I recently had my tax appointment with my accountant and realized just how much of a tax savings I had because of the smart things I did with my investments. The great thing here is that the things I did to help keep my tax bill low weren’t difficult to do.

Ways to Reduce Taxes through Investing

Here are some tips to reduce taxes through investing for you to take advantage of before the tax deadline.

reduce taxes through investing

(Photo Credit: Pong/FreeDigitalPhotos.net)

Put Money Aside for Retirement

I know, we’ve all heard this one, but you hear it because it works. For me, it works especially well since I’m self employed and contribute to a solo 401k. This allows me to not only put away the typical $18,000 limit as an employee, but I can contribute more as an employer.

In the couple years I’ve been working for myself, I never have been able to contribute the absolute max to this plan, but I sock away as much as I can.  If you are in the 25% tax bracket and contribute $4,000 to your 401k at work, you just saved yourself $1,000 in potential taxes. To me this is no-brainer. You save for retirement and you save on taxes.

Read More: Can You Have a 401k and an IRA at the Same Time?

Pick Smart Investments

Mutual funds are a good option for many investors. You invest with a little bit of money and get professional management and are diversified from the start. But mutual funds don’t allow you to control capital gains.

Even if you don’t sell any of your holdings during a given year, chances are you still will have capital gains. It might look nice to get a couple hundred dollars when a mutual fund distributes a capital gain, but the downside is that you are taxed on that money.

To avoid this, you should look into exchange traded funds (ETFs). Many of these don’t pay out capital gains, only dividends. This will help you to keep your tax bill in check at the end of the year.

Now, don’t go run out and change all of your investments. You should slowly transition over to ETFs because if you sell your holdings in a taxable account, you will owe taxes on any gains you have.

This doesn’t apply to investments held in retirement accounts, since any income you earn from investments is tax deferred until you begin to withdraw the money.

Read More: Do You Know the Difference Between an ETF and a Mutual Fund?

Pay Attention To Asset Allocation

Asset allocation is making sure your portfolio is well diversified and working at the best it can to grow for you over time. One area that is sometimes overlooked by investors is what investments are where. This is important because it can have a large impact on your taxes.

In general, you should have assets that are the least tax efficient in retirement accounts and those that are most tax efficient in non-retirement accounts. So what does this mean?

If you invest in a bond portfolio that doesn’t hold government or municipal bonds, you want to make sure this is held in a retirement account. This is because bond funds pay off interest each month and that income is treated as ordinary income. So if you are in the 25% tax bracket, the monthly distribution the bond fund pays is taxed at 25% as well if you don’t have it in a retirement account.

Furthermore, you want to keep high turnover holdings in a retirement account too. These funds tend to throw off lots of capital gains, which you owe taxes on. You can find out what you fund turnover is by looking at a site like Morningstar.

Read More: What is a Backdoor Roth IRA?

Sell Some Losers

Another way to save on taxes through investing is to sell some holdings that declined in value when you have any realized gains. You are allowed to use the losses to “cover” the gains. In other words, when you add the loss to the gain, it will result in a lower ending number. This lower ending number is what you owe taxes on.

The nice thing is that you can use these losses to offset other income too, but only to an extent. The IRS allows you to offset $3,000 of ordinary income each year with capital losses.

So let’s say you have a capital gain of $5,000 and a capital loss of $10,000. You can use $5,000 of that loss to offset the $5,000 gain, bringing it to zero. You can then take another $3,000 of your capital loss to offset your ordinary income. This leaves you with a loss of $2,000 which you are allowed to carryover into future years. You can either use it on capital gains next year or against ordinary income.

Read More: 3 Benefits of Tax Loss Harvesting

Donate Investments

One final option for investors to reduce taxes through investing is to donate securities. In this option, you can donate your holdings to a donor advised fund. With this option, you simply transfer holdings over to a donor advised fund. Once the assets are in this fund, you can instruct how you want the money to be divided up or what charity or charities you want it to go towards.

