Save More vs. Earn More: A Dollar Saved Is Two Dollars Earned

Earn more. Save more. Those are the two ways to get out of debt and build wealth. I’m a big proponent of doing both, but for many people it may be easier to cut back on some luxuries rather than land a higher-paying job, start a side business, or become an investing wizard. It’s also more effective due to marginal tax rates. Let’s say you are single resident of California and your (taxable) gross income is $50,000 a year.

If you were to go out and earn another dollar as an employee, here’s how that additional $1 would get broken down:


You’d only keep 58 cents. On top of that, a lot of extra or freelance work is done as an independent contractor. That means you’re self-employed and get the happy task of paying another 7.65% of payroll taxes (the employer share), which brings your total tax hit to 49.6%! So in order to keep $1 in your pocket, you’d have to get someone to pay you $1.99. In that case, your choice becomes:


This relationship helps me visualize the power of spending less. Now when you save $1, you can feel good knowing that you’d have to have earned $2 of income to equal that. But on the flip side, when I get a check from a side project for $500, I know I’ll only keep $250 of it. :(

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TurboTax 2011 Review: My Experience and Comparison With TaxACT

I just finished filing my federal and state income tax returns (again) using TurboTax Deluxe Online edition. This is the 2nd part of my series comparing the three major tax preparation websites: TurboTax, TaxACT.

You can see my TaxACT 2011 review here.

Tax Situation
Again, here’s a quick summary of our personal tax situation.

  • Married filing jointly, subject to state income tax
  • Both with W-2 income, as well as self-employed income (Schedule C).
  • Interest income and dividend income from bank accounts, stocks, and bonds (Schedule B).
  • Contribute to retirement accounts (401ks and IRAs).
  • Capital gains and losses from brokerage accounts (Schedule D).
  • Itemized deductions (Schedule A), including mortgage interest and charitable giving.

Retail Price
Although their website shows a “retail” price of $49.95 for TurboTax Deluxe, anyone who visits the site will at most pay $29.95 for Federal including e-File. TurboTax State is $36.95 including e-file. If you are a Vanguard Flagship Services or Asset Management Services client, you get a TurboTax Online Federal Deluxe + State + efile for free. All other clients get discount of about 25% off; you must log in to get your discount. There is also a free edition available if you have a very simple tax return – no itemized deductions, investment income, but remember that State is $27.95 extra in that case.

TurboTax Premier offers “additional guidance” for investment income from stocks and bonds and also rental income. However, I had the usual stock and bond sales and was able to complete my return without upgrading to Premier. I did not feel I needed any extra guidance, but if you do it will run an extra $20 for a total of $49.95. Finally, TurboTax Home & Business ($74.95) offers “additional guidance” for self-employment income including dealing with business expenses. However, if all you have is a couple of 1099-MISCs to report as I did, you can get by with Deluxe.

User Review

With all these tax sites you can start your return for free, and only pay when you file. Since I had already input all my tax data into, I simply opened that up in a web browser tab side-by-side and start filing things out. The Q&A interview questions are in roughly the same order, but there are enough differences to make you jump around a bit.

Import from TaxACT & H&R Block at Home
Last year, I used TurboTax for my tax return. Thus, this time around TurboTax had all my old tax info pulled up immediately. Filing status, dependents, address, DOB, SSN, etc. They also had all my old W-2 and 1099 providers to reduce my data entry needs a little bit more. For example, all my Employer Tax IDs and addresses were pre-filled. This did feel rather convenient, and it helped make sure I didn’t forget any 1099s from old bank accounts.

However, as a result I was never asked if I wanted to import a previous year’s return from another provider like TaxACT or H&R Block. Perhaps someone can shed some light on this in the comments?

W-2 and 1099 Direct Import from Providers
One of the strengths of TurboTax is that you can directly import your W-2 and 1099 information from a number of partner providers. However, the W-2 part didn’t really impress me. Our W-2s came from Ceridian and we had to enter some sort of username and password which I’ve never set up before. It was faster to just type in the 10 numbers and get on with it.

