E-File Federal and State Tax Extension Online For Free (Updated 2017)

stopwatch2Updated for 2017. This year, the deadline for federal tax filing is Tuesday, April 18th, 2017. If you file for an extension, you can extend the time allowed to file your return by six months to Monday, October 16, 2017. (It does not extend the time to pay any tax due.) There are many legitimate reasons to ask for such an extension, and the extension is granted automatically without needing to provide a reason.

Here’s how to e-File a official federal extension with the IRS in minutes for free (plus state extensions where available!). I have done a dry run with each option. Advantages of using e-File include:

  • You save the time and postage costs of paper mailings.
  • You can estimate your tax liability using online software and/or calculators.
  • You receive confirmation of receipt via e-mail or text, often within hours.

Option #1: TaxACT

2016extend_taxact0This is how I usually do my extension. Tax prep software TaxACT.com allows you to e-File your Federal and State extension (where applicable) for free through them. You don’t need to actually use them to file your taxes later, although you certainly can.

Directions
First, register for free at TaxACT.com with your e-mail address and pick a password. To go directly to the extension form, click on the “Filing” tab on the top, and then the “File Extension” link right below it (see below). You will then be guided through the Form 4868 in a question-and-answer format. TaxACT will file the form electronically for you (or you can print and snail mail).

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TaxACT also provides a tax liability estimator to help you determine if you need to make a payment with your extension. If you fill out more details in the main software, then the estimate will be improved. If you don’t think you’ll owe any taxes, you can just put down zero as your expected tax liability. If you wish to make a tax payment, you will be able to choose to pay with direct withdrawal from a bank account (account and routing numbers required) or pay with a credit card (IRS fees apply).

Afterward, you can confirm the status of your extension e-file by going to efstatus.taxact.com. They will even send you a confirmation via e-mail or text message. I got my confirmation less than 3 hours after submission.

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Free state tax extensions. As you can see above, TaxACT will now even file out your state tax extension online if possible, otherwise they will provide guidance fill out all the paper form entries for you and all you have to do is print it out and mail it in. Note that you will need to have started a State Tax return with them (even with no personal info added), for the State extension e-file option to be shown.

Option #2: TurboTax

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TurboTax.com also allows you to file a Federal extension online for free after signing up for a free account. They will not e-File your State extension, although they will provide some guidance for your state-specific needs. sign up for an account at TurboTax.com first and after logging in, look for the big search box on the top right and type in the keyword “extend” to be directed to their extension section.

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It will walk you through the information needed for Form 4868. Again, if you don’t think you’ll owe any taxes, you can just put down zero as your expected tax liability. If you wish to make a tax payment, you will be able to choose to pay with direct withdrawal from a bank account (account and routing numbers required) or pay with a credit card (IRS fees apply).

According to the Turbotax website, you should receive a confirmation email from the IRS within 48 hours of filing the extension.

[Read more…]

H&R Block Desktop Tax Software Discounts: Free $20 Nike Gift Card

hrb2016Updated with new deal. If you are still looking for downloadable desktop tax software that doesn’t require your Social Security Number and financial details to be stored in the cloud, here’s a limited-time deal on H&R Block Tax Software 2016.

NewEgg has H&R Block Deluxe Federal + State for $29.99 plus a free $20 Nike Gift card. If you can actually use that $20 Nike gift card, your net cost would be close to $10. The lowest price ever so far for the same H&R Block software on Amazon was $19 during a flash sale.

H&R Block Deluxe includes guidance for stock gains and losses, home mortgage interest deduction, and other itemized deductions. Compare that against TurboTax Deluxe Download which makes you upgrade to TurboTax Premier to get guidance for stock sales and dividends.

Keep in mind that for these products 5 Federal e-Files are included but State e-File is extra ($19.95 for all I believe). I would personally just print the (usually shorter) state return out and snail mail it in if you don’t have a free State e-File option.

Free State Income Tax E-File Options For All 50 States (Updated 2017)

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Links checked and updated for 2017 (Tax Year 2016). With commercial tax prep software, it is always wise to note the cost of your state return and e-File as it may actually cost more than your federal return (especially if you wait until April to file). As such, you may wish to do your state return separately. Based on their current, regular published prices at time of writing:

* Got a simple return? TaxAct will let you file Fed + State + eFile for $0 if you file Form 1040A or 1040EZ (amongst other things, you must be claiming the standard deduction rather than itemizing deductions).

