chart of the stock market and you see that over the long-term the market trends up. Note when I say long-term, I am talking 20 years or more. Even with recessions and stock market crashes, in time the market always comes back.

The rich know this and they invest in the stock market, both for price appreciation and for income. I’ll get to the income part shortly. But the price appreciation is where most other investors fail. The market takes an unexpected drop and people sell out. I bet with the recent volatility a bunch of people ran for the hills. This is exactly the wrong thing to do. When an airplane hits turbulence, does the pilot land the plane and cancel the flight? No, he pushes through knowing that it’s just a little bump along the way. If most investors could take this same view, they would experience the price appreciation of the stock market over the long-term as well.

Read More: 3 Steps to Successful Investing

Taxing Income, Not Wealth

As it stands now, our tax code is set up to tax income. If you make $500,000 from a job this year, you are going to pay close to 40% of that in federal income taxes. On the other hand, if you earn $500,000 from your investments as long-term capital gains or qualified dividends, you are looking at a maximum tax rate of 20% (plus a portion which could be subject to the Investment Tax). That is a huge difference!

The rich know this and “earn” a good amount of their money from investments and not a job like you and I have. This allows them to keep 20% more of their money.

Read More: Do the Rich Pay More or Less in Taxes?

Generate Investment Income: How To Make The Transition

Obviously, you should want to make the transition from generating most of your income from a job to your investments. How do you go about doing this?

First, you need to start investing in the stock market and then stay invested, no matter what happens. By staying invested, I mean keep the holdings you currently have. You can’t jump from one mutual fund or ETF to another every 6 months or year. You have to hold the same positions for the long-term.

But, you can’t just invest $20 here and there and expect to see any results. If you truly want to reach a point where you are living off of the income from your investments, you need to invest a decent amount of money. In order to do this, you are going to have to make some sacrifices. Question the things you buy. Do you really need the new iPhone 6? Can you shop around for insurance coverage and get a better deal? Does refinancing make any sense for you? The more ways you can cut costs and invest more, the better off you will be.

Read More: Why You Should Save 1% More Each Year

An Example of Making The Transition

Let’s say you really want to make the transition. Start by looking at how much you spend in a year currently. Let’s say you spend $40,000 per year. We will assume that the investments you choose (a healthy mix of stocks and bonds) will throw off around 3% worth of income each year. If we do some fancy reverse engineering ($40,000 divided by 3%) we get $1.3 million. This tells us that you need to invest $1.3 million. That amount will generate an annual income of roughly $40,000. (Note that I did some rounding to make this easier to follow.)

You are probably looking at this and thinking there is no way I can save/invest $1.3 million. While it may not be easy, it is possible. You just have to do some thinking outside of the box. How close are you to paying off your mortgage? If you get rid of that expense, your annual expenses will be much less than $40,000 meaning you need to save less than the $1.3 million. Same goes for getting rid of a car loan or buying an older car so your insurance coverage is lower. Or maybe even moving to an area where the property and school taxes aren’t so high.

I’m not saying you have to do any of these things, I am just showing you it is possible if you expand your thinking. Maybe none of those things are worth it to you. If this is the case, then maybe you revise your goal. Maybe instead of living off of 100% investment income, you replace 50% of your income with investment income. This would allow you to quit your job and work in a field that pays less, but makes you much happier.

I am certain that if you just take some time to think about various ways to cut your expenses or to change the overall plan, you can find something that will work for you and allow you to earn an income through your investments. Don’t give up hope too quickly, there are always other options.

Final Thoughts

The real reason why the rich are getting richer is because they are investing their money in the stock market and taking advantage of lower tax rates. You too can take advantage of the lower tax rates, you just have to start investing for the long-term. While the challenge of building up your investment income might sound overwhelming, focus on the benefits that it will provide you and how much happier you will be.

More on Investing and Retirement





It’s time for end of year tax planning! Time to get your financial house in order for tax season! What could be more fun that taking a break from holiday festivities and shopping to start thinking about taxes?

