The Goal is to Pay No Income Taxes, Legally

Taxes. They come in many forms. Some are hidden: corporate taxes are built into the cost of goods and services you buy; excise taxes are included into products like gasoline. 

Others are more visible like sales and property taxes. And then we come to the most visible and dreaded tax of all: income tax. When people complain about taxes they are usually talking about income taxes.

Avoiding income taxes should be easy considering the size of the tax code and the millions of loopholes available. And that is the problem. The tax code is so big that it is daunting so most people have their eyes roll back in their head when they should be facing the tax code head on.

We will discuss several avenues to a zero out your income tax, but first some ground rules.

  1. Keeping your income low is not eliminating taxes; it is eliminating income at a 100% tax rate. Our discussion will focus on ways to eliminate income taxes at any income level, with only a slight nod to lower incomes where incomes taxes rarely apply.
  2. Tax credits can cut your taxes significantly. I’ll point out a few of these obvious gems, but will not hang my hat on mainstream tax credits to eliminate your income tax.
  3. No using cheap gimmicks like “have three kids” to eliminate your income taxes. I will assume no children in most of my strategies here.
  4. Debt is not tax-free income. Borrowing more money is NOT a tax strategy! No universal life craziness on this blog, either.
  5. Our inquiry will focus on tax strategies available to a large number of people and legal ways of converting taxable income into tax-free income.

Before we begin our analysis I want to point you to an excellent article on this topic published by the Root of Good blog in 2013. The Tax Cuts and Jobs Act of 2017 (TCJA) changed many of the rules the Root of Good blog post used. Still, it is a good place to get ideas for the flavor of strategies available.

I also discussed 10 Ways to Legally Stop Paying Taxes in a prior post on this blog. You may wish to review that post as well if you are serious about reducing or eliminating your income tax.

 

Income Tax on Income Under $100,000

A short nod to readers with a five-figure income. 

There are so many tools for eliminating incomes taxes on incomes under $100,000 that I will only scratch a few. 

  1. Social Security benefits can be partially or totally tax-free. This link provides more details.
  2. The TCJA eliminated exemptions, but jacked the standard deduction. In 2017 the standard deduction on a joint return was $12,700. In 2021 the standard deduction is $25,100 on a MFJ return; $12,550 for MFS and single taxpayers; and $18,800 for heads of household. This means a married couple filing a joint return gets a $25,100 deduction right out of the gate. 
  3. Long-term capital gains enjoy a large 0% tax bracket. In 2021, the 0% tax rate for LTCGs income threshold is $80, 800 for married couples filing a joint return; $54,100 for heads of household; and $40,400 for single and MFS taxpayers. The easiest way to look at this is to add all your taxable income together and stack the LTCGs and qualified dividends on top. The portion below $80,800 for a MFJ return is taxed at 0%. Add this to the standard deduction and a married couple filing a joint return can enjoy $105,900 of income without an income tax with this one strategy alone in 2021. This is an incredible tax opportunity for those retiring early. 

A plethora of tax credits are available for low incomers. Your facts and circumstances will prevail. 

The Child Tax Credit (CTC) is a bit more complex in 2021 than in prior years. Portions of the CTC phase out well into the six-figures

Other common credits that can reduce your income taxes are:

  1. Earned Income Credit
  2. Saver’s Credit
  3. Education Credits
  4. Child and Dependent Care Credit

There is also a small credit for nonbusiness energy improvements for homeowners. Then there is the Premium Tax Credit. This is a big credit for those with lower incomes. You can do more research on the PTC here.

There is another new massive temporary tax-free employee benefit made available under the CARES Act. Employers can pay to the employee or the student loan provider up to $5,250 for student loan repayments. This break is available for tax years ending December 31, 2025 or before. That means you have several years to accumulate this tax-free income.

Note: You can’t take the student loan interest deduction if your employer provided the tax-free funds. However, if you made additional student loan payment you may get an additional deduction there as well. Example:

  • Student loan interest: $2,000
  • Employer paid $5,250 of your student loans
  • You paid an additional $2,000 of your student loans.

In this scenario you could also qualify for a $2,000 student loan interest deduction as long as you are below the income threshold. What is less clear to this accountant is if you need to pay the interest out of your funds and the principle from employer funds or not, and how that would be segregated.

One last gift from Congress for those with a modest income. If you have a health savings account qualified health insurance plan you need to fill that HSA savings account. Contributions are deductible, earnings grow tax-free and the whole thing comes back to you outside income taxes if used for qualified medical expenses or Medicare premiums once you turn 65.

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort. No need to succumb to anti-social behavior.

The Easy Income Tax Deductions

Now we turn to taxpayers with higher income. Some of these strategies apply to people with lower income as well, but the focus in the remainder of this article is on eliminating income taxes for taxpayers with a six-figure or higher income. 

Let’s start with some low hanging fruit. Here are several sources of tax-free income:

  1. Some alimony. Use the link for more details.
  2. Child support payments are always tax-free.
  3. Inheritances, gifts and bequests.
  4. Cash rebates
  5. Most employer provided healthcare benefits.
  6. Foster care stipends
  7. Worker’s Compensation benefits
  8. Disability benefits if you paid for the premiums.
  9. §121 exclusion of up to $250,000 of gains from the sale of your primary residence per person.
  10. Foreign Income Exclusion
  11. Death benefit from a life insurance policy

A source of income I do not consider tax-free income is employer matching in retirement funds because the employer contribution always goes to the traditional part of the retirement plan, even if you elect to have your 401(k) contributions treated as Roth contributions. The income is not tax-free; it is tax-deferred. This is where I disagree with the Root of Good blog post. That post suggested deductions for the current year eliminated income taxes when all it did was push them into the future where tax rates on retirement plan distributions are uncertain.

The same can be said about souped-up retirement plans like cash balance accounts. A lot of money can be deducted currently with these plans and investments grow tax-deferred. But somebody at some point is going to pay the national uncle on the east coast. 

 

Two Unique Sources of Tax-free Income

Now I want to share what I consider two very powerful tools for generating massive amounts of tax-free income.

The first involves the cash rebates listed above. Most credit and debit cards provide some kind of cash-back these days. Some offer airline or travel rewards. In either case, these rewards are tax-free. 

We need to delineate what is a rebate and what isn’t before continuing. When you get a bonus on a bank account that is interest income. Selling tradelines are also income. What I’m talking about is sign-on bonuses and the continuing cash-back rewards offered by the myriad credit card companies.

This leads to an interesting situation. The sign-on bonuses can be large, say, $500 for $3,000 of spending in the first 90 days, plus the regular cash-back the card offers. Churning cards and manufacturing spending can turn no real spending into large amounts of cash-back fast, which is still tax-free. 

There are so many ways to game the system with cash-back rewards. I suggest a deep dive into Doctor of Credit (DoC) if this interests you. Be warned, this is a rabbit hole. The number of ways to get a steady stream of small incomes is nearly endless. DoC provides a nice ongoing list of opportunities to profit. Subscribing to their mailing list is a must in such situations. (Note: I am in no way related or connected to DoC. This is NOT an affiliate link of any sort.)

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort.

A Billion Dollars Tax-free

A common complain in my email is that I focus too much on people with higher income. That isn’t true! I spend plenty of time outlining tax strategies for people with lower levels of income. The ones I tend to avoid helping (until now) are the uber-rich! (Except when consulting. Most consulting clients tend to be very high earners.)

One of the most powerful tools for generating tax-free income is the Roth IRA. The mechanics are as such: Money going in is after -tax (meaning it has been taxed already) and money coming out, including profits, are not included in income once you reach age 59½. (In most cases your basis is available for distribution at any age.) 

Most people don’t see the massive loophole. Any asset placed into the Roth grows tax-free. What asset could you possible own that grows really fast, turning a small amount into a really big amount in a short order of time?

Let me give you a hint. There is at least one guy (it is a guy) who placed less than $2,000 into his Roth IRA and turned it into $5  billion! Think about that for a minute: $4,999,998,000 tax-free. Sure beats winning the lottery and anybody can use the same strategy. One particular accountant in the room did, only to a much, much smaller degree.

Peter Thiel, a co-founder of PayPal, started with less than $2,000 in his Roth IRA and parlayed it into $5 billion. So how did he do it? And more important, can you?

Well, let me give you a hint. I have done it, only with a lot smaller balance.

It started many years ago when I ran a small hedge fund. Using my Roth I was able to turn a small amount into a much larger amount, all tax-free. In less than two years I can touch those gains and never pay a penny in income tax ever! Until then I can keep investing and growing the pile more. (The basis is currently available.)

What about you? How can you super charge your tax-free income? Simple. You can either invest in market securities or index funds and enjoy those returns, or, invest in your own company, placed inside a Roth. Cryptocurrencies can also be placed inside a Roth. 

It is the early years of business growth that pound returns north fast. Peter Thiel invests and continues investing in start-ups. You can do that to a lesser extent, but you can easily start a business with the shares held by the Roth. The biggest obstacle is finding an IRA administrator that allows such investments inside Roth IRAs. You may have a local firm that handles such Roth IRAs if you look. You can also check Equity Trust. (Not an affiliate.) Be sure to do your due diligence before moving money.