The reason this is a smart option is because you don’t have to realize any gains you earned when you donate. For example, let’s say you want to donate $10,000 to a charity. You have an investment that you bought for $2,000 and it is now worth $10,000. If you donate that $10,000 investment from your portfolio, you get to write off the $10,000 as a charitable deduction.

If you were to sell the holding and then make the donation, you would still get to deduct the $10,000 charitable donation, but you would also have to pay taxes on the $8,000 gain you realized when you sold the investment.

Read More: What to Do With Your Required Minimum Distribution

Final Thoughts

When it comes to taxes, there are many ways you can reduce your taxes through investing. Not all of these options will apply to everyone, but you should be able to use a couple of them to your advantage. Make sure you are doing all you can to keep your taxes low. The less you pay in taxes, the more money you keep in your pocket.

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Self employed tax deductions are an important part of offsetting your extra income when filing your federal tax return. For example, if you are flying for business, one of the 7 Commonly Overlooked Tax Deductions is baggage fees!

An old business partner wanted to know what he needed to keep track of for his venture into self employment. I ran through the list of self employed business deductions I have used in the past to get him started.

The tax deadline is just around the corner; many of you could also benefit from this information. This list is not a complete list, but rather the deductions that I routinely use. Most of the deductions are taken on Schedule C unless otherwise noted.

You can use TurboTax to enter your tax deductions yourself or you can provide the amounts to your tax accountant.

Self Employed Tax Deductions

  1. Internet Access. Both at home and in coffee shops that you work at for WI-FI access.
  2. Website Expenses. Fees paid to purchase domains, hosting, and other fees associated with running a website.
  3. Cell Phone. You cannot deduct the primary phone line at your house, but if you have multiple lines or a cell phone you use for business, the extra lines are deductible.
  4. Contract Labor. Independent contractor’s that you hire to complete work are not employees, but the payments can be deducted.
  5. Computer. Did you buy a new business laptop before December 31? If so, it’s deductible.
  6. Advertising. Advertising costs are deductible. This includes prizes for giveaways if you purchase the prizes.
  7. Tax and Accounting Software. Software you buy to keep the books for your business is deductible. I use Quickbooks.
  8. Filing Fees. You can deduct fees you pay to the state to maintain your business license.
  9. Postage and P.O. Box Fees. Don’t want your business mail going to your home address? Set up a P.O. Box and deduct the cost.
  10. Office Supplies. In addition to postage, you can deduct the cost of paper, pens, etc.
  11. Mileage. You can deduct business mileage on your personal car. Make sure you keep good records.
  12. Business Meals. Business meals are deductible at a rate of 50%.
  13. Retirement Contributions. Contributions to a Solo 401k or other qualified plan are deductible.
  14. Self Employment Tax. Half of the self employment tax you pay can be deducted.
  15. Home Office Deduction. If you work from home, you can deduct the costs associated with maintaining an exclusive home office on form 8829 as a Home Office Tax Deduction. You can include a portion of real estate tax, mortgage interest, insurance, maintenance, utilities, office furniture, casualty losses and depreciation.
  16. Health Insurance. Part of your self employed health insurance costs are deductible if you were not eligible to take part in an employer-subsidized health plan. However, to determine the amount, there is an iterative calculation if you also qualify for the Health Insurance Premium Tax Credit.
  17. Cost of Goods. If you are selling products on Amazon or any other platform, don’t forget to deduct the product costs when they are sold.

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Do you have to pay income tax on social security? How will it impact the taxes on your other income from interest and dividends?

Whether or not your social security benefits are taxable depends on your total income and filing status. In addition, it changes from year to year, so while your social security benefits may have been tax free last year, you could owe tax this year.

My grandma found herself in that very situation one year and was shocked she would owe tax on her social security benefits.