It seems like every year when we do our taxes, there’s a few things we wish we would have done in December to reduce our tax bill just a little more. Sound familiar?

That’s where a little end of year tax planning results in great rewards!

Here’s an updated list of money moves to make before the new year.

Year End Tax Moves

  1. Run a preview. Before the end of the year run an estimate using the tax calculator or Turbo Tax. If you wait until the new year, it’s often too late to go back and make changes. Start running projections now before the year end!
  2. Bump up contributions to retirement plans. Contribute more to your 401k by the end of the year to reduce your taxable income and your tax bill.
  3. Plan for health insurance changes. The new penalty for no health insurance in 2014 and the Health Insurance Premium Tax Credit both apply for the first time this year. Here’s How to Claim the Health Insurance Premium Tax Credit on your tax return.
  4. Take your losses. Did you lose money on your investments? If so, you might as well sell them and take the capital loss. Commonly referred to as tax loss harvesting, losses (that exceed gains) are capped at $3,000, but you can carry them forward into future tax years. To understand why you might do this, here are 3 Benefits of Tax Loss Harvesting.
  5. Take your gains. Once again, you can pay 0% long term capital gains if you are in the 10% or 15% tax bracket. If you are planning to sell, you might as well do it before year end if you fall in this tax bracket!
  6. Review investment tax rules. Don’t forget about the 3.8% Investment Tax on investment income, including capital gains and dividends, that kicks in for high income filers. If you are subject to the investment tax pay close attention to your end of year strategy to realize gains and losses.
  7. Prepay your mortgage and real estate taxes. Even if your payments aren’t due until January, you can pay them in December to deduct this year, if you itemize. Should you pay this year or wait? For more information, see how to determine if you should accelerate your property tax deduction into the current year.
  8. Give away your money. If you were planning to give a lot of money to someone special, utilize your annual gift exclusion of $14,000. More than that and you are subject to the gift tax.
  9. Use your flex spending money. The use-it-or-lose it rule makes your money disappear if you don’t use it. Check your plan for the deadline to incur costs and submit reimbursement requests. If you don’t know what to spend your money on, see the list of ways to use all of your flex spending account. It’s also a good time to remember to enroll in your 2015 flexible spending account if you haven’t done so already. The $2,550 flex spending plan limit will go up $50 for 2015.
  10. Donate. We all know we can donate clothes, books, and household stuff to Goodwill. But dig deeper and you might be able to find more ways to make a charitable donation. For example, I like to remind newlyweds that you can donate wedding dresses and attire to take a tax deduction. Be sure to research the charity to make sure you know how your donations will be used.
  11. Finalize your records. If you plan to deduct mileage on your personal car make sure your mileage logs are complete. Remember you will save yourself time by being organized! Review how long you need to keep your paperwork before throwing out any records.
  12. Review your checklist. I keep an end of year tax planning and finance checklist. The checklist comes in handy to determine what needs to be done each year to keep our finances in order. If you don’t have an annual list, now is a great time to make one. Just write everything down as you go.
  13. Make 529 plan contributions. If your state has a deduction for 529 plan contributions, make your contribution before year end.
  14. Do an AMT analysis. If there’s a chance that you will be subject to AMT, analyze your deductions to see if you are better off waiting to make some of the above moves.
  15. Close your IRA. While this one is very extreme, I keep it in the list to remind you to review the performance of your IRA. If you carefully evaluated the pros and cons, and decided to take a loss on an IRA, you must close your account before year end to claim your loss on your taxes this year.
  16. Fund your IRA. You have until the tax deadline to maximize your Roth IRA contributions. However, if you’re getting an end of year bonus, it might be a good time to stash it away!
  17. Convert your IRAs. After running our tax estimates, I determine if it makes sense to make a Roth IRA Conversion. If you need to make one, don’t forget it needs to be done by the end of the year. In addition, if you are planning to use the Backdoor Roth IRA strategy this year, you also need to determine if you want to make your conversion by the end of the year.