 

There are so many opportunities available to eliminate your federal income tax. You can mix and match the strategies listed above and more in an endless number of ways. I spend most days at the office consulting with clients on just such issues. Sometimes my hands are tied and the benefits are limited (still profitable for the client, but limited). Most of the time we crush the tax beast. 

One word of caution before I leave you to your cup of coffee. Never fall for the old trick of lower taxes for the current year only. That is a very easy game to play that ultimately screws the client (that is you, my taxpaying reader). When I work with clients I consider “all years involved”. That means investments into a traditional retirement account requires consideration for the tax consequences when the money comes out.

Now, get creative, but stay legal. You want to keep your money and enjoy it too.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here.

Blockfi is currently paying 7.5%.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Identify Your Ideal Client

The most common mistake I see in my practice when a client starts a new business or side hustle is that they try to be everything to everyone. This leads to overwhelm, burnout and alienates the ideal client. By identifying your ideal client you increase your chances you will have clients you love working with. And that takes the work out of work.

A prime example of this is when a client tells me they are starting a restaurant. Their logic is that everyone needs to eat, to which I reply, “Yes, but they don’t have to eat at your place.”

If a restaurant is the business you want to be in (in other words, you LOVE the idea of working with food, employees and customers at a hectic pace all day) then you better be focused. Will you serve ethnic food? Take out? Delivery? Hours?

Advertising you have good food will not cut it. People want to know what you serve. The best restaurants are always known for their specialty. In Menasha, where my office is located,  Mihm’s Charcoal Grill is known for their butter burger. People joke it is a heart attack waiting to happen. Their burgers are so moist and delicious! They are tucked away on a side street and the place is small. But those butter burgers are to die for, literally. People wait in line for that stuff! Business is good at Mihm’s. If you are ever in the area give them a try. You’ll visit more often afterwards.

Learn from successful business how to find your ideal client.

You don’t have to reinvent the wheel when searching for the ideal client or customer. Take a page from those who have done it successfully in the past.

In Wisconsin we have a gas station called Kwik Trip. They have the best coffee and pretty darn good food, too. 

You would think a gas station is impossible to differentiate from other gas stations. If you thought this you would be wrong. Kwik Trip has become a destination. People travel across the Wisconsin border just to visit a Kwik Trip. (Are your ideal clients this fanatic about what you do?) The stations are well-kept, clean, employees trained and properly paid. It shows.

Several years ago Kwik Trip showed how to find the ideal client and nobody noticed. Except me! I recommend a version of what they did to certain clients when the strategy is appropriate.

Here is what Kwik Trip did. They printed up a bunch of coupon sized glossy flyers one-third the size of a regular sheet of paper, printing on both sides. On the flyer was a $1 off coupon for any pizza. They also announced they delivered. Next to the coupon was a list of all the pizzas available and a notation that Kwik Trip made their pizzas fresh in-house. There was also information for ordering your pizza online and picking up later.

So far nothing special Anybody, or business, could do this and it would make no difference or would cost a fortune distributing the coupons.

Kwik Trip took one hour, just one hour max, to implement a stroke of marketing genius. Yes, they had the coupons available at their gas stations and yes, employees handed them out.

But they also had an employee deliver to each business near each gas station a wad of these coupon flyers. 

Wow! People didn’t read they delivered, they saw it in action. And they focused on their ideal client: people at work looking for a delicious, low-cost lunch. 

People have a hard time passing up a discount, especially when the price of the product is already reasonable. Dropping off a thick wad of coupons at each local business allowed people working near the gas station several opportunities for the discount. Kwik Trip sold a lot of pizzas. I mean a LOT of pizzas and still do to this day.

How is this the ideal client? First, Kwik Trip promised delivery and they focused on delivering pizzas to the closest customers. Second, by focusing on local small businesses many delivered orders contained several pizzas. (It is cheaper to deliver five pizzas to one location than five separate locations.) Many people also picked up their pizza, fresh and ready, when they arrived.

I suggest to my restaurant clients they modify this strategy for their personal situation. I have never seen this strategy fail! For a few hundred dollars and an hour or so of time you explode your restaurant business. 

The perfect client values my services and advice. They engage and implement. They consider my firm part of their team and work together with that mindset.

The Ideal Client for You

What about other side hustles and businesses? How do they find the ideal client? The ones they love working with? The clients/customers that turn a job into a vacation because you love doing it so much?

The strategies listed above were to get you in the right mindset. Your business is probably different from Kwik Trip or Mihm’s. 

Before you can have ideal clients you need to identify what your ideal client looks like and where they live and work. This is important: You must be very specific and detailed! It’s not enough for a dog walking side hustle to list “all dogs”.  

Below I am going to outline the ideal client for my tax and accounting practice because, as you might guess, I’m looking a few few excellent new clients. Maybe most people need their taxes filed, but I don’t want everyone as a tax prep client. 

Specifically, I’m looking for a client that needs bookkeeping. That will include tax prep work, payroll and consulting, too. 

Below, I will outline my specifics of my ideal client. This means that most people that walk in the door or email will not get an offer to be my client! Read the last sentence 30 or so times if you are a business owner. Don’t act desperate. Many potential clients are a poor fit. 

Remember, most clients on the prowl for a new accountant left their previous accountant for a reason!

I expect a new client will be a long-term relationship. This is not a one-and-done. I am not interested in cleaning up years of bad books only to have the client go AWOL for five years, returning with same same exact mess, IRS notices and all. Note: I don’t mind fixing messes as long as the mess stays fixed.

 

Ideal Client Sample

First, we need to be honest with ourselves. Why did we lose clients in the first place? Are we starting out in business? Are there things we need to fix internally before bringing in new clients? Are employees properly trained?

For readers on the Facebook page of this blog, you will already know why I am in the market for two, maybe three, new clients. To bring the rest of you up to speed: My office has had a high fatality rate. Over the past year over 4% of my clients died; over 1 in 25!

These clients died because they got old. It wasn’t a disease issue. Most were clients since the 1990s. Those that didn’t die decided to retire. Who can blame them. And then there were a few business clients close enough to retirement that took the opportunity when the economy was shut down for a while. The timing was right for them.

I think the reason for client loss isn’t an issue I need to deal with internally. Now I can focus on what I want new clients to look like:

  • Must be U.S based. Some international sales are okay, but too much international and I need to bring in outside help.
  • They can be located anywhere in the U.S. If outside my local area, must be willing to use our secure portal for document transfer.
  • Will need more than tax preparation. Must also desire bookkeeping and consulting, plus maybe some payroll.
  • Landlords are a specialty of mine and would love a few new clients that are landlords with multiple properties.
    • Landlord clients should also be interested in consulting over all the tax reduction strategies possible. 
  • New business clients must be in a growth phase or stability phase. I don’t mind helping a firm wind down, but prefer new clients as long-term relationships.
  • Must consider my services a value. If taxes, bookkeeping and consulting are done begrudgingly, I’m not a good fit for you.
  • Pay my fee in a timely manner. 
  • Find my fee a value.
  • When reviewing a potential new client I need to see at least a 5x return for the client, preferably 10X (see next bullet point).
  • An ideal client is one that probably has fees to my firm of $5,000 or more per year. $400 of bookkeeping a month get them there. Even a small amount of monthly bookkeeping coupled with tax preparation and consulting should be sufficient.
  • The minimum return to the client can come from tax reduction or additional business profits annually. An increase in the value of the business is also considered. However, the new client should be able to clearly see at least a 5X return on any fees they pay me. That means they should see $25,000 minimum in increased profits and tax reductions annually.
  • A new client should be eager to communicate with my firm regularly. Disclosure of all pertinent information is a must. They must consider us part of their team.
  • Must provide data in a timely manner.
  • Must file all tax returns by the due date, plus extensions.
  • Must remain current on tax payments. No self-inflicted tax wounds that require unlimited time trying to contact the IRS.
  • Must be pleasant to work with.
  • If they are leaving an accounting firm it should have been an amicable separation (firm closing/owner died/firm can’t handle all its work). Not a deal breaker, but a warning sign if they had problems with their previous accountant.
  • If they have employees they use a proper payroll service so payroll taxes are paid and federal, state and local regulations followed. 
  • No paying employees or contractors under the table!
  • Reports all income and expenses. No tax cheats!

 

I know the list is long, but it isn’t that hard for a new client to make the cut. They need to follow the rules, work with their friendly new accounting team and pay their bill. 

Yes, I do make exceptions.

Yes, I say “no” to a lot of potential clients. I would rather take an afternoon nap than deal with the angst of having bad clients on my books. You, as the client, want the same thing. These rules also apply to me!

Feel free to use my list and modify to your needs. I know I will so don’t be surprised if I come back over the next weeks and months and clarify the list more.

Finally, if you are in need of an accountant that cares enough to be this specific, contact me. I really am in the market for two or three new clients of the right type. If it isn’t a good fit, I sometimes give referrals if I know a professional that might be a good fit. Sometimes it isn’t you; it is me. 

And this is how you love your work, have less stress, start the day excited and make the world a better place. 

It is also profitable for all parties involved, as it should be.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Self-Sabotage: The Biggest Risk Once You Have Money

Having money can change you, and not always in good ways. The risk is greatest for those who start out poor. For those lucky people, they have an additional challenge before them. If they fail they go all the way back into the swamp. Self-sabotage is an insidious demon.