1099s were a different story, at least for me. I was able to provide my Vanguard username and password and have my 1099-INT, 1099-DIV, and 1099-B data imported in seconds. Other partners that I was able to use included Betterment, Chase Bank, Capital One 360 (Sharebuilder), and Pentagon Federal Credit Union. USAA, TD Ameritrade, E-Trade, and Wells Fargo were also available. For those with a lot of transactions, this is a great time-saver.

In addition, after comparing with my TaxACT data, I found that I had made a data entry error of $300 with one wrong digit when manually entering all those capital gains and losses from stock sales. The TurboTax import would have help me avoided that mistake, which I don’t think I would have caught otherwise.

Finally, a cool feature is that if all your accounts are linked to the aggregation site, you can simply log into your Mint account and have all your available forms imported with one login (Intuit owns both TurboTax and Mint).

The Small Stuff
This time around, I did notice that TurboTax has something called “Flags” that are the same as Bookmarks with TaxACT that allow you to mark confusing questions to come back to. The icon is small and there is no text, so I probably would have missed it again if I wasn’t looking for it. A minor positive I noticed is that TurboTax automatically enters commas when you reach thousands (ie. 3,459 instead of 3459). It helps with data entry, as I have already shown that I am error-prone!

A minor negative is that TurboTax had many more server delays where the page would not load or would be blank and I had to refresh the page. I did not have any such problems with TaxACT, which I was using simultaneously on the same internet connection and computer.

Foreign Tax Credit
After everything was entered, there was a difference of less than $50 in my total calculated refund between TurboTax and TaxACT. After some research, I found that it was due to my treatment of my foreign taxes paid as a deduction vs. credit. TaxACT appeared to be more aggressive and just allowed me to take it as a credit, while TurboTax seemed to require more information and otherwise steered me towards taking it as a deduction. This was partially my own fault, but the two questionnaires definitely had a different approach. In the end, I got everything to match up between them. (Take the credit if you can.)

Upselling and Price Tricks?
There are some upsell attempts during the tax return to upgrade to Premier or Home & Business, however it was only a couple times and didn’t feel overly pushy. At the end, the price total was as expected with no bogus charges. There was a final pitch for a product call Audit Defense for $39.95, which provides you “professional representation in the event of an audit” and covers both federal and state returns. As before, I am not convinced of the quality of such representation.

Turbotax showed why it remains the best-known and popular tax software. That is, it covers all of the tax aspects about as equally as well as the others, perhaps with a bit more thoroughness (anality?). However, where it separates itself is the importing of data from financial institutions. It is indeed more expensive – for most people TurboTax will cost $30+ more than TaxACT but if it saves you both time and effort in data entry (and potentially prevents errors), then I can definitely see how people would be willing to pay a premium.

There is also the familiarity factor. I definitely kept feeling the benefit of using it last year and again this year. It compared all my 2010 and 2011 numbers side-by-side, which was nice for us financial geeks. It also remembered little things like my old IRA basis, so I wouldn’t have to look it up again. On the other hand, if my return was simple and would not benefit much from automatic importing, I would probably rather stick with TaxACT.

LendingClub 1099 Forms and Tax Reporting Questions

If you’re a newer investor in Lending Club P2P notes, you may be wondering how to handle your investments at tax time. Will I get a 1099? Even if you do get a 1099, it might not cover all your loans. Unfortunately, the documentation provided by LC is often inadequate on its own. Here is what their website says you will receive in terms of tax documents;
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TaxACT 2011 Review: My User Experience With Screenshots

According to my tax software poll, it appears that the vast majority of readers are using one of the “big 3” tax filing software: TurboTax, H&R Block At Home, or TaxACT. This matches industry-wide estimates; Did you know that H&R Block tried to buy TaxAct last year but was blocked by the Justice Department as it would hurt competition and basically create a duopoly?

Here is my hopefully-useful review of, the first part of a series to try out each of these three products to do my real-life taxes and then compare each of them.