Determine if You Need to Pay Tax or File

Finally, after you’ve reviewed all the end of year planning, review the requirements for filing and paying taxes. Finding out in April that you need to pay tax on unemployment, you made over the minimum income to file taxes, your kids need to file taxes or that your social security benefits are taxable aren’t usually welcome surprises. Do yourself a favor and review the requirements before the end of the year.

What additional moves are you planning to make for 2014 end of year tax planning?

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If you filed for a tax extension last April today, October 15, 2014, is the tax extension deadline for your 2013 tax return.

The original 2014 tax deadline for your 2013 tax return was on April 15, 2014. If you filed Form 4868 you got an automatic extension, which is due six months after the April tax deadline.

Tax Deadline Postmark

Whether or not you meet the tax extension deadline is based on the postmark on your taxes. You must have your taxes postmarked by the deadline, but the IRS doesn’t need to receive your taxes by the 2014 tax deadline. If you plan to mail your taxes, deliver it to the post office before closing time on October 15, 2014.

Can You Efile an Extended Tax Return?

Yes, you can efile an extended tax return. If you are using TurboTax or another efile option, you’ll also need to submit your return electronically by October 15.

Tax Filing Extension Does Not Extend Payment Deadline

Don’t forget the extension for taxes only pushes back the due date for filing your taxes, not the due date for tax owed. Hopefully, you paid the tax due by the original April 15 tax deadline. You can now reconcile the amount you paid using the Tax Estimator and your final return to get your tax refund. If you did not pay the tax due, you will be subject to penalties.

What if You Miss the Tax Extension Deadline?

If you miss the tax extension deadline today, you should file your tax return as soon as possible! Here’s how to get started on How to File Old and Delinquent Tax Returns. If you are putting off filing because you owe the IRS money, see What are Your Options When You Owe the IRS Money?

File and Amend

If you file today to meet the tax extension deadline, you can amend your tax return to correct mistakes. I wouldn’t plan on making an amendment, but if it’s the only way you can meet the deadline, it might be an option.

Self Employed Retirement Contribution Deadline

If you are self employed, October 15 is also the extended deadline for many retirement plan contributions.

If you have a Solo 401k Retirement Plan that was already set up, the deadline to make contributions is the tax-filing deadline for that year, including extensions. If you Filed an Extension to Lower or Hedge Your Tax Bill with this in mind, October 15 is the last day for solo 401k contributions.

The October 15 deadline also applies to SEP-IRA Retirement Plans. You can establish and fund a SEP-IRA today if you filed for a tax extension. In addition, employer matches for SIMPLE IRA Retirement Plans are also based on the tax extension due date.

It’s important to note that the extended deadlines do not apply to traditional and Roth IRA contributions.

File Your Extended Tax Return Online

If you put off filing until now, it’s time to get it done! Now that you know when the 2014 tax deadline is, you can file your tax return online with TurboTax.

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Most of us sit down sometime around the new year, organize our finances, and create a budget for the upcoming year. We plan out our expenses and how much we want to save. Then, many of us either put the budget aside and never look at it again, or we follow along, exactly as planned. No matter which camp you fall into, I am here to tell you that it is important for you to take a mid-year review of your finances. You don’t need to take a magnifying glass to each and every category, but rather take an hour or so to look things over. Here are some of the things you should be focusing on.

financial review

Mid-Year Financial Review Checklist

  1. Expenses
    It’s always important to keep an eye on your expenses. Now is a great time to look back over at what you had planned for the year and what has actually occurred. Are there some areas where you are overspending that you can cut back? Maybe there are some areas where you budgeted more than you actually needed.

    In both cases, it is important to know these things. If you aren’t spending as much as you thought, then you can adjust the amount you are saving or investing each month. After all, there is no point in leaving the money in a checking account. That is just tempting you to spend it.