Money doesn’t make you a better person; it makes the kind of person you are more pronounced. If you are a kind and generous person, money will tend to make you more kind and generous. And if you are a a-hole, money will make you a much larger one. 

Today I will share with you three stories: two personal and the other from a client. My hope is that you, kind readers, will learn from these lessons rather experience them personally.

I work hard sharing ideas on building wealth and lowering taxes. These are worthy goals that make the world a better place. What I don’t talk about often is the risks people face once they make it. There is no greater thrill than to watch someone born in poverty finding their way to an abundant life. All too often this is the moment they destroy their lives. Usually it is temporary; sometimes not. These lessons can help you avoid the same fate.

 

Turning on the AC

Believe it or not, you need to give yourself permission to be successful. Most people get exactly what they think they deserve. When their net worth declines the mental thermostat is turned up to bring them right back where they think they belong. And when things start going well, all too often the thermostat is turned down until the AC kicks in and pulls you down to where you think you belong.

There were two times in my life where I kicked on the mental AC is a big way. Working with clients on a regular basis as a tax professional I should have known better. I should have seen it coming. Yet, I let my guard down and suffered financially in each case.

My background starts on a farm in the backwoods of Nowhere, Wisconsin. We were poor, yet happy. We didn’t know better. We milked cows, planted and harvested crops and enjoyed life to the fullest in our sheltered world. 

By the time I reached high school I realized there was another world out there. I was driven. Coupled with the energy of youth I kicked tail and took names.

The family farm went through a wrenching bankruptcy in 1982, the year I graduated high school. I’m not certain, but I might have been the only one in the family with a positive net worth. Not bragging. Just had no debt so the nickels and dimes in my pocket was my edge.

Destructive financial habits are set at a young age. Learn to give yourself permission to have nice thing, a good life and financial success.

As hard as losing the farm was on me (I always thought I was going to be a farmer all my life) it was a blessing is disguise.

Rather than dig into a farming lifestyle I focused on blazing my own path. I started several businesses. We call them side hustles now. One of those businesses was preparing taxes for up to 50 people. It took seven years to realize that would be the course my life would take.

I started buying real estate. Most properties were single family homes and duplexes in the beginning. I bought larger and varied types of property as I gained my sea legs.

By 1990 I figured out I was going to be a tax guy. (What better way to keep your real estate profits than by learning the Tax Code inside and out?) 

My dad and brother joined me in a real estate partnership called LuK Enterprises. No LLC. Nothing special. Just a family general partnership. 

My tax practice that started as a side hustle preparing 48 returns per year jumped to 148 returns the first year full-time and 402 the second year. I never looked back.

A backwoods farm boy saw his net worth and income explode. My tax practice started earning real money by 1992-3. I was living the dream.

And my subconscious started to scream You don’t deserve this! 

By all outward appearances I was handling the wealth rather well. Except for an early mid-life crisis.

I bought a Z-28. It was a sporty little number. Bought it from Fox Communities Credit Union (back when they sold their repos to the public rather than ship them to auction). Sold it a year later at a profit. (As much as the car made me look cool, it was small even for me back in those day. I could barely get in and out of the driver’s seat.)

This is the part of the story where I will refrain from an info-dump. Suffice it to say, I did not feel good about myself. I felt like an imposter. Farm boys don’t end up like this.

So I sabotaged myself. And boy did I do a number. Looking back it I was lucky to come out alive.

My income stagnated for a few years while my net worth kept growing. I had a good setup and it worked while I was flipping out. Fortunately.

The worst part is I saw it coming! When I couldn’t self-destruct, I upped the ante and made it known I was off the rails. I never hurt anyone or put anyone at risk. But I certainly loaded both barrels and pulled both triggers with the barrels pointed at my feet. Toes were flying everywhere. Now you know why I limp; self-inflicted financial wounds.

It took a long time to undo the damage and in some ways never did. The good news is my tax practice eventually started growing again. I sold most of my real estate 5-10 years later, converting equity into cash. I rebuilt my life and moved on. Lesson learned? I wish it were that simple.

 

Self-Destruct

You would think once a farm boy became seasoned he would not be so prone to industrial-strength stupid. Ah, but I’m going to make you proud.

You see, I have a strong drive to learn and try things. Drake Software developed a DIY program based on the professional version used by my firm. I thought this could be a real profit generator while providing a powerful tax preparation tool for those going it alone. I got half of it right.

The software worked just fine and Drake kept improving the product. I think it is the best product on the market. Unfortunately, it is hard to get people to try your tax software when the major players are dug in deep. Even price didn’t encourage people! They gladly pay more for TurboTax when I see many of these folks in the summer when they need issues fixed their software screwed up.

I needed a hook to get people to try the product. That is when I came across a blogger called Mr. Money Mustache (MMM). 

I loved Pete’s (Mr. Money Mustache is Pete Adeney) work, especially the frugal ideas he espoused. His real claim to fame is early retirement. He dumped traditional work at age 30 and had a stint in real estate before rocketing to fame in the blogosphere. 

Retirement never interested me. There are too many things I want to do. Mix in some OCD and I’ll probably twitch in my grave, to say nothing of my behavior while alive. But for Pete the message resonated. He worked hard building his blog and his IT background gave him a serious advantage. He likes to make it look easy. Blame it on social media and cherry picking daily activities to report.

Well, I packed my bags with a plan to meet MMM and sell him on the DIY tax software idea. 

I attended a Camp Mustache outside Seattle that year. As long as I was there I figured I may as well give a presentation on some tax strategies. Pete took an instant like to me.

Pete made me his tax guy on the spot. It was time to spring my idea. He shot it down posthaste. 

Little did I know how badly the wheels fell off! It was the worst possible outcome and I had no idea what was about to hit me.

Pete published a post about my presentation on his blog, a blog with the better part of 10 million page views per month. Do you have any idea what that does to a small tax office? It nearly destroyed my business. But that isn’t where I went off the rails.

And I had no partnership with Pete on the tax software.

While still at Camp Mustache people started asking me if I had a blog. Well, ah…

I purchased the URL for this blog a few years prior with plans for what eventually came to pass. My timetable was pushed forward is all. I now needed to have a blog up and running!

With a push from an A-list blogger I was on the map. Blog traffic jumped right out of the gate.

Traffic climbed and people took notice. People knew me! A farm boy! From the backwoods of Nowhere, Wisconsin! And my brain started to plot revenge. This isn’t right.

Fame (even if only modest in scope) brings out the less desirable people of the world. Some would email or call, trying to use me as a relay to contact Pete. (Me: Call Pete yourself. Them: He doesn’t answer. Me. Then he doesn’t want to talk to you.) Others wanted to pitch me. And 20,000 people wanted me as their tax preparer!

I was a popular dude, at least from what I ever experienced prior in my life. I was getting more uncomfortable by the day. I never connected well with the FIRE (financial independence/retire early) community. I found nothing familiar about them, except for the frugality.

Pete was the father of the FIRE movement. I felt obligated to attend more gatherings and conferences. I hated it with every fiber of my being. My brain was working hard now on a way to sabotage me. 

Beat self-sabotage.

The best things in life are worth having. You are worth everything you have and more.

The zenith was at hand. This blog was nominated for a Plutus Award: The Best New Personal Finance Blog of the Year. And I won! I think a lot had to do with me being Pete’s tax guy.

But that is not where my brain loaded both barrels again. 

The night before the awards ceremony I had three late visitors to my hotel room. Remember how I told you fame, even a small amount, attracts the least desirable people in the world? Well, three showed up at my door. The worst part is I knew who they were and liked them! Not so much now. The warts are too visible to me now. There goal was to hurt me and I fully cooperated!

Without going into too much detail, I found my way to get out of the trap I felt I was in. After the awards ceremony I wrote a blog post, and boy was it a blistering attack. I pulled it down a few hours later and eventually deleted it in my files. But the damage was done. It was a terrible post, a rambling attack on all I felt slighted by. I gave new meaning to the acronym FIRE.

Blog traffic slowly declined as the FIRE community kept their distance. (Who could blame them? Even I scare me sometimes!) Now I’m working on rebuilding this blog. No more awards, no more conferences and a lot fewer emails.

Without a doubt I could have done things differently. I did not have to be an ass about it. It is easy to point finger. The thing is, I can’t control them, but I can control my behavior. 

If I wanted out I should have politely excused myself and left it at that. There was no reason to bring a blow torch into the picture. (Note: A large number of people in the FIRE community still communicate with me. They are good folks and forgave the wayward child.)

Of course, there is plenty more. Buy me a beer (or three) and I’ll tell you more than even I know. 

My stories were only to warm you up. The real reason for today’s post involves a long-term client. Her risks are no less than what I faced. Hopefully I can help her navigate the swamp better than I did. I’ll let you be the judge.

 

Rags to Riches

The year is 1992. Brenda walks into my office for the first time. (Faces and names have been changed. Brenda is aware of this post and approves.) She said two words at best. I prepared her return. As soon as she was finished she turned with a snap and left.

As the years went by I discovered she had a story that breaks the heart. She was molested by her step-father from the time she five or maybe even younger. This had a profound and negative impact on her adult life.

Brenda had no self worth. She didn’t talk because she was so abused. As a young adult she got pregnant, married the man and later divorced him. She told me she was practically forced into the marriage when she got pregnant. 