Tax Situation
Here’s a quick summary of our personal tax situation, which I think should cover the most common features of tax software. We don’t have any rental income, however.

  • Married filing jointly, subject to state income tax
  • Both with W-2 income, as well as self-employed income (Schedule C).
  • Interest income and dividend income from bank accounts, stocks, and bonds (Schedule B).
  • Contribute to retirement accounts (401ks and IRAs).
  • Capital gains and losses from brokerage accounts (Schedule D).
  • Itemized deductions (Schedule A), including mortgage interest and charitable giving.

Retail Price
Of the Big 3, TaxACT regularly has the lowest retail price. I will be using the online version of TaxACT, of which there are two editions:

  • Federal Free Edition (Basic): Free for Federal return + efile, $14.95 for State return + efile
  • Deluxe: $9.95 for Federal return + efile, $8.00 for State return + efile

Both versions include all Schedules and all e-fileable IRS Forms. Reasons for upgrading to Deluxe (basically an extra $3 for Fed + State) are the ability to import information from your 2010 TaxACT return, import info electronically from Gainskeeper, help with valuing donation items, as well as free phone support. If you are not subject to state income tax, then you can indeed use TaxACT completely free including efile regardless of income level or complexity of return. Nice! There is also a desktop version available on CD and via download for Windows only.

User Review

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Payroll Tax Cut Extended For 2012: Increase 401k Contributions?

Congress has just passed a bill which the President has promised to sign that includes an extension of the 2% payroll tax cut for the rest of 2012. Specifically, the employee portion of the Social Security tax is reduced to 4.2% in 2012 instead of the standard 6.2%. The employer portion remains unchanged at 6.2%. The Medicare tax remains unchanged at 1.45% each for employers and employees. This tax cut has already been in effect since the beginning of 2011 and was scheduled to end at the end of February 2012 before this most recent extension.

For example, someone earning $50,000 annually will see increased take-home pay of $1,000 spread out evenly over a year of paychecks. The limits on wages subject to Social Security tax is $110,100 for 2012, so the maximum savings per person is $2,202. You can verify this tax cut for yourself by checking your most recent paycheck stub. Divide the Social Security tax line by your Gross Pay line. It should be either equal or less than 0.042, or 4.2%. (It might be less than 4.2% due to items that are exempt from SS tax like flexible spending account contributions.)

Spend it, or save it?

The idea behind this tax break is to provide a small, steady increase in income that you’ll hopefully spend quickly and thus stimulate the economy. Even though $1,000 sounds like a lot, when it comes to you as $40 every bi-weekly paycheck, you tend not to notice it. Surveys confirm that the majority of people don’t even know this tax cut exists after enjoying the benefits for a year.

However, if you’re happy with how you’ve already stimulated the economy and would like to put something away to invest and spend later, this might be a good time to increase your savings rate instead. Remember that your savings rate is the most important factor in whether you’ll be able to retire early (or perhaps ever).

Since this tax break comes automatically every paycheck, it makes sense to “pay yourself first” by putting it aside immediately via automatic savings. Instead of mindlessly spending like they want you to, mindlessly save it instead. 😉 If you have a 401(k) or similar employer-sponsored retirement plan, why not increase your contribution rate by 2%, and see if you notice it for the rest of the year? Of course, if you have high-interest debt and some extra willpower, perhaps you should put it aside each paycheck and pay that off instead. You can also use direct deposit or automatic transfers to send money over every paycheck to an online savings account.

Sources: Philadelphia Inquirer, Associated Press

Non-Deductible IRA Contribution & Roth IRA Conversion Rules

Mrs. MMB and I both contributed $5,000 each to a non-deductible Traditional IRA again for the 2012 tax year this week, with the intention of converting it into a Roth IRA in the future. Are you eligible to do this as well? Of course, we had to wade through a ton of IRS fine print to try and achieve a bit of tax savings.