    If you are spending more than you planned, it’s time to look at why and make the necessary adjustments. This could mean allocating more to the category in your budget or maybe simply cutting back.

    One additional step to cut back on expenses is to look at your bills – cable, internet, insurance, cell phone, etc. and see if there is a way to lower them. You don’t have to spend an entire weekend on this, just make a call to your service provider and see if there is any way they can lower your monthly bill. You’d be surprised to find it’s that easy to save $5 or $10 a month.

  2. Income
    We all love to have income. This too is an important area to look over. Are you earning more than you thought? Maybe you are earning less due to a layoff or career change. On the surface it might not seem like a huge deal if you are earning slightly less or slightly more than you planned, but it can have big consequences.

    If you are earning less, maybe you now qualify to save for retirement in a Roth IRA. If you are earning more, maybe you can bump up how much you are putting away in your 401k plan or are saving in general. Or maybe you can put more towards any debt you are still paying off. You might see some additional money if you have crossed the Social Security wage base.

    In the case where you are making significantly less than you planned, maybe it is time to look into getting another job or even turning some hobbies into income streams. If you do, be sure to review how to calculate self employment taxes.

  3. Investments
    Mid-year is a great time to review your portfolio as well. Look back at your investment plan to see what your intended allocation should be and where you stand. If you haven’t rebalanced lately, chances are your holdings are out of alignment. I typically rebalance when my holding vary from my plan by 5% or more. Take the 15 minutes to see if you are in line with your plan.

    Again, it might not seem like a big deal, but if you are too heavy in stocks, you are taking on more risk than you are comfortable with. If you have too much money in bonds, you risk not earning the high return you need so that you have enough money for retirement.

  4. Taxes
    Dreaded taxes. No one likes to pay them. But again, it is important you look over things in this area as well. Depending on your income, you might be withholding too much or not enough. While it isn’t the end of the world if you are withholding too much, withholding too little could mean a large tax bill in the new year. I don’t know about you, but having to pay into the system by writing a check in April always hurts. Make it a point to review your taxes so you don’t have any unwanted surprises.

    One other thing with taxes to consider is any life changing event. Have you gotten married or will be getting married later this year? Have you had a child or will be having a child? These events will impact your taxes so it is important to take the steps now while you still have time.

    My wife and I got married last November. In the summer we met with our accountant and found out that we were going to owe a lot in taxes last year because we would be filing a joint return. We made it a point to start taking every tax deduction we could – maxing out 401k plans, maxing out health savings accounts, and adjusting our withholdings. While we still ended up having to pay in April, it was a lot less than we would have if we weren’t proactive about it.

    With that said, taxes don’t stop there. You can work on getting some of your tax documents in order so that in the new year, it is one less thing you need to do. Create a folder and place your property and school tax stubs in the folder so you have them. If you have donated anything so far this year, be sure to place the receipts in the folder or at least write down what you’ve donated on a piece of paper so that you don’t forget about it and pay more taxes than you should. Also, keep any documentation needed for the new health insurance premium tax credit.

Final Thoughts

Creating a budget at the start of the year is a smart move to make if you plan on taking control of your finances. But it is equally important to review and adjust your budget as the months go by. We all know that life happens. As a result, we spend more in certain areas and less in others. By constantly reviewing your budget, you are able to see where you are overspending or under spending and make the needed adjustments. This could mean allocating more to certain areas or boosting your savings. Either way, an up to date budget ensures that you are doing everything you can to be financially successful.

More Mid Year Tasks from Years Past





With the volatility of the stock market and low interest rates, many investors are looking for ways to earn a decent return on their money and also keep their principal safe. While it is common knowledge that you cannot earn a high return unless you take on a higher risk, you can still earn a decent return while playing it safe. To do so, look no further than municipal bonds.

municipal bonds

3 Benefits of Municipal Bonds

Municipal bonds offer investors 3 great things: safety, income and tax benefits. But as with any investment, municipal bonds aren’t for everyone. Read on for each one of the benefits that municipal bonds offer and then you can begin to decide if there is a fit for them in your portfolio.