After the first failed marriage she jumped into an abusive relationship next. That marriage also failed. 

The details are too sordid to include here. Suffice it to say, she was one suffering young lady. 

Fifteen years ago, after she put her failed marriages behind her, Brenda finally met a decent man worthy of her love. Brenda took her time to get it right this time. She took years to make a commitment of marriage. She wanted a real marriage; one that lasted. (They have an awesome marriage I am proud to report.) 

Brenda was still deep in debt and lived in a $500 mobile home. Life was not good. Financial problems were crushing her. All she had was a man that loved her. Her body and spirit broken from an abusive step-father and marriage to a man no less abusive had crushed her spirit. 

Over the last 10 years she made every attempt possible to dig out of the financial hole she was in. She had a good man in her life. She now had a reason to live, to build a life worth living.

Somewhere around this time she started talking to her tax professional a bit more. Even before this blog I worked with clients on financial issues as well as tax. Brenda would be a special case, handled pro bono.

She listened hard. Much of the advice she refused to take. If it worked it would be too much too fast. I could see it on her face. Her AC kicked in below the freezing mark!

Slowly her finances improved. She got out of the mobile home and bought a “real” home. Her debt declined to a manageable level. Her retirement account was growing. She was starting to live the dream. Her credit score approached 800; it had been in the 500 range most of her life.

All the while this was happening I could see in her face she felt deep down she did not deserve a life as good as it had become. She was about to release a subconscious financial bomb, something I am all too familiar with.

The money grew; her lifestyle did as well. She now has more money than she ever had in her life. She has a good job. A good stock market meant her index funds (my advice) exploded! She was sitting on a nice stack of green.

Not an overwhelming amount, mind you. A nice stash of moolah, for sure, but not enough to go crazy.

All the pandemic craziness worked on Brenda’s mind. She wanted to get away. 

Earlier this year she informed me she was checking out.

While my flare-outs were much more entertaining (ahem!), she is doing what she knows best: running away. It is a common trait among abuse victims. She has enough money for a gap year or so, but she also has some debt. There is a bit more financial work to do before she can punch her card.

When I talked to her recently she informed me she tendered her resignation at work. She has a good job! One she actually keeps instead of switching jobs every few years. And she likes the people there; the people there like her! 

I asked her to reconsider before the two-week notice came due. She has stability in life now. She doesn’t have another job lined up and doesn’t know where she wants to go. She is scared because this kind of life is so alien to her. 

I suggested she cut her hours instead because it will not take long for her finances to start screaming for help if she takes early retirement too early. 

She can always quit later if that is her desire. My advice was to think before she leapt. 

Her employer allowed Brenda to rescind her resignation. She will be taking a shorter workweek and more days off. That makes sense to me. No bridges in flames and more time with her family. Now if she can only convince herself she deserves such a rich life.

There is no magic answer. Sometimes, when you are too close, it is hard to see the forest from the trees. We are all guilty of it. It is also the worst time to make a decision…

…without input from a third-party interested in your well-being.

The story hasn’t ended. She could easily crash and burn. She is at a dangerous time. Things have never been better for her, but deep down she is still fighting the demons of a past that tells her she is worthless. 

It is hard when you care for your clients. I hurt when they hurt. I can’t fix her or any client for that manner. She has to find her own way. All I can do is hold the lamp and hope she makes the right decision.

 

Advanced Self-Sabotage

Brenda’s and my stories have multiple lessons. But there is one more lesson. 

Self-sabotage doesn’t always take place once you have had some success. Often, we have an idea that when fleshed out has real promise. Before we ever begin our brain envisions the successful outcome. 

To prevent any overheating our brain tells us to sabotage the effort. Procrastination kills more wealth than all other dangers combined. 

There are so many ways to burn your future. The goal is to short circuit the thermostat. Life when you were a child built many of these walls. They need to come down.

You do deserve a good life, filled with financial abundance and good friends and family. Break the thermostat. Let your dreams flourish.

 

Coda

There is no other line of work for me. I make a difference. Every morning I jump out of bed ready to serve. It gives my life meaning, helping others find meaning in theirs. 

I made enough mistakes, some rather large as we just saw. Perhaps if the right person came along I would not have committed the slash and burn I did. I doubt anyone knew how deep the knife cut. I needed to open up and accept help.

Coming from the outside I can help people see the forest from the trees; provide a gentle guiding hand. I have plenty of experience, and the scars to prove it. I have no problem telling my stories, even the less flattering ones. 

The story doesn’t end here. It never really ends. Each day is a challenge to live up to our potential and convince ourselves we are worth everything we have.

 

Have you ever self-sabotaged? Of course you have. Same as Brenda and me. How did you find your way back to the light? What lessons did you learn? How did you convince yourself it was okay to be wealthy, to have life good? Are you still picking up the pieces?

Many times the conversation ends up on Facebook. Consider adding the conversation to the comments here so others that come along later have a full guide on how to avoid the self-sabotage we all plan when things go better than we feel deep down we don’t deserve.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

7 Tools to Build Wealth After 50

There is an old joke in my office that goes like this: Everybody can retire in 15 years starting with nothing. I can prove it. Most people overspend until their birthday has a 5 in front of it. Then they panic. OMG! I have only 15 years until retirement! And then they get serious and get it done.

Of course it isn’t that simple. Many people do save early. Yet all too many suffer a diminished retirement due to financial habits in the years leading to retirement. A heavy debt load can move the starting block to negative territory, making the drive for retirement all the more challenging. 

No matter your age or financial condition, you can always improve your situation. We will focus on tools for those 50 and older in this post, but make no mistake, each tool listed here has potential for people of all ages.

Using the story above, people who get serious about retirement can reach that goal by age 35 and even younger. The FIRE (financial independence, retire early) community is a prime example of people moving the urgency of retirement from age 50 to an earlier age. Which leads us to a simple concept: Decide when you want to retire by picking the year you will get serious about planning for retirement. Start at 25, retire by 40; start at 40, retire by 55; start at 50, retire by 65; never start, never retire.

The closer you are to retirement the more important it is to make financial decisions that will keep you on course. A major financial setback in the final run to retirement can be devastating. Today we will deal with those risks and work to mitigate them.

 

1.) You Need a Budget

When I was a wee tyke I was already budgeting. It was a simple ledger listing income and expenditures. If I wanted a new Wrist Rocket slingshot I needed to save for the purchase. (This is a true story.) That required a plan.

A budget is not about deprivation! A budget is about knowing where you are financially and managing income and spending. 

A simple spreadsheet can do the trick. This is something I have used since I was in middle school. Back then I used paper and pencil. Later I graduated to Excel and similar spreadsheet software. It doesn’t have to be fancy; it just has to work! If you want bells and whistles you can try You Need a Budget. Fancy or something simple, all works as long as you start and remain consistent. 

Budgeting is more than limiting expenses in each category. A budget shows you where you are spending and this allows you to eliminate waste without any sacrifice. Sometimes you will notice an expense that is out of line and it will become a conscious choice to reduce spending in that area.

The point is budgeting gives you control of your finances. You can’t manage what you don’t understand. As much as you think you know where your money is going, there is no way to really know and manage money properly unless you can see it. That is what a budget does. It works for anyone at any age, but is vital if you are reaching the end of your working years. This frees up money so you can pay-yourself-first.

 

2.) Eliminate Debt

It is hard to enjoy retirement when you are managing debt payments. A mortgage would be bad enough, but credit cards, auto loans and student loans are things you want wiped off the slate before you enter retirement.

Remember: Paying off debt is a form of investing. It is a backward way of thinking about allocation of excess funds. Investing is straightforward. Yet, paying off debt also has a return. High interest debt is a cancer to a budget. Paying off the debt reduces the interest expense. That lowers expenses and makes budgeting a world better.

Getting into debt is easy; getting out can be a serious challenge for many. There is help. If you have reached the crisis level consider contacting the National Foundation for Credit Counseling

Most people can reduce and eliminate their debt by tracking their income and spending on a spreadsheet. Budgeting is the place to start so you can visualize your finances. This should reveal the low hanging fruit. Modest tweaks to your finances can yield a significant boost to your free cash flow

Dave Ramsey has made a career out of helping people get out of debt. His baby steps and debt snowball programs have helps thousands of people get out of debt and stay debt-free. I have witnessed many clients over the years benefit from Dave’s system. If you have debt you might want to consider looking into Dave’s programs. You can check out his books from the library if you don’t want to spend a penny. Financial Peace University is a good program. Or you can own his book The Total Money Makeover for under $12 at the time of this writing from Amazon. (Note: Many years back I was a Dave Ramsey Endorsed Local Provider in the tax field. Dave Ramsey is not an affiliate, but the Amazon link is.)

Enjoying the retired life. It can be all fun and games.

3.) Take the IRS Up on Catch-up Contributions

Once you reach age 50 the IRS allows you to supercharge your retirement savings. Congress made these rules because they stood behind me when I was working and quickly realized I was not joking when I say people get serious about retirement when the calendar stamps 50 candles on their birthday cake. 

Of course, you can start before age 50, too. You can stash away serious money with a 401(k) or other retirement program. Once you are 50 and older you can top off your annual retirement contributions with an additional $6,500 in a 401(k), 403(b), 457 or SARSEP; $3,000 for SIMPLE plans; $1,000 for traditional and Roth IRAs (these are all 2021 numbers). 