First, can we just contribute directly to a Roth IRA? Per this IRS flowchart, because we are married filing jointly and will most likely have a modified adjusted gross income (MAGI) over $183,000, we are unable to contribute to a Roth IRA. How many people know what their MAGI is? It’s not impossible to figure out, but if I was closer I’d rather wait and have TurboTax figure it out for me when I filed my 2012 taxes.

Can I contribute to a Traditional IRA, even if I have a work retirement plan? Yes, it doesn’t matter if you have a 401k or 403b or whatever. The question is whether it is tax-deductible. Remember, when money is withdrawn from a Traditional IRA, it is taxed again at ordinary income rates.

Well, is the contribution tax-deductible? From this other IRS flowchart, because we are married filing jointly, covered by a retirement plan at work, and have an MAGI of over $112,000 or more, I see out that our contribution is not tax-deductible. Finally, you should remember to note the non-deductible (post-tax) contributions on IRS Form 8606 at tax time.

Can I convert my non-deductible IRA to a Roth IRA? In 2010, the previous $100,000 income limit for Roth IRA conversions was removed. It was initially thought to be a temporary thing, but it has not been addressed since. There is some speculation that the government is quietly (and happily) collecting taxes right now on all the rollover money, as opposed to later. Thus for 2012, there is again no income limit on the conversion from a Traditional IRA to Roth IRA. Even so, there are still some catches if you have both deductible and non-deductible (pre-tax vs. post-tax) IRA balances available to be converted. We have already converted all our pre-tax IRAs a while back, so it will be a simple “same trustee transfer” at Vanguard for us.

Okay, so we successfully navigated all these IRS rules and legally minimized our tax liability. But how many people won’t? Even for tax benefits for low to moderate-income earners like the Earned Income Tax Credit, the Government Accountability Office (GAO) found that between 15% and 25% of households who are entitled to the EITC do not claim their credit, or between 3.5 million and 7 million households. I mean, just look at how long the Wiki page that supposedly summarizes the credit is. It shouldn’t be this complicated.

What Cities Are People Moving To For Financial Reasons?

This post has been revised with new info and added to my Expense Reduction Guide: Housing.

Although it takes considerable effort, nearly 40 million Americans move every year. Now, the reasons for all these moves are not all financial, but you can improve your financial situation drastically by moving. You might increase your income, decrease your housing costs, or decrease your tax bill.

Where are people moving to? This Forbes article analyzed address data from IRS tax filings, and found that a trend that households are moving to warmer climates with lower taxes and property values. The majority of the top ten counties are in Texas and Florida, where there is no state income tax.

After accounting for property taxes, Shrum’s analysis shows that Texas has the fourth-lowest personal tax burden in the country, and Florida has the eighth lowest.

They also compiled an interactive map which shows relative inflows and outflows for each county. (Previous year’s version here). It’s pretty fun to click around to where you live, and where you might consider moving to.

Below is the map for Travis County, TX, where Austin is the major population center. A blue line between two counties mean that more people migrated to Austin than left, and a red line means that more people left Austin for that county than came in.

Where are people leaving? Places with high tax rates.

Shrum also points to eight states that have targeted wealthy households with extra-high tax brackets: California, New Jersey, New York, Maryland, Hawaii, Oregon, Connecticut and Wisconsin. Six of the top 10 counties the rich are fleeing are located in those states.

Personal case study. My sister used to live in San Francisco, California. She recently moved to Austin, Texas where her income increased and her housing costs decreased at the same time. Texas has no state income tax but relatively high property taxes. But since she rents in both places, the lack of state income tax becomes yet another boost to her bottom line. I should note that we both lived there for a while as children, so there is some familiarity, but she left in elementary school. From the looks of it, she wasn’t alone!

Poll: Which Tax Software Did You Use In 2011?

January 31st was the deadline for companies to mail out W-2 forms and 1099 forms involving other income and interest. Coming up is February 15th, the deadline for brokerages to send out 1099-B forms listing stock sale proceeds.

That means you early-birds out there (not me) are probably chomping at the bit to file your taxes! So here’s a question to you readers about last year:

What Did You Use To File Your Tax Return in 2011?

Total Voters: 2,027

Loading ... Loading ...