Municipal Bond Safety

Overall, municipal bonds offer investors safety. This isn’t to say that you cannot lose money when you invest in municipal bonds, but the odds of losing money are not high. This is due to the fact that they historically have had a very low default rate.

Of course, you can’t base all of you investment decisions on history. There are many communities in California that are bankrupt. In Michigan, Detroit recently declared bankruptcy. This means that bankruptcy and default on municipal bonds can and does happen. Before you invest in any municipal bond, make it a point to research the municipality of the bond you will be buying.

Some investors have made the mistake of thinking that municipal bonds are risk-free, meaning there is no default risk. This is not true. The only investments that are truly risk-free are US Government and Treasury bonds.

Municipal Bond Income

The next great feature of municipal bonds is the income they generate. While the income isn’t life changing, it usually ranges around 5% and is predictable.

Most all municipal bonds pay interest semi-annually. But you should be aware that many municipal bonds get called. This means that a municipality will retire a bond before it matures. For example, a municipal bond might mature in 20 years but have a call feature after 7 years. When the seventh year passes, the bond can be called by the municipality. You will receive your principal back, but you lose out on the future income payments. But, with your principal returned to you, you are free to buy other municipal bonds.

What happens when the community who issued a municipal bond defaults?
One more note about municipal bond income, in the case of a municipal bond defaulting, you will not earn the interest payments going forward as well. The municipality will simply suspend future income payments. It is rare for you to lose your principal when a municipal bond defaults.

Municipal Bond Tax Benefits

The third benefit of municipal bonds is the tax-free treatment of the income. Municipal bonds are tax-free on the federal level, meaning you won’t pay federal income tax or investment tax on the income. But, many states also offer tax-free treatment to their own municipal bonds as well. This means that if you live in Pennsylvania and buy a Pennsylvania municipal bond, you will not pay state income tax on the income either. In fact, you won’t pay local tax on it. This makes the income “triple tax-free”.

Note that not all states offer tax-free treatment on municipal bonds and that if you invest in municipal bonds from another state (for example, if you live in New York and invest in a municipal bond from Kansas), you will most likely have to pay state income tax on the income.

For many investors, the tax treatment of municipal bonds (along with the predictable income they provide) make them a wise choice for those who are retired. But, as with any investment, look into the tax treatment of the income for your state before you go out and buy any municipal bonds.

Final Thoughts

Of course, as great as municipal bonds sound, this doesn’t mean that you should rush out and buy a bunch of them. You have to determine if they fit within your investment plan. There is no point in buying something that doesn’t help you reach your goals. For example, a younger investor might not invest in municipal bonds simply because he or she needs a higher rate of return.

However, on the flip side, this same investor may want to invest in municipal bonds because they are in a very high tax bracket and want to limit income taxes. Before you do anything, you need to weigh the advantages and disadvantages of such an investment. Only after careful consideration can you make an informed decision that is right for you and your situation.

More on Municipal Bonds and Treasuries





In order to be a successful investor, one has to learn how to buy low and sell high. This can be hard since many of us allow for our emotions to get involved. As a result, we tend to buy high and sell low. But even when the buy low, sell high strategy is followed, there are times when it makes sense to sell low. When you strategically sell low in order to offset gains realized with other investment holdings, you apply the technique known as tax loss harvesting. Let’s walk through the various benefits of tax loss harvesting.

tax loss harvesting

What is Tax Loss Harvesting?

As I mentioned above, tax loss harvesting is when you sell a security for a loss. While on the surface this doesn’t make much sense, the benefit will be clear in an example. Let’s say I have two holdings, A and B. Holding A has produced a short term capital gain distribution for me. On the surface a capital gain payout is a good thing, but the downside to short term capital gain distributions is that the payout is taxed at ordinary income levels. Therefore, if you are in the 28% tax bracket, you will be taxed at 28% on that short term capital gain.