 

4.) Start a Health Savings Account (HSA) if Allowed

The HSA is one of the best financial tools in the tax code. If your health insurance is HSA qualified, be sure to contribute to an HSA savings account. Contributions are deductible. Withdrawals are tax-free if used for qualified medical expenses. You can’t use HSA funds to pay for health insurance premiums, but you can use them to pay Medicare Premiums. That means if your medical expenses are low your HSA becomes a wonderful tax-free tool as you prepare for retirement.

For 2021, you get a $1,000 contribution limit increase if you are 55 or older. 

Consider Fidelity or other low-cost investment house for managing your HSA funds.

 

5.) Consult a Tax Professional

Most people reading this are not concerned about starting their financial plan; they already started and want to manage their finances to maximize benefits while reducing taxes.

Even in retirement taxes are still a major expense. Consulting with a tax professional is a high-value investment. 

In my office I make it clear to clients I am not interested in saving them money for one tax year only. My goal is to get the lowest tax possible for all years involved combined! 

Retirement is different than your working years. The rules change and the tax code is different once you push into the traditional retirement years. You spent your entire life looking at income and the slice you will dedicate towards retirement investments.

Now you need to balance Social Security income, retirement income, tax brackets, tax credits and more. Social Security benefits can be tax-free, but it is getting harder to accomplish that. This is where a good tax pro comes in. Required Minimum Distributions play a role. Pension income and capital gains, too. Tax professionals who can navigate the moving parts are worth their weight in gold.

Steps you take today will affect your taxes in future years. I consult with many clients approaching retirement and in retirement each year. It is always a profitable consulting session for the client. The moving parts are numerous. A seasoned tax pro can help you navigate the options. Your facts and circumstances determine your optimal path. One size does not fit all.

 

6.) Insurance

Insurance is a strange animal. Each person’s situation is unique. Your health will determine the health insurance policy best for you. Some people might need life insurance, many will not. What about long-term care?

Insurance has a built in profit for the insurance company. Insurance should not be considered a good financial investment. Instead, it is a tool to help manage and protect your wealth.

As your financial resources increase you might wish to increase the deductible on your policies. Depending on the value of your vehicle, you may wish to forgo collision completely. 

Insurance gets expensive as you get older, especially health insurance. It might be a wise choice to have disability insurance or long-term care coverage. Your personal situation will determine the proper course. 

Discuss the issues with your insurance agent and then have a disinterested third-party  (someone not getting paid a commission for the sale of the insurance policies) to review the choices provided. A financially knowledgeable family member or trusted friend might be a good choice. Or, you can discuss the options provided by the insurance agent with a tax professional or attorney that is versed in these matters.

 

7.) Legal Matters

All the bad party jokes have attorneys as the butt of the joke. While attorneys get a bad rap, they are the most powerful tool out there in protecting your wealth as your nest egg grows. 

Estate planning requires a legal professional. Do you need a trust? Will? Durable Power of Attorney?

Attorneys are also trained in asset protection. When you have only a small net worth there is less to worry about. Once you build serious retirement assets you need to take steps protecting those assets. 

Finding a qualified attorney is the challenge. I use Legal Shield (not an affiliate) in my office. They can answer simple legal questions and refer you to an attorney specializing in the area of practice you need. 

 

Risks

The biggest risk is not starting or starting too late. The second biggest risk is a financial disaster as your approach your retirement date. 

You do not want a financial surprise after 50. There just isn’t enough time to recover as you get older. And who want to work forever anyway? (You might enjoy working, but you don’t want to be required to work over poor financial planning.) 

Tax planning  and legal help are vital. The key is to review each facet of your life annually once you reach 50: investments, health, tax, legal, et cetera. Several tools have been provided above. I encourage you to use them. 

Retirement isn’t out of reach. You can do this. If you are looking forward to an early retirement you can use most of the tools in this post; if you are over 50 you can lock and load on powerful programs that supercharge your net worth. 

It all boils down to a plan. With a proper plan retirement will be the blessing you dreamed it would be. 

It is never too late to start.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

US Savings Bonds and Taxes

Millions of Americans own U.S. savings bonds. They are the perfect gift for a newborn and young children you want to teach habits of thrift. U.S. savings bonds also get special tax treatment and can be used as a higher education funding tool for some taxpayers. We will focus on the tax benefits of Series EE, Series HH and Series I savings bonds in this article. 

We will start with the basics of each series of bond followed by tax benefits and potential tax pitfalls surrounding savings bond ownership. A savings bond calculator is provided at the end of this post so you can find the current value of U.S. savings bonds you currently own.

 

U.S. Savings Bond Basics

Series EE Savings Bonds

Paper EE bonds were issued at a discount. Example: a $50 face value bond was purchased for $25. Paper EE savings bonds are no longer issued, but continue to accrue interest for 30 year from the issue date.

Electronic EE bonds are purchased in any amount $25 and over and are issued at face value. Example: A $50 bond is purchased for $50. Interest accrues from the face value.

Interest is tax-free at the state or local level, but taxed on the federal level. Interest is not taxable until the year redeemed.

Taxpayer can elect to pay taxes on the interest as it accrues. If the election is made it applies to all EE bonds currently owned and EE bonds purchased in the future. Accrued interest is reported the year of the election. The election must be made on a timely filed return (Rev. Rul. 55-655). The election can be revoked by attaching a statement to the return the year of revocation.

EE bond interest used to pay college tuition may be tax-free (details below under Tax Strategies).

EE bonds purchased between April 30, 1997 and May 1, 2005 earn interest at 90% of the average yields of the 5-year Treasury notes for the preceding six months. Interest accrues monthly (the value of the bond increases each month) and interest compounds semiannually. If the bond does not reach face value in 17 years a one-time adjustment is made to bring the bond’s redemption value to the face value.

EE bonds issued after April 30, 2005 earn a fixed rate of interest. The rate is outlined on the issue date and is fixed for at least 20 years. The price is guaranteed to double (reach the maturity price) in 20 years or the bond is adjusted accordingly. There is a 3-month interest penalty for bonds held less than 5 years.

If the EE bond owner dies there are two ways to report the deferred interest:

  1. Include the accrued interest on the owner’s personal tax return — called the decedent return. Beneficiaries pay tax on interest accrued after death.
  2. All the interest is taxed by the beneficiary when redeemed or, if elected, as it accrues annually.

Series HH Savings Bonds

The U.S. Treasury has discontinued issuing HH bonds after August 31, 2004. 

HH bonds:

  • Were issued at face value.
  • Paid a fixed interest rate semiannually.
  • Are subject to federal income tax.
  • Are not subject to state and local income taxes.
  • Were only issued in exchange for Series E and EE savings bonds.
  • The accrued interest from the E or EE bonds was deferred until the HH bonds matured, but
  • The interest on the HH bond itself cannot be deferred.

 

Series I Savings Bonds

Series I paper bonds come in 5 denominations ($50, $100, $200, $500, $1,000 and $5,000) and you can use your federal income tax refund to purchase them.

Electronic I bonds are available in any amount $25 and over. Purchases can be made via Treasury Direct

Are issued at face value. All interest is paid at redemption or maturity.

The interest rate contains two components:

  1. A fixed rate of interest effective for the life of the bond, and
  2. A semiannual inflation rate that is based on the Consumer Price Index for all Urban consumers (CPI-U). 

Interest is added each month and compounds semiannually. 

Once again, interest is subject to the federal income tax, but is not included in income on the state and local level. Federal income tax is due when either the bond matures or is redeemed. Cash basis taxpayers can elect to pay taxes as the interest accrues using the same rules as for Series EE bonds (where interest is taxed annually) [IRC Sec. 454(a)].

Interest used to pay college tuition may be excluded from income. See Tax Strategies below.

 

Tax Strategies

In a world of low interest rates, U.S. savings bonds can be a powerful option with tax advantages. Not only can you earn a higher rate of return on your emergency funds, but the interest is excluded from income tax on the state and local level.

You also have the option of paying the federal tax on the interest when you redeem the bond or when it matures, OR you can elect to pay as you go. Your personal tax situation will dictate which method affords the lowest tax over all years involved.

I have included two charts in this post: How Long Bonds Earn Interest and Who reports Interest on U.S. Savings Bonds.

The first chart is important because savings bonds have an interest-bearing life. No interest will accrue or be paid after the stated number of years. Interest accrued during the interest-bearing years is not lost even if the bond is held longer than the interest-bearing life term.

The second chart helps you navigate the tricky rules for who reports the income on their federal income tax return. 

If you buy a bond for a grandchild (or any other person for that matter) the interest is reportable by that person unless the bonds are not titled in their name. 

The interest from bonds bought in the name of co-owners (as bonds for children are usually purchased) is reported on the federal income tax return of the co-owner whose funds were used to purchase the bond, even if the other co-owner cashes in the bond and keeps all the proceeds. 

Gifting: Gifting a savings bond prior to maturity accelerates accrued interest. Prior unreported interest is reported in the year the bond is gifted. The bonds need to be reissued into the transferee’s name.

Charitable Contribution: If you donate a savings bond to a charity the interest accrued needs to be included in your federal income. The value of the bond is then included with your other charitable contributions on Schedule A.