A better question would be why you chose that software – price, convenience, trust, quality of product, or what? Would you have switched if a competitor was $25 cheaper?

Active Mutual Funds, Passive ETFs, & Tax Efficiency

When looking at your investment returns, it’s important to calculate your return after the impact of taxes and expenses (management fees, commissions, bid/ask spreads). That number is what you really end up with, but it’s never shown on any year-end statements. ETF provider iShares put out a Managing Tax Challenges brochure that shows the average annualized tax cost for actively-managed mutual funds over the last 10 years. Via Abnormal Returns and Mebane Faber.

(Click to enlarge)

Many actively managed mutual fund managers have had difficulty delivering benchmark-beating, after-tax returns. Figure 1 shows the 10-year average tax cost for active funds and top quartile active funds. What’s striking is that in every case except for mid cap blend and small cap value, top quartile funds’ tax costs (as indicated with a white dot) were equal to or greater than those of the category average (black dot). Even worse, after taking taxes and fees into consideration, the average active fund underperformed its benchmark.

The takeaway is that expenses and tax-efficiency both matter greatly to the bottom line, and passively-managed ETFs are much more tax-efficient than actively-managed mutual funds, possibly enough to counter the performance benefit of active management. For one, being passively-managed on its own means lower turnover (less buying and selling) and thus less taxable events. Second, the ETF structure itself has inherent advantages over open-ended mutual funds. Neither of these traits are specific to iShares, by the way, although they do have some of the most popular index ETFs out there.

I should note that many Vanguard ETFs are simply different share classes of open-ended mutual funds (Example: VTI and VTSMX). Theoretically, this extends the tax-advantages of ETFs to the mutual fund shareholders, as described in Vanguard’s ETF brochure:

Tax advantage. Like other ETF providers, Vanguard can push low-cost-basis shares out of the portfolio through the in-kind redemption process. Our patented share-class system provides an additional benefit. To meet cash redemption requests from non-ETF shareholders, Vanguard can sell high-cost-basis securities to generate a capital loss. These losses offset any current taxable gains and, if not exhausted, can be carried forward to offset future capital gains—a recycling that is not likely within stand-alone ETFs. Theoretically, cash redemptions could trigger a gain instead of a loss; however, Vanguard’s deep tax-lot structure has allowed us to select high-costbasis shares in both good markets and bad, resulting in a high degree of tax efficiency.

As a result, in many cases if I can own Admiral shares of Vanguard index funds that have the same low expenses as the ETF version, I’d rather just own the mutual fund version for the sake of simplicity. For instance, I like making dollar-based transactions at net-asset value (NAV) instead of having to place a market order (potential loss due to bid/ask spread) and also worrying about NAV discount/premiums. It also keeps me from doing silly things like trying to time the market intraday.

IRA Monte Carlo Revisited: Undo Traditional IRA to Roth IRA Conversions

My post yesterday about the varying performance of different asset classes reminded me about a Businessweek article called the IRA Monte Carlo. This is a tax-saving trick for those who wish to convert their Traditional IRAs or old 401ks to Roth IRAs. Here’s a snippet:

1. Let’s say an investor has one traditional IRA with a value of $4 million.

2. The traditional IRA is split up into four traditional IRAs, each worth $1 million.

3. The investor converts all four to Roth IRAs at the beginning of the year.

4. The IRS effectively allows taxpayers to undo the conversion for up to 21 months. So in 21 months the investor looks at the performance of the IRAs. Say two of them go up from $1 million to $2 million and two drop from $1 million to zero. Because the IRAs were split into four, the investor can change her mind on the two that went down and revert those back to traditional IRAs. Thus, she owes taxes on only the two contributions that went up in value, and nothing on the two that went down, cutting her tax bill in half. This lops 21 months of risk off the bet that paying taxes now will be paid off with tax-free appreciation later.