* New for 2017: CreditKarma Tax. This is a new option that promises free Federal + State + eFile for all users with no income restrictions, although their business model is to use your information to show you targeted advertising. See my CreditKarma Tax Prep review for details.

Now, the convenience that these programs offer may be worth the extra money to you. But there may be other options available. States that levy individual income taxes fall into three categories:

  1. They offer all taxpayers free electronic filing via official state-supported software.
  2. They offer all taxpayers access to free “fillable forms” which are basically electronic versions of the paper forms where you can type in numbers and any mathematical calculations are done for you. If your state tax returns are relatively simple, this is all you really need.
  3. They allow commercial vendors via the “FreeFile Alliance” to offer free online filing for certain groups, usually through income limits, age restrictions, and/or active duty military personnel. The vendors in turn make money when some folks end up not qualifying and have to pay at the end.

Below, you’ll find free e-file information for all 50 states. See my comparison review of TaxACT, TurboTax, and H&R Block for why it may be worth it for some folks pay more for the time-saving or audit-protection features of the “brand name” products.

In alphabetical order (just click on the state):

State Restrictions
Alabama Free electronic filing using through My Alabama Taxes (MAT). No income restrictions.
Alaska (no state income tax)
Arizona File using AZ-specific fillable forms; No income restrictions. FreeFile options also available; income and/or other restrictions apply.
Arkansas Various FreeFile options; Income and/or other restrictions apply.
California Free electronic filing using through CalFile. No income restrictions. No capital gains/losses or Schedule C income allowed.
Colorado Free electronic filing using through Revenue Online. No income restrictions.
Connecticut Free electronic filing using through TaxPayer Service Center (TSC). No income restrictions.
Delaware Free electronic filing through official state website. No income restrictions.
Florida (no state income tax)
Georgia FreeFile options available; income and/or other restrictions apply.
Hawaii FreeFile options available; income and/or other restrictions apply.
Idaho FreeFile options available; income and/or other restrictions apply.
Illinois Free electronic filing through MyTax Illinois. No income restrictions.
Indiana FreeFile options available through INfreefile; income and/or other restrictions apply.
Iowa FreeFile options available; income and/or other restrictions apply.
Kansas Free electronic filing through KS WebFile. No income restrictions.
Kentucky FreeFile options available; income and/or other restrictions apply.
Louisiana Free electronic filing through Louisiana File Online. No income restrictions.
Maine Free electronic filing through Maine FastFile. No income restrictions.
Maryland Free electronic filing through their iFile service. No income restrictions.
Massachusetts FreeFile options available; income and/or other restrictions apply. WebFile for Income was shut down in 2017.
Michigan FreeFile options available; income and/or other restrictions apply.
Minnesota FreeFile options available; income and/or other restrictions apply.
Mississippi FreeFile options available; income and/or other restrictions apply.
Missouri FreeFile options available; income and/or other restrictions apply.
Montana Free electronic filing through Taxpayer Access Point (TAP). No income restrictions.
Nebraska Free electronic filing through NebFile. No income restrictions.
Nevada (no state income tax)
New Hampshire Free electronic filing through e-File New Hampshire. No income restrictions. (No state personal income tax, but there is tax on investment income.)
New Jersey Free electronic filing through NJ WebFile. No income restrictions.
New Mexico Free electronic filing through New Mexico Taxpayer Access Point. No income restrictions.
New York Free electronic filing of select forms online with New York State Income Tax Web File, but note that New York law prohibits commercial software from charging an additional charge for e-filing.
North Carolina FreeFile options available; income and/or other restrictions apply.
North Dakota FreeFile options available; income and/or other restrictions apply.
Ohio Free electronic filing through I-File from Ohio Online Services. No income restrictions.
Oklahoma Free electronic filing through Oklahoma Taxpayer Access Points (OkTAP). No income restrictions.
Oregon File using OR-specific fillable forms; No income restrictions. FreeFile options also available; income and/or other restrictions apply.
Pennsylvania Free electronic filing through PA DirectFile. No income restrictions. Free Fillable PDF Forms also available.
Rhode Island FreeFile options available; income and/or other restrictions apply.
South Carolina File using SC-specific free fillable forms; No income restrictions. FreeFile options also available; income and/or other restrictions apply.
South Dakota (no state income tax)
Tennessee Free electronic filing through state website of Hall Income Tax. No income restrictions. (No state personal income tax, but there is tax on investment income.)
Texas (no state income tax)
Utah Free electronic filing through Taxpayer Access Point (TAP). No income restrictions.
Vermont FreeFile options available; income and/or other restrictions apply.
Virginia File using VA-specific free fillable forms; No income restrictions. FreeFile options also available; income and/or other restrictions apply.
Washington (no state income tax)
Washington DC File using DC-specific free fillable forms; No income restrictions. FreeFile options also available; income and/or other restrictions apply.
West Virginia FreeFile options available; income and/or other restrictions apply.
Wisconsin Free electronic filing through Wisconsin efile. No income restrictions.
Wyoming (no state income tax)