Higher Education: The interest on EE and I bonds can be tax-free when used for higher education. there are some rules that need to be followed:

  • The bonds must have been purchased after 1989 by people 24 years of age or older on the first day of the month the bond was purchased.
  • The bonds redeemed must be used for undergraduate, graduate or vocational school tuition and fees (Example: lab fees) for the taxpayer, spouse or dependent.
  • Tuition must be paid in the year the savings bonds are redeemed.
  • Room and board costs and books are not eligible expenses.
  • Qualified education expenses are reduced for tax-free portions of scholarships and other forms of tax-free tuition assistance. Education credits on your tax return also might be reduced. 
  • The bonds must be in the taxpayer’s name, not the dependent (child).
  • Grandparents can only use this tax break if they can claim the grandchild on their tax return as a dependent.
  • Income limits apply. For 2021: Joint returns begin phasing out the education exclusion of U.S. savings bond interest when modified adjusted gross income (MAGI) exceeds $124,800 and is completely phased out at $154,800. Everyone else begins to phase out the exclusion when MAGI exceeds $83,200 and completely phases out at $98,200.
  • Claim the exclusion on Form 8815.
  • Compare the various strategies for tax benefits regarding education expenses. 529 plans, tax credits (American Opportunity Credit or Lifetime Learning Credit) and Coverdell ESAs all play a role. The savings bond interest exclusion is a last line of defense when prior planning has been lacking or when personal facts and circumstances recommend that course of action. 

 

You can use the savings bond calculator  below to determine the current value of paper bonds. 

U.S. Savings Bond Calculator

Log in to your Treasury Direct account for the current value of electronic bonds.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Minimize Taxes on Day Trading Profits

The risks associated with day trading extend beyond the actual investment. Before the trade is placed consideration needs to be given to the tax implications. 

Profits and losses for day traders can be taxed under the rules for an investor, trader, mark-to-market trader or dealer. There are pros and cons to each method.

Facts and circumstances prevail. Yet, the rules are not always clear. 

 

Investor vs. Trader

The factors you need to consider when determining if you are a trader or investor, include:

  1. Holding period.
  2. Frequency of trades and dollar amount of those trades.
  3. Does the taxpayer pursue the activity as a livelihood?
  4. Time devoted to the activity.

On the surface this may sound straight forward, but as Endicott vs Commissioner, TC Memo 2013-199 shows, it is not.

Endicott used a strategy of selling covered calls. He did not trade every day and usually allowed the options to expire.

Most people would consider Endicott an active trader. He had 204 trades in 2006 and 303 trades in 2007. The court concluded this was not substantial trading. However, in 2008, Endicott made 1,543 trades, which the court said was substantial.

Endicott had purchases and sales of around $7 million in 2006; nearly $15 million in 2007; and about $16 million in 2008. The court agreed these were all substantial amounts. But the court couldn’t keep it simple. They went on to say “managing a large amount of money is not conclusive as to whether a petitioner’s trading activity amounted to a trade or business.” The court is saying large amounts of money being traded is not enough. This is why tax professionals say “facts and circumstances” so often.

You can use this chart to help you make a determination for your situation.

Characteristics of Traders and Investors

 

Cryptocurrencies

Remember, these rules apply to taxpayers who buy and sell securities or commodities only. These rules do not apply to cryptocurrencies. The IRS considers all crypto as property. The SEC clearly states wash sale rules only apply to securities.  This means wash sale rules do not apply to crypto. Significant tax-loss harvesting is possible as a result.

 

Tax Implications for Investors, Day Traders, MTM Traders and Dealers

The chart at the end of this post provides a guide on how taxes apply to investors versus day traders. The advantage of being a trader is the deductibility of margin interest and other business related expenses on Schedule C. Both investors and traders still face the capital loss limits, but traders get the additional deductions of related expenses and margin interest. (Long-term capital gains are taxed preferentially. As a trader, all the LTCGs get the favorable treatment while expenses can be deducted against other income, usually taxed at ordinary rates.)

(The capital loss limit allows the taxpayer to deduct losses of up to $3,000 ($1,500 if married filing separately) against other income.)

To avoid the capital loss limits you can elect to be a mark-to-market trader. Wash sale rules also do not apply to to MTM traders.

Dealers are required to follow MTM rules. (Dealers have a place of business where they engage in the buying and selling of securities for customers. )

A trader can elect to use mark-to-market rules [IRC Sec. 475(f)]. Most tax software has an elections page where you can check a box and the election is automatically populated.

Mark-to-market rules:

  1. All securities gains and losses are treated as ordinary income or loss.
  2. Securities held at the end of the tax year are deemed sold at FMV.
  3. Basis of securities deemed sold at year-end are adjusted accordingly.

The biggest advantage of making the MTM election is to avoid the wash sale rules and to sidestep the capital loss limitations.

The MTM election can be revoked, but you must wait at least 5 years before you can elect again. Since the mark-to-market election has limits, you need to consider the election carefully.

Other issues to consider if you are thinking of making the MTM election:

  1. The MTM election must be made on a timely filed original return, without consideration for extensions, for the taxable year immediately preceding the election year. 
  2. You can attach the election to a timely filed extension.
  3. You also must attach Form 3115 (Change of Accounting Method) if you do not make the election in your first year as a trader (Rev. Proc. 2019-43).

Investors, traders and MTM traders do not pay SE tax and earnings cannot be used to fund IRA/SEP contributions. However, a dealer does pay SE tax and can use gains for IRA/SEP contributions.

Taxing Individuals Who Buy and Sell Securities

 

As you can see, this isn’t the easiest area of tax code to navigate. I strongly recommend you consult with a competent and qualified tax professional when dealing with the trader/investor classification and before you make the MTM election.

May all your trades be profitable.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

 

10 Early Retirement Considerations

Before taking the plunge into retirement, early or traditional, you need to consider factors that will reflect the rest of your life. Handled correctly, early retirement can be a fulfilling blessing. Without proper planning you risk a return to employment you wanted to get away from.

Retirement means different things to different people. Some want to sit back and enjoy a life of leisure. Others wish to travel extensively. And there are some who consider retirement the grand opportunity to start the business of their dreams (maybe not technically retirement, yet still fulfilling), write a book or engage in charitable work.

The path you choose is up to you; there is no right or wrong answer as long as it suits your temperament. There are considerations with right and wrong answers. Get these wrong and retirement can be less than the blessing planned.

Money and taxes play a large role in when you retire and what activities you engage once in retirement. Meaningful activities and family are also serious considerations. 

To help you prepare for retirement, I will discuss 10 things of vital importance to smooth the transition. I provide a starting point. You need to prepare from the starting point I provide so retirement plans are retirement realities.

 

1.) Meaningful Activities

Money gets all the attention. What you do with all the extra time available to you is even more important.

The planning takes on heightened significance when a spouse, significant other or children enter the picture. Will you travel or be a homebody? Where will your travel plans take you? World or domestic travel? And what activities will travel involve? Hiking? Mountain climbing? Tourist areas or off the beaten path? Tours or on your own? These and other questions need to be addressed.

Travel duration also needs consideration. Some people are wired for long duration trips, with the itinerary stretching months to even years. Other folks start feeling anxiety after a week or so on the road.

Between travel you will have time to explore things you may have wanted to do in the past. Charitable work now becomes more than just a small donation periodically. You can put serious work in at the food bank or homeless shelter. Animal lovers might consider animal shelters.

When working on retirement issues I remind clients, “Retire to something, not from something.” Don’t turn retirement into an empty shell. Make it the most exciting time of your life. So exciting you wonder why you didn’t start retirement sooner. That requires moving to something better than you have right now.

 

2.) Dream Business

There is always that one thing you wanted to do, that business you wanted to open. Early retirement is the perfect opportunity. Not that you can’t start your dream business if you retire at an older age; you just have more years to explore and evolve your business if early retirement is on the menu.

The time to start planning your dream business is before you punch the clock the last time. Every business idea requires research, and the time to start that research is now. You might discover your dream business pays better than working for the man, which means you get to retire to the life you want as a business owner a lot sooner.

The business ideas that excites you will determine your course toward and in early retirement. Many businesses are full hands-on operations. Restaurants, for example, are not a side hustle, while forensic accounting can be.

 

3.) Share Your Knowledge

Retirement is not death. If you look up the definition of retire in the dictionary it isn’t something you want to aspire to. Who wants to be “used up”, “obsolete”? When you don’t plan your retirement it can end up that way. Not you! The most important part of your life is about to begin.

You have a story and you need to tell it. You have acquired skills and experience from years of work and living. Don’t let it go to waste.

A large part of life outside formal work, what we call retirement, is sharing. You never know when an opportunity to help someone arrives.

Retirement should offer a comfortable pace in living life. This means you have time to notice things and help as needed. 

You can also create the opportunities to make a difference. Consider mentoring a child or even an adult. 

Write a book. I mean it! It doesn’t have to be an 800 page doorstop. It doesn’t have to find a home with a traditional publisher either. It should be a long as it needs to be and not a word longer or shorter. Offer it for free as an e-book if your story doesn’t fit traditional book categories. Your personal experiences are a story you need to tell. Your experiences in your profession are another story. You may need to write several short books or maybe a long one will do. Regardless, get your story, knowledge and experiences on paper. Let your story continue on with all your readers. Let your readers grow from the base you built. I call it the pay-it-forward revolution. Join the greatest army ever envisioned.