How Social Security Benefits Are Taxed

If Social Security is Your Only Income. There are general rules for the minimum income to file taxes based on gross income. However, gross income doesn’t include social security benefits; as long as Social Security benefits are your ONLY income, your benefits are not taxable.

You’ll get a SSA-1099 form which shows the amount of social security income you received.

Social Security Plus Other Income

If you have other income besides your social security, we’ll have to dig a little deeper:

When Social Security Benefits are Taxable. If you have other income in addition to your social security benefits, you’ll need to use the following formula to determine if your social security is taxable.

You must file a tax return if the following calculation is true:

1/2 (Total Social Security Benefits) + All Other Income > Base Amount

The Social Security base amounts are:

  • $25,000 (single, head of household, qualifying widow with dependent child, married filing separately who did not live with their spouses at any time during the year)
  • $32,000 (married filing joint)
  • $0 (married filing separately, but lived together)

When Social Security Benefits are Not Taxable. And in the reverse situation, you do not need to file a tax return, and your social security benefits are not taxable if the following is true:

Half of your Social Security plus all your gross income from other sources is less than or equal to $25,000 (or $32,000).

What is All Other Income?

In the calculation you have to add all other income to half the social security benefits. What is included in all other income? Almost everything. Be sure to include:

  • Taxable pensions
  • Wages
  • Interest and Dividends
  • Other taxable income
  • Tax-exempt interest
  • Interest from U.S. savings bonds
  • Employer-provided adoption benefits
  • Foreign earned income or foreign housing

Social Security Tax Filing

If you will have to file a tax return, you can see how much tax you will owe on your social security benefits using the Tax Calculator.

The free edition of TurboTax works well for filing simple returns with social security benefits, or you can figure it by hand, like my grandma prefers!

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Obamacare, or the Affordable Care Act is now in the third year of providing health insurance. However, it’s only the second year of reconciling the health care requirements and the health insurance premium tax credit on your tax return.

The fee, or insurance penalty tax, for going without health insurance increases each year. Here’s how to determine if you need to report the penalty on your tax return and how much it might be.

Health Insurance Penalty Fee

If you went without health insurance last year, you’ll be subject to an annual fee. The fee does not provide health insurance and is assessed after the year is over when you file your tax return. The penalty fee is calculated based on your Modified Adjusted Gross Income and is due with your tax return on the tax deadline. For more background the penalty fee see our introduction to the Penalty for No Health Insurance.

How Much is the Penalty for No Health Insurance?

The tax penalty for no health insurance varies by year. Penalty tax by year is the higher of:

  • 2014 insurance penalty fee: 1% of income or $95 per adult/$47.50 per child (up to $285 per family).
  • 2015 insurance penalty fee: 2% of income or $325 per adult/$162.50 per child (up to $975 per family).
  • 2016 insurance penalty fee: 2.5% of income or $695 per adult/$347.50 per child (up to $2,085 per family).
  • 2017 insurance penalty fee: Increases will be based on inflation.

The fee is calculated per month and includes household members you claim as dependents. For each full month without coverage, you’ll pay 1/12 of the above fee.

Penalty Maximums

The maximum penalty using the % of income is the national average premium for a Bronze plan. The average price of a Bronze plan is:

  • 2014: $2,448 per person.
  • 2015: $2,570 per person.
  • 2016: $2,699 per person.

Where to Pay the Penalty

You will report the health insurance premium tax credit penalty on your tax return.

Minimum Essential Coverage

You do not have to pay the penalty if you have minimum essential coverage. If you have insurance already through a job or the government you won’t have to worry about the penalty. This includes marketplace health insurance, individual insurance, health insurance through an employer, COBRA, Medicare, Medicaid, CHIP, Tricare and veteran health insurance plans.