 
Whew, that took a while. Please share this if you think it’ll help others! Also let me know if you find any errors or changed links.

2017 IRS Federal Income Tax Brackets Breakdown Example (Married w/ 1 Child)

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In a continued attempt to better explain the 2017 federal income tax brackets, here is a graphical breakdown of a simple scenario for a married filing joint couple with 1 dependent. See also my previous examples for a single filer with no dependents and married filing joint with no dependents. I will try to explain the differences in terms such as gross income, taxable income, marginal tax rate, and effective tax rate.

Here is a chart of 2017 federal income tax rates for married joint filers, based on the official IRS tax tables:

2017tbrac_mfj

Simple example. Let’s say your combined gross income is $100,000 a year. You are a married couple with one child under 16, and both earn $50,000 gross income. You are both employees that receive W-2 income only (i.e. neither are self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $100,000 gross income. You each get a personal exemption of $4,050 in 2017, including your dependent child. That’s $4,050 x 3 = $12,150. You also get something called the standard deduction which is $12,700 for married filing joint in 2017. Since you don’t have a lot of itemized deductions, you fall back onto the standard deduction.

2017t_brackets_mfj1kid

The first 24,850 of your gross income is not taxable. Without doing anything special at all, your $100,000 in gross income is now only $75,150 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $18,650 of taxable income is subject to a 10% tax rate. Shave off 10% of $18,650 and put that on your tax bill ($1,865). The remaining $56,500 of taxable income is moved onto the next tax bracket.

The next $57,250 in taxable income is subject to a 15% tax rate. However, we only have $56,500 left. So we shave off 15% of $56,500 ($8,475) and add that to the existing $1,865. The total tax bill is now $10,340.

In this example, this 15% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 15%. Even with a six-figure income, a couple with at least one kid can still land in the 15% marginal tax bracket (pre-tax 401k or IRA contributions would reduce taxable income even more).

Federal Child Tax Credit. As this income doesn’t exceed the phaseout limits and your child is 16 or under, you also get the full $1,000 Child Tax Credit. A tax credit lowers your tax bill dollar-for-dollar as opposed to a deduction that only lowers your taxable income. Thus, your tax bill is reduced from $10,340 to $9,340.

2017t_compare_mfj1kid

Payroll taxes. These aren’t technically federal income taxes, but you must each pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,100 a year for Social Security and $725 a year for Medicare. You both earn $50,000 gross and don’t exceed the income caps. (Your respective employers pay the same amount.)

Overall effective tax rate. You paid $9,340 in federal income taxes on $100,000 of gross income, for an average or overall effective tax rate of 9.34%. Again, you also paid 7.65% in payroll taxes. Your average tax rate is lower than a couple without kids due to the combined effects of the additional personal exemption and the child tax credit. In this specific example, having a kid reduced your tax bill by $937.50 + $1,000 = $1937.50.

Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint with no kids).

2017taverage

Vanguard ETF vs. Mutual Fund Admiral Shares

Building My Portfolio BlocksAllan Roth has a new ETF.com article called Why ETFs Won’t Replace Mutual Funds. Inside, he offers the following reasons why if you are buying Vanguard funds, he typically recommends the Admiral Shares mutual fund over the ETF.