 

4.) Where Will You Live?

As you consider your options in retirement be sure to think in three dimensions. Planning your finances are important. Planning life activities are important. Where you live is of vital importance.

Your favorite accountant lives in the backwoods of Nowhere, Wisconsin. I love it here and will spend my remaining days on this hallowed ground. You may feel the same about where you live. Or, maybe not.

Thinking in 3D means opening your mind to options. Living in a home bolted into the ground is traditional, but not required. I know many people who took to the road in an RV once they retired.

Challenging vacation destinations are still on the table since you probably still possess the vigor of youth. (Note: Never grow old. It’s a trap!)

Little pink houses might be the traditional course expected of you. Instead, living in the mountains might fill you with the juice of life. Then you should do it! Maybe you want to live in another country, enjoying a new culture, people and language. If that is you, then do it! 

And remember, you are not wedded to any choice you make. You might have an itch to RV for a few years before settling down. No problem. While on the road you can open your horizons and start planning where you will live as you enter the next phase of your life.

Planning your early retirement is planning your future. Who you travel with makes all the difference.

5.) Manage Assets

We started with the fun stuff to consider as you prepare for early retirement. Now we need to get serious and talk about money and {ugh!} taxes. 

First, debt in retirement is an unacceptable risk. Paying off the credit card in full each month is not considered debt in my book. Credit cards used this way are a money management tool. Some debt isn’t the kiss of death. Still, if you enter retirement, early or traditional, with debt, you need to have a firm action plan to reduce and eliminate that debt.

Your investments now need attention. The current economic environment will determine the stock/bond/cash mix. As I write, I do not consider bonds a viable option for most investors. Maybe a few bonds in the right situation, but when interest rates are low, bonds will not do the job. And long-term bonds have high risk if interest rates climb.

Having all your money in stocks (index funds preferred) isn’t a smart move either. Instead, you need the right mix of index funds and cash. How much you need in cash takes some explaining. Good thing I fleshed out the details in a previous post. I highly recommend you read, bookmark and re-read that post. It is vital information.

 

6.) Taxes: Overview

Like it or not, you need to spend time considering tax consequences in retirement. Taxes take a serious bite out of your wealth. Retirement does not change that.

We will spend a few minutes discussing the more important issues surrounding taxes in retirement. Nearly every consulting session I have in my office involves the issues I discuss below. 

Taxes are complex. Even the Tax Court disagrees with itself on what the tax code means in certain instances. You might think you understand tax law. You don’t. No one human can understand the entire U.S. tax code. That is why I strongly recommend you build a relationship with a competent tax professional. Pay them for consulting! My wealthiest clients demand 2-3 consultations per year on taxes alone. That is why they are the wealthiest. Read and study tax issues that apply to you. Then bounce it off a tax professional with the experience to show you the cause and effect over all tax years involved.

 

7.) Taxes: Converting Traditional Retirement Accounts to a Roth

A common issue I have in consulting sessions is the client’s focus on required minimum distributions (RMDs) from traditional retirement accounts. While it is a tax issue, it usually should be third or fourth on the list.

A primary concern as you plan for early retirement is using low tax brackets. Unless you have a high income from a side hustle, business or investments, converting traditional IRAs to a Roth is a primary concern. Over your working career you built a retirement account. The non-Roth retirement monies will be taxed at ordinary rates when they are distributed. Using your lower tax rate once you retire allows you to move money from traditional retirement accounts to a Roth with little to no tax pain. Under current tax law, the 0%, 10% and 12% tax brackets are where you want to play. Your facts and circumstances will determine your course. For most, utilizing low tax brackets is a powerful wealth retention tool.

I want to toss another tax planning tip into this section. Long-term capital gains (LTCGs) and qualified dividends are taxed at preferential rates. On a joint return in 2021, for example,  LTCGs and qualified dividends that fall under the $80,800 threshold are taxed at 0%. Knowing this, you now have an interesting interplay between converting traditional IRAs to a Roth and maximizing the LTCG 0% tax bracket. A tax professional can help you maximize the benefits of converting to a Roth while considering the LTCGs preferential tax treatment.

 

8.) Taxes: Social Security Benefits

Early retirement has benefits few consider, but should. Social Security benefits might be in the distant future. But time counts and before you know it you will actually be retirement age. (Good thing you were practicing all the while.) 

In Point #7 we discussed the interplay between tax rates for ordinary income and LTCGs. Here is why it is so important to use those lower tax brackets when you can.

Social Security benefits are sometimes tax-free. There are income levels where Social Security benefits start getting taxed. For example, on joint returns, combined income (see link for calculating combined income) over $32,000 can see up to half of benefits added to taxable income and 85% of benefits for combined income over $44,000. These numbers are low so it is getting harder each year to stay below these limits because they are not indexed to inflation. Early retirement changes that! You might save serious taxes currently and down the road with proper planning. Utilizing low tax brackets optimally can reduce taxes even more once you start collecting Social Security benefits.

 

9.) Taxes: Required Minimum Distributions

The Secure Act raised the age where you must take required minimum distributions (RMDs) from 70 ½ to 72. As I write, Congress is working on the Secure Act 2.0, where RMDs will gradually more to age 75. Both sides of the isle like the higher RMD age and passage is likely.

People worrying about RMDs at a young age might be focusing on the wrong issue, as a result. Yes, contributions into a traditional retirement account feels like taking out a loan sometimes, since you later have to pay tax back on all the distributions, your original money, plus gains. With RMDs getting pushed to higher ages, you have more years to maneuver your finances for lower taxes. 

As easy as the RMD concept is, it is really very complex. The interplay between LTCG rates and traditional IRA distributions taxed at ordinary rates, requires a seasoned hand in the planning process. This is where your tax professional comes in. Your facts and circumstances will determine your optimal tax and financial course. 

 

10.) Legacy Planning

 

Early retirement means you are still young. Thinking about your legacy doesn’t always cross the mind. It should.

As you review early retirement considerations, commit time to legacy planning. Are there charities you would like to support? How much do you wish to leave the kids (enough to help, but not too much to spoil)? Are there family members that could really use financial help? Friends?

Planning your legacy means seeing an attorney. You need a will and a durable medical power of attorney. Consider a living will. Your legal and tax professionals team can help you determine which tools are best for your situation. There are so many vehicles out there to accomplish your goals. Who know? You might end up with a NIMCRUT

 

11.) Bonus: Dealing with Medical Issues

I write for an American audience primarily. That doesn’t mean incredible people around the globe shun your favorite accountant. For my friends around the world, you can sit this first bonus tip out, since this is solely an American problem.

Early retirement has once serious flaw, health insurance. Prior to age 65, when Medicare kicks in, you need to have a budget that includes medical insurance and out-of-pocket medical expenses. I wish I had a magic bullet that serves all readers. Instead, I have a few options to consider. 

There is medical health sharing to consider. However, these are Christian based and not all readers are of the Christian faith. I published previously several choices when it comes to health care coverage. Having a side hustle or small business helps. If you are looking for health insurance options, be sure to read the linked post.

 

12.) Bonus: Loneliness

No matter what age you retire, time will keep counting. Friends will move on to different things. Family and friends may not retire when you do. Health issues may change your best-laid plans.

And worst of all, couples need to talk about the inevitable. The odds are one of you will leave this world first. The crushing pain can become unending loneliness.

Talk with your significant other, children and friends about life when one of you is gone. Build a network. 

The best time to start planning for loneliness issues is yesterday. You never know when the Good Lord will call. I have ample examples in my small tax practice of people dying at a young age. It will be a difficult time regardless the age the Reaper comes knocking. By planning ahead you give ample consideration to your options. There will still be times of loneliness, but they can be kept to a minimum.

As you discuss with your significant other about life where one of you is gone, topics to discuss include: travel plans, activities, support, living arrangements and friends. 

 

Coda

Retirement is a major lifestyle change. This accountant would like to manage his business forever, but reality suggests that is not the best plan. The earlier you retire the more financial resources you will need. Your health plays a powerful role. 

Early retirement isn’t a solo journey. Many will travel with you, if only for a short distance of the journey. Have a team. Family and friends, of course. But seasoned professionals, experienced in working with people on a life journey.

Remember, you only come this way once.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

 

The Two Biggest Risks of Owning Bitcoin and Other Cryptocurrencies

The excitement of bitcoin and other cryptocurrencies has risen to the height of the casino run. The house holds the odds, but for the moment, the card gods are looking kindly upon the gambler.

Some say the run has just begun. As I write, bitcoin is north of $50,000 with at least one large investor feeling bitcoin is going to somewhere around $500,000 per bitcoin! Mark Cuban was not interested in plastic wristbands that promised more energy (a scam), but has no problem with owning cryptocurrency. Interesting. 

Then we have the other side of the, ahem, coin. Black Swan author, Nassim Nicholas Taleb, calls bitcoin and other cryptocurrencies a “game” and “gimmick”. He has a point. While fans of cryptocurrencies consider the digital currency the future medium of exchange, no cryptocurrency is considered legal tender anywhere on the planet.

Then we have the touted benefits. Bitcoin is safe, secure and anonymous. You don’t have to be up to no good to want your personal information private. And most feel strongly that the government should not have detailed financial information on its citizens. Facebook and Google, either.