Did that make sense? It was a little confusing for me, so here’s my take on it. Right now, there is no income limit converting Traditional IRAs to Roth IRAs (and paying the taxes owed). Everyone can do it. Basically, in the conversion you pay taxes now on gains at your current tax rate, but then as a Roth IRA your future gains are tax-free. This works out to be a good idea if your future tax rates upon withdrawal end up higher than your tax rates right now.

It boils down to: Pay your taxes now? or pay taxes in the future?

Let’s say you agree your future tax rate will be higher, whether for personal reasons (you think future income will be higher or at least the same) or external reasons (you think Uncle Sam will raise tax rates). The loophole here is that you are allowed an “undo” by the IRS, which you can take advantage of by splitting your big traditional IRA into multiple, smaller, separate traditional IRAs. Then convert the smaller IRAs, and wait up to 21 months:

  • If the value of the converted IRA goes down, then you can undo the conversion and then redo it later, saving you on taxes. For example, if you converted $100,000 in Emerging Markets stocks in the beginning of the year and it went down to $80,000 – would you rather pay taxes on $100k or $80k?
  • If the value of the converted IRA went up – say from $100k to $115k if you invested in Treasury bonds throughout 2011 – then you’re happy because that $15k gain is all tax-free. You just sit back, sip your cocktail, and leave it alone.

There’s not many times in life you get to hit the “undo” button. As in the examples given, I would recommend putting different asset classes in your separate IRAs so that you can take advantage of any non-correlated performance. Don’t completely change your investment holdings just for this tax trick, though. Just putting stocks in one and bonds in the other can offer a potential benefit.

How To Find Amount and Date of Past Roth IRA Contributions?

Here’s a reader question about tracking Roth IRA contributions is previous years (slightly paraphrased for clarity) that I answered to the best of my ability, but perhaps there is a better solution out there.

I am looking to make a withdraw of my Roth IRA contribution that I made
prior to 5 years to avoid taxes and penalties. My question is:

How do I find out how much and when I made contributions?

This will tell me how much I can withdraw without taxes or penalties. I am also only age 50. Thank you!

My initial answer was to look at past income tax returns, as that should provide a good record of your Roth IRA contribution history. However, since Roth IRA contributions do not affect your tax liability, they likely aren’t listed directly on the tax return. Going through my own old returns, I found my contributions noted in a supporting document called a Roth IRA Carryover Worksheet. In addition, your IRA broker (trustee) should send an IRS Form 5498 (PDF) showing the amount of your contribution each year. If you’re really lucky, perhaps your broker has records for previous years.

If you don’t have access to old returns or the proper supporting documents, you can ask the IRS for a copy. There are two options:

  • Request a tax return transcript. A transcript is not a direct copy of your actual return, but includes most of the line items of a 1040 Form going back up to 10 years. It is free and can be done online, via mail, or over the phone. However, as noted above the return itself may not include Roth IRA contribution information. Update: Form 4506-T does allow you to request Form 5498 transcripts, which should include IRA contribution data.
  • Request an exact copy of your tax return and all attachments. This option gives you an exact copy of a previously filed and processed tax return and all attachments. You must complete Form 4506 (PDF) and include a check for $57 for each year requested. Copies are generally available for returns filed in the current and past six years. Would Form 5498 be an included attachment? I’m not sure.

Any better suggestions?

Compare Sales, Income, and Property Taxes By State – US Map 2011

(Update 2011: I ran a search for this topic and found my own site. Ha! The maps were from 2009, so I updated this post with the updated 2011 information. They appear to have actually taken some of the feedback from earlier comment and improved the general applicability of each chart.)

I ran across some nice visual maps from today. Each one compares a different type of tax across all 50 states. How does your home state choose to extract revenue from its residents? (Yes, extract. They have to pay for things, but I doubt asking gently with a packet of free address labels would work very well for them.)

State Sales Taxes – State and Local (Combined) General Sales Tax Rates, 2011 (Greener is higher)


State Income Taxes – Top Marginal State Income Tax Rates By State, 2011


State Property Taxes – Median Property Taxes Paid by County, 2005-2009 (Darker is higher)

Click on the images for a bigger source version.