Vanguard Mutual fund advantages

  1. Can buy fractional shares
  2. No premium or discount—all transactions are at net asset value
  3. No spreads between bid and ask
  4. Less cash drag, as dividends are reinvested more quickly
  5. Can do a tax-free exchange from mutual funds to ETFs, but not the reverse
  6. Can do automated dollar cost averaging

In the interest of fairness, I will offer up the following:

Vanguard ETF advantages

  • Lower minimum investment amounts. Usually one share is only about $100, and some brokers even offer fractional shares.
  • No purchase or redemption fees. No short-term trading fee. Vanguard has these on a few mutual funds, for example the Vanguard Global ex-US Real Estate Fund Admiral Share charges a 0.25% fee on both purchases and redemptions.
  • You can easily hold, buy, trade Vanguard ETFs at any brokerage firm. The cost to trade will be as with any stock. (Vanguard mutual funds and ETFs trade free with a Vanguard brokerage account.) You might prefer the customer service of another firm, or you might prefer the convenience of having everything together if you hold non-Vanguard investments. You might already have free trades anyway, for example with the Robinhood app.

Expense ratio is a tie with Admiral Shares. I don’t know if it an official “written in stone” polcy, but Vanguard has a long history of keeping the expense ratios of ETFs and Admiral Shares mutual funds the exact same (mostly $10,000 minimum investment). The Investor Class usually has a slightly higher expense ratio (mostly $3,000 minimum).

Tax-efficiency is a tie. I will add in this reminder that in the case of Vanguard (and only Vanguard as far as I know), the ETF and mutual funds share the same underlying investments and thus the same level of tax-efficiency, utilizing the benefits of both where possible. From the Vanguard ETF FAQ:

Are there any tax advantages to owning a Vanguard ETF®?
Because Vanguard ETFs are shares of conventional Vanguard index funds, they can take full advantage of the tax-management strategies available to both conventional funds and ETFs.

Conventional index funds can offset taxable gains by selling securities that have declined in value at a loss. In addition, they tend to trade less frequently than actively managed funds, which means less taxable income gets passed on to shareholders. Vanguard ETFs can also use in-kind redemptions to remove stocks that have greatly increased in value (which trigger large capital gains) from their holdings.

My money. I hold most of my portfolio in Vanguard mutual funds (Admiral Shares). One reason is that I am old and have a good amount of capital gains in the mutual funds bought before ETFs gained traction. I also hold some Vanguard ETFs, mostly bought back when ETFs were cheaper because I didn’t have enough money to qualify for Admiral shares. (Prior to 2010, the minimum for Admiral funds was $100,000! These days the minimums are mostly a more reasonable $10,000.) These days, I don’t have a strong preference, but I slightly prefer the simplicity of buying mutual funds.

Vanguard ETF tool. If you really want to pick at the details, Vanguard offers their own ETF vs. mutual fund cost comparison calculator. It’s pretty good and even includes things like historical bid-ask spreads.

Bottom line. There are certainly differences between ETFs and mutual funds. It is worth comparing the advantages and disadvantages before making your decision. However, in terms of the big picture, we are talking about relatively small differences. Being low-cost, transparent, and diversified are more important features. Given that both have their relative advantages, both ETFs and mutual funds will be around for a long time.

2017 IRS Federal Income Tax Brackets Breakdown Example (Married No Kids)

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In a continued attempt to better explain the 2017 federal income tax brackets, here is a graphical breakdown of a simple scenario for a married filing joint couple with no dependents. See also my previous example for single filers with no dependents. I will try to explain the differences in terms such as gross income, taxable income, marginal tax rate, and effective tax rate.

Here is a commonly-used chart of 2017 federal income tax rates for married joint filers:

2017tbrac_mfj

Simple example. Let’s say your combined gross income is $120,000 a year. You are a married couple with no dependents and both earn $60,000 gross income. You are both employees that receive W-2 income only (i.e. neither are self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $120,000 gross income. You each get a personal exemption of $4,050 in 2017. You also get something called the standard deduction which is $12,700 for married filing joint in 2017. Since you don’t have a lot of itemized deductions, you use this standard deduction.

2017t_brackets_mfj

The first 20,800 of your gross income is not taxable. Without doing anything special at all, your $120,000 in gross income is now only $99,200 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $18,650 of taxable income is subject to a 10% tax rate. Shave off 10% of $18,650 and put that on your tax bill ($1,865). The remaining $80,550 of taxable is moved onto the next tax bracket.