Exemptions to Avoid Paying the Obamacare Penalty Fee

You will not need to pay the penalty for Obamacare fee if you qualify for any of the following:

  • Unaffordable Insurance: If the insurance would cost more than 8% of your income.
  • Short Gap: If you go without insurance for less than 3 months of the year.
  • No Filing Requirement: If your income is below the minimum income to file a tax return.
  • Hardship Exemption: The exchange certifies that you suffered a hardship including that you would qualify for Medicaid but your state has chosen to not expand Medicaid.
  • Member of Select Groups: If you are a member of a recognized Indian Tribe, healthcare sharing ministry, religious conscience sect member, incarcerated, or not lawfully present in the US.

More Health Insurance and Tax Topics





We’re pretty familiar with the tax deadline on April 15 (although it’s extended to Monday, April 18, 2016 this year). 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.

When is the Earliest You Can File Taxes?

The IRS announced the first day to file 2015 year taxes in 2016 will be on January 19, 2016.

Is there a delay this year?

The IRS is currently predicting an on time start to filing season. A few years ago, there was an IRS Tax Delay after the government 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 18, 2016. 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 19. E-filing will still be the faster option to get your tax refund. The earliest you can file your taxes is set for January 19 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 2015 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.

In addition, if you are claiming the health insurance premium tax credit, you’ll need your forms to claim the health insurance premium tax credit. Otherwise, you’ll be subject to penalties for no health insurance.

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





If you have money in a traditional IRA and want to take advantage of a Roth conversion, you need to know about the pro-rata tax treatment of conversions.

If you have both tax deferred and after tax money in a traditional IRA, you could face hefty taxes on the deductible IRA money, since you must convert a pro-rata amount of deductible and non-deductible money.

If you want to convert just your after tax money, which is common when using a backdoor Roth IRA strategy, you can use this Roth IRA conversion strategy to avoid taxes if your 401k provider allows transfers of IRA money. It’s one of our 11 Unusual Roth IRA Strategies.

Roth IRA Conversion Strategy to Avoid Taxes

When you make a Roth IRA conversion for your IRA you must include a portion of tax-deferred money in the IRA in proportion to the amount held.

If your 401k provider allows transfers of IRA money, you can transfer your deductible IRA money to your 401k. When you convert your remaining non-deductible money in your traditional IRA to your Roth IRA, it will be tax free!

Tax Free Roth IRA Conversion Steps

  1. Identify how much money in your IRA was (or will be) deducted on your taxes.
  2. Move your deductible IRA money to your 401k.
  3. Make a Roth IRA Conversion with your non-deductible money.
  4. Report your conversion with 100% basis on form 8606.
  5. The conversion will be tax free.

Example:
Let’s say I have an IRA worth $100,000, with $50,000 (50%) tax deferred and $50,000 after tax. If I complete a conversion of $20,000 to a Roth IRA, I will be responsible for taxes on $10,000, or 50%. You cannot specify to convert only the after-tax money in the account.

If I used the strategy above, I would first move $50,000 of tax deferred money to my 401k. Then, when I make my $20,000 Roth IRA conversion, the taxable amount will be $0.

More Considerations

Which IRAs count? Don’t forget to account for all of your IRA money when you determine how you might make this work. All IRAs including rollover IRAs are considered one IRA for conversion purposes. The traditional IRA also includes your SEP-IRAs and SIMPLE IRAs.

Add additional money. Before your conversion, you can also contribute to a non-deductible traditional IRA at your broker of choice up to the IRA Limits.

Should you convert to a Roth IRA? To see if a Roth IRA Conversion makes sense for you, check out Should You Do a Roth Conversion?

Don’t have a 401k? If you don’t have a 401k, or your current 401k provider doesn’t accept incoming money, you could establish a solo 401k for the purpose of moving your deductible money in your traditional IRA.

Keep detailed records. If you do this, you need to keep very detailed records. For more see How to Track Your Roth IRA Contributions… and Why You Need To!