You can offset your investment gains with your losses. However, the IRS allows you to offset up to an additional $3,000 in income each year with investment losses. If I sell a portion of Holding B for the same amount as the short term capital gain distribution of Holding A, I offset that gain with my loss and don’t incur any taxes. In essence, I just saved myself 28% since I am in the 28% tax bracket.

Benefits of Tax Loss Harvesting

  1. Tax Savings.
    The first benefit of tax loss harvesting is the tax savings. Whatever amount of short term gains I can offset through selling “losers”, saves me on my taxes. Note that I don’t even need to have capital gains to save on taxes. Assume that I have no gains this year, but I sell a fund that I lost $3,000 on. I can apply that $3,000 towards my ordinary income, reducing the taxes I owe there. If I were in the 25% tax bracket, that $3,000 loss saved me $750 in taxes.
  2. Carry-forward Benefit.
    Another benefit of tax loss harvesting is the carry-forward benefit. Remember how I told you that you can offset $3,000 annually? Well if you have $5,000 in losses this year, you can apply $3,000 worth of the losses this year against your taxes and the remaining $2,000 in the next year. Just because you can only offset $3,000 per year doesn’t mean you lose any additional losses. You carry that amount forward until you are able to use it. I’ve known people that have $15,000 worth of losses that they carried forward for many years.
  3. Potential Higher Returns.
    Taking advantage of tax loss harvesting can allow you to realize a higher return. For example, let’s say you bought a mutual fund for $10,000 and you plan on holding it for a long time. But a few months after buying it the stock market drops and your $10,000 is only worth $7,000. You sell the fund and wait 31 days (more on the reasons for this later) and then buy back into the fund. At the end of the year, assuming you have no capital gains, you have a realized loss of $3,000 that you can write off of your taxes.

    That $3,000 is worth $750 to you if you are in the 25% tax bracket. With your reduced tax liability, you take the $750 and invest it back into your mutual fund. You then hold the fund for 10 years and it earns 7% annually for you before you sell it. After those 10 years, you have $15,375.16 as seen below:

    $7,000 + ($15,245.42-$7,000) * .85 + $750 + ($1,475.36 – $750) * .85 = $15,375.16

    Note that this assumes you are paying 15% in long term capital gains taxes. The $15,245.42 is what the $7,000 grew to in the 10 years and the $1,475.36 is what that $750 grew to. How much would you have if you didn’t sell your fund and held for the entire 10 years? You would end up with $14,458.61:

    $10,000 + ($15,245.42 – $10,000) * .85 = $14,458.61

    By taking advantage of tax loss harvesting, you earned an additional $916.55. This is all from the $750 that you were able to invest because of tax loss harvesting. If you held onto this fund for longer than 10 years, the difference would be even greater.

Notes About Tax Loss Harvesting

Wash Sale Rule. There are a few things you need to know about tax loss harvesting before you jump into it. The first is the wash sale rule. Without going into great detail, a wash sale is when you sell a mutual fund (or other investment) for a loss and buy back the same fund (or investment) within 30 days before or after the sale. If you do this, the IRS does not allow you to recognize any loss you realized on the sale of the mutual fund (or investment).

Taxable Accounts Only. Secondly, tax loss harvesting only makes sense in a taxable account. Since your retirement accounts, such as a 401(k), 403(b), Traditional IRA or Roth IRA accounts, are all tax deferred, you get no benefit of tax loss harvesting since any gains in these accounts aren’t taxed until you withdraw the money.

Final Thoughts

There are many benefits to taking advantage of tax loss harvesting. When I worked in a high net worth investment firm, we placed tremendous emphasis on tax loss harvesting as a way to reduce our client’s tax liability. Many times when we first did tax loss harvesting, our clients would question why we were selling so called “losers” and realizing a loss. Once we explained the benefits of this practice, and they saw the benefit when completing their taxes, they were on board 100%. I encourage you to analyze your investments to see if there is an opportunity for you to take advantage of tax loss harvesting.

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