The next $57,250 in taxable income is subject to a 15% tax rate. Shave off 15% of $57,250 ($8587.50) and add that to the existing $1865. The tax bill is now $10,452.50. The remaining $23,300 of taxable is moved onto the next tax bracket.

The next $77,200 in taxable income is subject to a 25% tax rate. However, we only have $23,300 left. So we shave off 25% of $23,300 ($5825) and add that to the existing $10,452.50. The total tax bill is now $16,277.50.

In this example, this 25% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 25%.

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Payroll taxes. These aren’t technically federal income taxes, but you must each pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,720 a year for Social Security and $870 a year for Medicare. You both earn $60,000 gross and don’t exceed the income caps. (Your respective employers pay the same amount.)

Overall effective tax rate. You paid $16,278 in federal income taxes on $120,000 of income, for an average or overall effective tax rate of 13.6%. Again, you also paid 7.65% in payroll taxes. You see that two married people earning $60k each pay the same percentage in tax as a single filer earning $60k.

The “marriage penalty” usually occurs when two individuals both with either low- or high-incomes marry. The “marriage bonus” usually comes about when the incomes are quite different. For example, a single person earning $120k in gross income would pay an extra $7,000 in income tax vs. married earning $120k.

Married earning $60k gross annually. Alternatively, a married couple earning $60k gross would pay roughly $3,000 less in income tax vs. single earning $60k (and only reach the 15% marginal tax bracket). Here’s that visualization:

2017t_brackets_mfj60

Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint).

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2017 IRS Federal Income Tax Brackets Breakdown Example (Single)

irsclipI was looking up the 2017 federal income tax brackets and pulled up the commonly-used chart below. This tax table has many applications in personal finance, but it can be hard to understand. What is the difference between gross income, taxable income, marginal tax rate, and effective tax rate? Sometimes I like to run through simplified examples to help my understanding.

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Simple example. Let’s say your gross income is $60,000 a year. You are single with no dependents. You are an employee that receives W-2 income only (i.e. you are not self-employed). You don’t have any additional income sources like interest, capital gains, rents, etc. You don’t have any extra deductions like IRA/401k contributions or mortgage interest. You live in a state with no state income tax.

Gross income. Let’s start with your annual $60,000 gross income. You get something called a personal exemption which is $4,050 in 2017. You also get something called the standard deduction which is $6,350 for singles in 2017. Since you don’t have a lot of itemized deductions, you use this standard deduction.

2017t_brackets

The first 10,400 of your gross income is not taxable. Without doing anything special at all, your $60,000 in gross income is now only $49,600 in taxable income after personal exemptions and the standard deductions. If you’ve already done your taxes, your taxable income should be line 43 on Form 1040, line 27 on Form 1040A, and line 6 on Form 1040EZ.

The first $9,325 of taxable income is subject to a 10% tax rate. Shave off 10% of $9,325 and put that on your tax bill ($932.50). The remaining $40,275 of taxable is moved onto the next tax bracket.

The next $28,625 in taxable income is subject to a 15% tax rate. Shave off 15% of $28,625 ($4293.75) and add that to the existing $932.50. The tax bill is now $5,226.25. The remaining $11,650 of taxable is moved onto the next tax bracket.

The next $53,949 in taxable income is subject to a 25% tax rate. However, we only have $11,650 left. So we shave off 25% of $11,700 ($2,912.50) and add that to the existing 5,226.25. The total tax bill is now $8,138.75.

In this example, this 25% is your marginal tax bracket. If you earned another $1, it would be taxed at this marginal rate of 25%.

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Payroll taxes. These aren’t technically federal income taxes, but you must pay a Social Security tax (OASDI) of 6.2% and Medicare payroll tax (HI) of 1.45% of your gross income. That’s $3,720 a year for Social Security and $870 a year for Medicare. (Your employer pays the same amount.)

Overall effective tax rate. You paid $8139 in federal income taxes on $60,000 of income, for an average or overall effective tax rate of 13.6%. Again, you also paid 7.65% in payroll taxes. Here’s a chart from OurWorldinData.org that shows how the average tax rate changes with taxable income (2016, married filing joint).