Early retirement and Roth IRAs. This strategy sounds like a lot of work to move money into a Roth IRA…. why would you want to hassle? If you are considering an early retirement, the Roth allows much more flexibility in early withdrawals than a traditional IRA. After a conversion, you only need to wait 5 years, then you can withdraw your conversion money tax free. A real benefit for anyone considering early retirement!

Avoid IRA fees. You can transfer your IRA to Scottrade and stop paying fees. Whether your account is Traditional, Roth, SEP or Rollover, you won’t pay set-up, annual, custodial, inactivity or closing fees with Scottrade. Open a No-Fee IRA now!

More on Roth IRAs





Most taxpayers are well aware of the deduction that comes from claiming dependent children on their taxes. But what are the rules on claiming dependents on taxes? And what about other relatives? And, when can those formerly claimed as dependents on someone else’s return begin to claim themselves?

If someone else can claim you as a dependent, you cannot receive a personal exemption for yourself, and your standard deduction is limited. If you are filing using TurboTax, the program will help you determine the limitations.

You can claim someone as a dependent if they are a United States citizen, do not file a joint return, and meet either the qualifying child test or qualifying relative test, both discussed in IRS Publication 501 and explained below.

Qualifying Child

The most common reason to claim someone as a dependent on your taxes is because they are a qualifying child. To be a qualifying child, the dependent must meet all six of the following tests:

  • Relationship: the dependent must be your child (including foster, step, or adopted child), your sibling (including half or step), or any of their descendants (e.g., your grandchild, niece, or nephew)
  • Age: the dependent must be under 19 and younger than you (younger than either you OR your spouse if filing jointly), under 24 and a full-time student for at least part of 5 months of the calendar year, or permanently and totally disabled regardless of age.
  • Residency: the dependent must live with you for at least half the calendar year.
  • Support: the child cannot have provided more than half of his or her own support (i.e., necessary living expenses) for the year.
  • Joint Return: the child cannot have filed a joint return with a spouse, except if the return was only filed to claim a refund.
  • Special Test: if the parents are divorced, only one can claim the child as a qualifying child. If both would be otherwise eligible, this is usually the parent with the highest gross income, unless the parents have agreed otherwise.

Qualifying Relative

If your potential dependent does not qualify as a qualifying child, he may instead be classified as a qualifying relative, and still be claimed as a dependent. To be a qualifying relative, the dependent must meet all of the following tests. Note that there is no age test for a qualifying relative.

  • Not a qualifying child: A dependent cannot be deemed your qualifying relative if he is a qualifying child for you or any other taxpayer.
  • Relationship: the dependent must live with you OR, if he does not live with you, be your child (including foster, adopted, step, or in-law), your sibling (including half, step, or in-law), your parent or grandparent (including step or in-law but NOT including foster), or a direct descendant of any of the preceding relatives.
  • Gross income: the relative’s gross income must be less than $4,050 for 2016 year taxes.
  • Support: you must provide more than half of the support for this person during the year. If multiple parties combine to provide more than 50% (e.g., two adult children each provide 30% of a parent’s support), any one taxpayer who provides more than 10% can claim the relative with the written permission of the others.

With the tax deadline approaching, it’s important to understand the rules on claiming dependents on taxes and when claiming dependents is appropriate.

More Tax Topics for Parents





Being a college student is an expensive job. Throughout the year, hopefully you are keeping in mind ways to save money in college and how to avoid student loan debt. You can get creative to save money on food in college, apply for scholarships, and save money on textbooks that can become quite pricey.

But one very important time for every college student’s finances is tax time. While college is a costly venture, you can actually get a lot of breaks around tax time for being a college student. The U.S. Government Accountability Office estimates that more than $800 million worth of college tuition tax benefits go unclaimed every year.

If you are a parent, college tax credits are one of the top 10 ways to lower your taxes with kids.

Here are some questions you might have about claiming these benefits and the answers to point you in the right direction:

Are You Eligible for College Tax Credits?