The downside is that cryptocurrencies are not that safe. People lose the key or password to their crypto wallet and there is no way the retrieve the money. It is gone forever, like cash left in a burning house. And if you are diligent about safeguarding your password, the are stories of people losing serious money in stolen cryptocurrency.

I am not here to judge. Whether you love, hate or don’t care a lick about cryptocurrencies, they are here to stay for the foreseeable future. At some point you will be tempted to either invest in a cryptocurrency or accept it as a form of payment.

The pros and cons have been shouted from the rooftops by traditional media and trumpeted on social media ad nauseam. And all that shouting forgets to mention two very serious issues with bitcoin and other cryptocurrencies.

The first risk involves lost opportunity costs coupled with the realization more and more supply of cryptocurrencies will continue as long as there are buyers. This eventual realization will drive home the fact that nothing of value supports the price of any particular cryptocurrency. Most currency on the planet is fiat, or by decree of the government issuing the currency. Some would argue nothing backs this form of money either. But at least fiat money is usually legal tender, which means they must be accepted in the country of issuance as a form of payment for a debt.

The second rarely discussed risk is taxes, Yes, plenty has been said about the reporting of cryptocurrency transactions on your tax return. What I am talking about goes much further. There is a final endgame that must be reached and when it does there will be a taxocalypse for many people and businesses. 

The list of virtual currencies is growing. Supply is not limited. Bitcoin.

The list of virtual currencies is growing. Supply is not limited.

Risk #1: Interest on Bitcoin and Other Cryptocurrencies

Interest rates have been scraping the floor for a decade and longer. Still, if you save money you have the possibility of earning interest on that savings. You can be even more certain you will pay interest if you borrow money. 

The interest rate a borrower asks covers risks of nonpayment, inflation, lost opportunity cost (could the lender earn more lending elsewhere) and the change in the value of the currency the money is lent in. 

Inflation and risk of nonpayment predominate almost all lending. The less financially sound the borrower, the higher the rate of interest changed to offset the risk. If inflation rears its ugly head you can be sure lending rates will go up for all borrowers. 

Lost opportunity cost plays a very small role because borrowers rarely consider alternative investments. They are in the business of lending money and lending money is a reasonably exact science. Credit scores, for example, allow all lender to see the same information when making a decision on lending funds. Different lenders have different rates. All loans from that particular lender will have the same interest rate (or reasonably so) for loans to borrowers with a similar financial makeup.

The value of the currency and its rate of change also play a small, if nonexistent role in lending rates. Most currencies change in value against other currencies by insignificant amounts on a daily basis. Periodically a currency will go into free fall. This is caused by high inflation which is caused by a government out of control in the money printing business. We saw some countries in Western Europe require bailouts recently due to loss of confidence. The rate of interest these countries had to pay was extremely high compared to other developed nations. The currencies suffered as a result. With uncertainty in the currency, few wanted to lend or borrow in that currency.

Now let’s relate this to cryptocurrencies. Bitcoin, as our example, can change in value more than the currency of a failing state. It is not uncommon for a cryptocurrency to change in value more than 20% in a single month. 

With such volatility in the currency, the risks to the lender and borrower are massive and go beyond the normal credit-worthiness of the borrower and the current and expected inflation rate. If everyone believes the cryptocurrency is going to continue climbing, lenders will be reluctant to borrow, except at extraordinary rates. Lending out their bitcoin would cost them the opportunity to benefit from the continued rise in the value of bitcoin. It would take a very high interest rate to seduce the lender to lend out their digital currency. 

Borrowers will have the opposite attitude. They will not be willing to borrow at such high rates with the risk that the cryptocurrency does not change in value as assumed. If bitcoin doesn’t climb in value enough the borrower is stuck with an even higher interest rate as compared to other currencies.  

Update: I was reminded you can deposit your virtual currencies and receive interest here. That means you can earn a return on your savings in cryptocurrencies. As a comment introduced me to this, I decided to sign up for the affiliate program. You could turn this accountant into a massive liar if you sign up with BlockFi using the link, as they pay $10 in bitcoin. (I said I would never buy a cryptocurrency. As for owning, well, that could be a different story.)

When was the last time you heard anyone worried about the change in the value of the dollar playing into their lending attitudes? When inflation ran high in the 1970s and and early 80s it was an issue. Inflation was killing the dollar, causing higher interest rates, and rates climbed to adjust for the currency devaluation (inflation) risk. High interest rates carry a higher risk. If the asset purchased with the borrowed funds does not appreciate at least as fast as the loan interest, the borrower is effectively paying a higher original price for the asset. 

Who wants to borrow 10 bitcoins to mortgage a home purchase when those same bitcoins might be worth $500,000 per bitcoin later? Unless you think you will see high inflation increasing your income, the risk is phenomenal. (Yes, if you are paid in bitcoin it affects the numbers.) Of course, you could borrow the bitcoins and hedge it against another currency like the US dollar. But that is the point. If everything goes back to legal currency, the cryptocurrency is just a high stakes gamble. Only when people start converting dollars to cryptocurrencies because the cryptocurrency is the overwhelmingly preferred mode of exchange, will cryptocurrencies replace legal tender. And that is unlikely because governments do not like to lose control over money within their borders.

There is a reason why opportunities to lend out your bitcoin are scarce and options to earn a return on saving in fiat money are numerous. At what rate would you lend out your bitcoin, knowing bitcoin could appreciate 50% or more over the next year? 

Until cryptocurrencies have a stable value will they be a serious form of exchange contender. That means lending out your cryptocurrency for a return is an unlikely option and one that could easily backfire. That leaves you with cryptocurrency appreciation or you will lose.

Bitcoin, cryptocurrencies, digital currency, virtual currency. The ultimate fiat money.

The ultimate fiat money? By decree of blockchain.

Risk #2: Taxes on Bitcoin and Other Cryptocurrencies

This one is easier to explain even though it is rarely discussed.

Cryptocurrencies are a pain in the tail to account for on the tax return. If held as an investment it in not a serious matter. If you use bitcoin to purchase goods and services, each transaction is considered a sale of bitcoin and needs to be reported on the tax return. 

If the cryptocurrency exchange gives you an annual printout the problem is muted. Drop the bottom line numbers on the tax return and scan and attach the printout. That is the easy part.

Since cryptocurrencies are pointing skyward, nobody asks about the consequences if bitcoin started to slide for a prolonged period of time. It is inevitable! Eventually the climb will stop and there will be times where the currency declines in value.

The IRS has provided guidance in Notice 2014-21. All virtual currencies are property according to the notice. That means each exchange of the virtual currency is a taxable event. We discussed that above.

What it also means is that if you are using bitcoin or any other cryptocurrency and you suffer a loss due to sale or purchase of a good or service, the loss can be limited. 

Under current law, capital losses are allowed to the extent of capital gins, plus up to $3,000 per year against other income. In laymen’s terms, all gains are taxable immediately while losses in excess of gains of more than $3,000 are carried-forward to future tax returns instead of being currently deducted.

At first glance this might not be such an issue. But once you consider the large changes in value many cryptocurrencies are experiencing, it is easy to see a taxpayer with large losses that will take decades or centuries to deduct. 

Why do I consider this such a serious risk? First, at some point virtual currencies will suffer a prolonged downturn. It is inevitable. When that happens, people who bought bitcoin with dollars already taxed will be unable to deduct the losses for a very long period of time, if ever.

Then we come to divorce. Where you live determines the rules. Regardless, it will not be fun.

We end with your end. When you die (as inevitable as bitcoin dropping in value some day) your unused tax losses are lost. Married couples living in marital property states might find a way to preserve half those losses.

Even worse, upon death there is a step-up in basis, or step-down! If your cryptocurrency appreciated then the step-up in basis to the value on the date of death will be a tax benefit. But if we are in the midst of the inevitable decline at the time of your demise, there will be a step-down in basis. Yes, that means it is possible to be double taxed if the virtual currency starts to climb again. (If you buy $100 of bitcoin (bought with money already taxed) and it declines to $50 on the date of your death, the basis is adjusted to $50. If bitcoin then climbs to $100, your beneficiaries will have a $50 gain if they sell at that time. $50 is double taxed!)

Is bitcoin the future of money?

Parting Notes

I have never owned any cryptocurrency. I’m an investor, not a gambler. The risks are too great for this country accountant. Knowing the risks outlined at the beginning of this article coupled with the less often discussed risks listed in the heart of this article make virtual currencies unenticing to me. 

The tax issues surrounding cryptocurrencies add complexity where none is needed. As an investment, these virtual currencies rely upon the greater fool theory: you are counting on a greater fool to pay you more than what you paid for the virtual currency. I’m not trying to be rude. These digital currencies are backed by nothing. Blockchain is not a backing, only a security and anonymity feature. Like any currency bought and sold on the futures markets, you are either hedging or speculating. Businesses might consider hedging virtual currencies if they become widespread in use in trade. Everyone else is a speculator and needs to know it.

Again, I am not here to judge. It matters nothing to me if you invest in bitcoin or not. It’s actually good for my business, all those transactions to report.  If it is what you want to do, I have no problem with it. If someone is trying to talk you into buying a virtual currency, consider that you might be the greater fool.

And remember, the greatest fool is the last one holding the bag.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.