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IRS Estimated Taxes Due Dates 2017

irsclipIf you have significant self-employment or other income outside of your W-2 paycheck that is not subject to witholding (interest, rents, dividends, alimony), you may need to send the IRS some money before the usual tax-filing time. This is my annual reminder to either slide in a last-minute payment for 2016 if needed, or plan ahead for four equal installments in 2017.

Here are the due dates for paying quarterly estimated taxes in 2017; one last one for 2016 tax year and four quarterly installments for 2017 tax year. This is for federal taxes only, state and local tax due dates may be different.

IRS Estimated Tax Payment Calendar for Individuals

Tax Year / Quarter Due Date
2016 Fourth Quarter January 17, 2017* (Tuesday)
2017 First Quarter April 18, 2017 (Tuesday)
2017 Second Quarter June 15, 2017 (Thursday)
2017 Third Quarter September 15, 2017 (Friday)
2017 Fourth Quarter January 16, 2018 * (Tuesday)

 
* You do not have to make the payment due January 17, 2017, if you file your 2016 tax return by January 31, 2017, and pay the entire balance due with your return. You do not have to make the payment due January 16, 2018, if you file your 2016 tax return by January 31, 2018, and pay the entire balance due with your return.

Who needs to pay estimated taxes?
In general, you must pay estimated tax for 2017 if both of the following apply:

  1. You expect to owe at least $1,000 in tax for 2017, after subtracting your withholding and refundable credits.
  2. You expect your withholding and credits to be less than the smaller of
    • 90% of the tax to be shown on your 2017 tax return, or
    • 100% of the tax shown on your 2016 tax return. Your 2016 tax return must cover all 12 months.

If you forget to pay (like I’ve done before), then you should make a payment as soon as possible even though it is late. This will minimize any penalty assessed.

How do I pay? When does the payment count?

  • By check. Fill out the appropriate IRS Form 1040-ES voucher (last page of the PDF) and snail mail to the indicated address. The date of the U.S. postmark is considered the date of payment. No fees besides postage.
  • By online bank transfer. You can store your bank account information and pay via electronic funds transfer at EFTPS.gov or call 1-800-555-4477. It takes a little while to set up an online account initially, so you’ll need to plan ahead. For a one-time payment, you can also use IRS Direct Pay which does not require a sign-up but it also doesn’t store your bank account information for future payments. Both are free (no convenience fees). The date of payment will be noted online.
  • By debit or credit card. Here is page of IRS-approved payment processors. Pay by phone or online. Fees will apply, but the payment will count as paid as soon as you charge the card. You may also earn rewards on your credit card.

The following credit cards currently have the ability to offer rewards equal or greater than 1.87%, meaning you could theortically make money by paying your taxes with them. Please read my card-specific reviews for details.

How much should you pay in estimated taxes? You’ll need to come up with an expected gross income and then estimate your taxes, deductions, and credits for the year. The PDF of Form 1040-ES includes a paper worksheet to calculate how much in quarterly estimated taxes you should pay. You can also try online tax calculators like this one from H&R Block to estimate your 2016 tax liability, and divide by four quarters.

Free Estate Planning Guide and Workbook from American Red Cross

arc_estateIf one of your New Year’s Resolutions is to create an estate plan for you and your loved ones, here’s a good starter kit. The American Red Cross has a free Estate Planning Guide and Workbook which comes in both electronic fillable PDF form or a paper workbook format if you give them your address. It is roughly 50 pages and includes blanks to store your asset and beneficiary information, make future edits when needed, and print multiple copies to share with your attorney and family members. The guide will help you to:

  • Understand estate planning and the importance of having a will.
  • Gather the information they need to prepare to draft or update your will.
  • Discover ways to minimize taxes and liabilities for your families.
  • Explore the benefits of making charitable gifts in your estate plans.

Here’s a snapshot of the Table of Contents:

  • Why Everyone Needs a Will
  • When to Revise Your Will
  • Get a Head Start on Writing or Updating Your Will
  • Three Pillars of Every Estate Plan
  • Will Planning Workbook
  • Charitable Giving Through Your Will or Other Gift Plan
  • Including the Red Cross in Your Will
  • Making a Gift Outside Your Will
  • Gifts that Benefit You and Keep the Red Cross Strong

The American Red Cross also offers another free PDF resource called Disasters and Financial Planning: A Guide for Preparedness and Recovery.