  • You are eligible for tuition deductions or tuition tax credits if you, your spouse, or a dependent you claim is a student at an eligible education institution. Your college should be able to tell you if they are an “eligible education institution.” Most colleges, universities, vocational schools, or other postsecondary education institutions are eligible. Simply contact your college’s administrative office if you are unsure if they are an accredited school.
  • However, if you are married and filing separately, you can’t any claim any of these deductions.
  • If your parent or someone else is claiming you as a dependent, you are also not eligible for these deductions either. If you are a young college student, check with your parents to see if they are claiming you. For more see When Do Dependents Have to File Taxes?

Tax Credits for College Students

There are two main credits you can claim as a student. You can only choose one of these credits and cannot claim both. Use Form 8863 to claim either of the education tax credits.

  • American Opportunity Credit
    The American Opportunity Credit allows you to claim up to $2,500 the first four years you are in college. So this means if you’re in graduate school or anything after those four years, this credit is not for you. So what are you claiming for that $2,500? You can claim tuition, course fees, and books and supplies you were required to purchase through your college. If you are filing jointly, you and your spouse will need to learn less than $160,000 to claim the entire credit. ($180,000 for partial credit). If you’re single, you’ll need to make less than $80,000 ($90,000 for partial credit). $1,000 is a refundable tax credit on your tax return if you don’t owe any tax. If you and your spouse are both working on your first four years of college, you can both qualify for this credit.
  • Lifetime Learning Credit
    Unlike the American Opportunity Credit, this credit is for any stage of your education. So if you are working on an advanced degree, like a Masters or Doctorate, you can still claim the lifetime learning credit. You can claim 20% on up to $10,000 ($2,000 maximum credit) of college related expenses, such as tuition, books required by the school that you purchased at your school, and any course fees that you were charged throughout the year. This credit is available for couples who have a MAGI less than $128,000 and if you’re single, you must earn less than $64,000 per year.

Tax Deductions for College Students

There are other tax deductions you should keep in mind if you are a college student while filing your taxes. Here are a few things to keep in mind:

  • Student loan interest deduction.
    While in many cases, you do not have to make student loan payments while you are currently a student, you may have opted to pay interest while you were still in college. If so, you can deduct this. This is also something to keep in mind if you have already graduated or have stopped taking classes and have already begun paying back your student loans. You may receive Form 1098 from your loan provider. This contains the amount of interest your lender received from you in the year you are filing taxes for. If you have not received this, you can try logging onto your account online. Your loan provider may have included a link so you can access this form online and print off for your convenience. This is also something you can watch for in the mail as they may have also sent it out to you. If you don’t see it online or unsure if you even paid this interest, you can call your lender directly and someone can help you see if this is something you may be eligible to deduct.
  • Tuition and fees deduction.
    If you were enrolled in an accredited college the year you are filing taxes for, you may be eligible to deduct some of your higher education expenses. Use form 8917 for Tuition and Fees Tax Deduction. Keep in mind you must decide between the tuition deduction and the tax credits above; you cannot claim both. To help you decide which one is better see Tuition Deduction Versus Tuition Tax Credits.

    Some of these expenses include your tuition that you paid out of your own pocket or took out loans for, any fees associated with your course enrollment, and books that you are required to purchase through the school. Buying books that your professor asks you to purchase does not count as required books and cannot be factored into the amount you can deduct.

    You cannot deduct any student health insurance you purchased, the cost of your room and board if you are living in a dorm or campus apartment, your transportation to and from your college, or any other supplies you were not required to buy directly from you school. For example, while you may have needed a computer to do your research on or a particular study guide to help you, these do not qualify for a deduction.

    Keep in mind that you will need to subtract the amount of any scholarships, grants, education assistance, and tuition reimbursement you received from the total cost of your tuition.

Sometimes there is a delay in your tax refunds when you claim a college tax credit. This is usually because the IRS is verifying the attendance at an accredited school.

What are your best tax tips for college students? Have you ever qualified for these credits on your taxes?

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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.

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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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