ETF Tax-Loss Harvesting: 70% Overlap Rule of Thumb for Substantially Identical

calc_10keyTax-loss harvesting (TLH) is a common practice used to improve after-tax returns by realizing losses to either offset realized capital gains or to defer capital gains into the future. Many robo-advisors including Betterment and Wealthfront offer automated tax-loss harvesting as a feature. As nearly all of them hold ETFs, they accomplish this by selling the primary ETF for each asset class and replacing it temporarily with an alternative, secondary ETF. DIY investors can perform a similar maneuver as well.

The IRS wash sale rule states that you can’t deduct a loss by selling a security and immediately replacing it with something “substantially identical”. Instead, harvesters buy an ETF that is slightly different. It’s a grey area, as there is no solid definition of what “substantially identical” means. However, this recent Barron’s article (paywall, use Google News) offered up a rough rule of thumb that I hadn’t seen before (bolding mine):

Although the wash-sale rule remains ambiguous, there may be an alternative standard that investors can use for guidance. In the 1980s, the IRS created the “straddle rules” to address a loophole in hedged long-short portfolios. For tax-loss purposes, the portfolios on the long side couldn’t be “substantially similar” to those on the short, which the IRS defined as having over 70% overlap. “Some people use the straddle-rules definition as a surrogate to apply to the wash-sale rule,” says Eric Fox, a principal at Deloitte Tax. “If two ETFs don’t have more than 70% overlap and they’re not substantially similar, how could they ever be considered substantially identical?” That should give loss harvesters some confidence.

I was surprised by the conservativeness of this rule of thumb. Most of the TLH articles I have read by both human and software-based advisors implement more aggressive strategies than the 70% maximum overlap suggested above. A traditional advisor quoted in the Barron’s article admitted swapping between the Vanguard Total International Stock ETF (VXUS) and the Vanguard FTSE All-World ex-US ETF (VEU). VXUS and VEU have a 76% overlap by weight, according to this ETFResearchCenter.com Overlap Tool:

etf_tax1

Perhaps more importantly, these two ETFs have a near 100% performance correlation. Here’s a chart of the two ETFs over the last 12 months, per Morningstar (click to enlarge):

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Meanwhile, this Wealthfront whitepaper shows their ETF tax-loss pairings and their correlations. Out of the 7 pairs, 4 have correlations of 97%+ and all of them are over 70%.

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Commentary. There are few firm answers here. If robo-advisors marketing aggressive ETF tax-loss harvesting gather a lot of assets, I suspect the IRS will eventually provide additional guidance. I imagine the worst-case scenario as the IRS classifying past trades as violating the wash sale rule, nullifying your tax losses and possibly imposing additional penalties. I guess current practitioners don’t see a big risk of that happening. They essentially see a nearly free lunch by substituting these similar ETFs. Still, when you market something publicly as 99% correlated, aren’t you basically admitting that they are “substantially identical”?

Flexible Spending Account Reminder: Last-Minute FSA Expenses Ideas

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Updated. Here’s my annual reminder to use up your Healthcare Flexible Spending Accounts before the end of the year. First, here are some possible exceptions:

  • Some plans allow a grace period until March 15th of the following year as opposed to a December 31st deadline to use your 2016 funds, but it may only apply to claims and not late purchases. Check with your employer.
  • Some plans allow participants to carry over up to $500 in unused FSA funds into next year. Check with your employer.

What are FSA-eligible expenses? Here are the large, well-organized lists:

Quick tip. Since 2011, certain over-the-counter (OTC) items such as cough medicines, pain relievers, acid controllers, and diaper rash ointment now require a prescription for reimbursement. In addition to the written prescription for the OTC medicine, you should obtain a detailed receipt that includes the following:

  • Date of service or purchase
  • Name or description of the item
  • Amount of purchase

Last-minute FSA-eligible items. If you didn’t exhaust your funds with insurance copays or deductibles, here are eligible items that you can still buy over-the-counter without a prescription. Examples included are the best-sellers in each category at Amazon.

Finally, only your FSA administrator can provide you with the exact guidelines for reimbursement according to your plan. I learned this the hard way when our FSA administrator switched one year from in-house to Conexis. Wow, Conexis was a pain in the butt. So many hurdles and rejections without good explanations. I had to submit some claims three times before finally getting approved. If you count the time wasted, I probably lost money by participating in the FSA at all. The other employees in the company must have also complained so much that the very next year, FSA reimbursement was again managed in-house.

Credit Karma Tax: Free Federal and State Tax Software, What’s The Catch?

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Credit Karma is expanding beyond free credit scores and free credit monitoring. Beginning in January 2017, they will offer completely free Federal and State tax preparation software with free e-File and no income restrictions. You must first join CreditKarma.com and then you can reserve a spot for when it opens. The tagline is “$0 Federal, $0 State, $0 Always. Truly Free Tax Returns.” Here’s an overview of what is and isn’t included in this offer.

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Is this legit? Yes. Credit Karma purchased AFJC Corporation, which was a private-label software provider and previously supplied the online tax software for Jackson Hewitt. They use your personal information to show you targeted ads. They used to do this with your credit report data, and now they want to do it with your tax return data.

What’s included.

  • Free Federal filing with free e-File for 90%+ of filers with no income restrictions.
  • Free State filing with free e-File for 90%+ of filers with no income restrictions.
  • No upsells, no upgrades, no “premium version”.
  • You can print and snail mail if you choose not to e-File.

Here are some popular forms included by Credit Karma Tax that the download edition of TurboTax Deluxe 2016 will require you to upgrade to Premier (~$20 extra) or Home & Business (~$30 extra).

  • Schedule C – Profit or Loss from Business (Sole Proprietorship)
  • Schedule D – Capital Gains and Losses (Stock Sales)
  • Schedule E – Supplemental Income and Loss (Rental property)
  • Schedule SE – Self-employment tax

What’s NOT included. Credit Karma will NOT support the following forms this year:

  • Filing multiple state or non-resident state returns
  • State filings without a federal return
  • Non-resident federal filing – 1040NR (non-resident tax return)
  • Foreign earned income credit
  • Non-dependent earned income credit
  • Married filing separately (MFS) in common law states
  • Estate and Trust income from K1 forms

No business tax returns. Credit Karma Tax supports Sole Proprietorships and income reportable on a Schedule C/E/SE, but does NOT yet support business tax returns for an S corporation, C corporation, partnership or multi-member LLC.

Credit Karma Tax does NOT support importing tax return information from other providers this year. There is no download version. There is no app version.

How does Credit Karma make money then? Quoted from their site:

When you visit Credit Karma, we show you offers and recommendations (like credit cards or loans) that could save you money. If you take one of these offers, the bank or lender usually pays us. We never charge you a dime. And we never sell your info to marketers.

My take? They should say they won’t sell your information to other marketers. They are the marketers, and now they’ll know more about your financial situation than anyone else besides you. On top of your credit report data, they’ll have income and expense data. For example, if they know you have a 4% rate mortgage, they could sell you a 3.5% refinance mortgage. If they know you are older and have a paid-off home (i.e. you pay property taxes but no claim no mortgage interest), they could sell you a reverse mortgage. If they know your income, they can estimate the amount of life insurance you need. You could actually like this customization, be creeped out completely, or simply plan to ignore the ads.

What could go wrong? The most common drawbacks mentioned are the idea that (1) “you are the product” and (2) what if they get hacked and you lose your personal information?

  1. Well, yes you are the product. Google and Facebook work the same way. You use their free service, they show you targeted ads and hope to extract money from you indirectly.
  2. If you really are worried about your personal information, you should buy tax prep software on physical CDs so that nothing is stored on anyone’s cloud servers. Don’t use any online tax prep software, including that of TurboTax/H&R Block/TaxACT.

I would say a less-mentioned drawback is lack of customer service or support. If there is a bug or tax question that I need help on and I have to spend an hour to fix it, then I’d rather have just paid upfront for better service. Other providers advertise human phone support and/or unlimited live chat.

Bottom line. It’s a pretty simple deal. Credit Karma will give you free Federal and State tax returns. You let them show you ads based on your financial data. Is this a good deal? For most people that have straightforward taxes and don’t usually need support, then quite possibly yes. If you do Federal + State + e-Files with TurboTax or H&R Block, the total cost can be $100+. If you have a complicated tax return or can get value from the conveniences offered by competitors (import last year’s data, unlimited phone support for weird situations, import of 1099-B tax lot data), then it may be worth paying extra elsewhere. I signed up on the waiting list and hope to compare the accuracy early next year.

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