Banks Paying Back Taxpayers Money

Ten large banks are paying back treasury with 68 billion dollars, so that they can be freed from government meddling in paying their executives. Now that all of their accounting book is blessed with marked-to-fantasy, they don’t need the cash anymore. Can we put in a clause in the payback that “please don’t come back again even if you’re insolvent (after squeezing out more bonus for executives)?”

I’ve said many times, and I will repeat it again. Option ARMs and AltA are resetting starting from about now until the end of 2011. The wave of notice of defaults is already coming (Dr. Housing Bubble has got all the charts here). It’s not a question of if, but when (the next wave of financial crisis will hit). Mark-to-fantasy by thinking that you have not sold your stocks (mortgages on the book of these banks) after 60% losses and that they will come back to full value after 10 years will not help at all. The end game will come, when the homeowners stop paying mortgage and/or walk away from properties. When the properties go into foreclosures and get sold, banks have to mark down the losses without a choice. The fact that banks are not in a hurry to foreclose all the properties tell you that the level of losses in a foreclosure will probably destroy the banks. By choosing not to foreclose (and not mark-to-market), insolvency can persist in fantasy land.

And before they go down, CEOs are going to squeeze out more from shareholders, bondholders, and taxpayers. They’re definitely a smart bunch.

Tax Rebate Checks Coming

Economic stimulus is coming. And many retailers are looking for you to spend your check. In the recession, it’s a good time to spend money if you have it.

Of course, the amount of my rebate check is $0. I’m not getting any. But it’s not like I’m making a lot more. The tax rebate calculation and tax system was unfair to places with a very high living cost structure. Even though you are supposed to have a “high” income on a national basis, your high income simply doesn’t go far enough after all the needed expenses.

So what’s my advice on your rebate check? You guess it. You should SAVE it. The current economic slowdown is not going away yet. You will have plenty of chances to spend it on good purposes later.

But if you have to spend, make sure you spend it wisely. Find good deals. Pay down your credit card debts. Pay down your college loans. Build your emergency savings. These are just basics. I hate to repeat what Suze Orman would say, because what she says is obviously boring. But the truth is often boring, and not pleasing to your ears or heart. There is never a get-rich-quick scheme (or if there is, it won’t last very long at all). To accumulate more net worth, you simply have to save/earn more and spend less. I know every reader here would like to earn more instead of to save more. But saving more is actually a whole lot easier than earning more.

Anyway, if you still don’t know how much you may be getting, here is a calculator from IRS for you to figure it out. Hopefully, it’s something non-zero for you.

Reversing My Positions On Canadian Trusts

After I thoroughly reviewed the tax law changes, I believe that they should be sold. Not only corporate income will be taxed, withholding rates for US investor will be raised to 41.5%. If anyone of you have further details on the tax changes, please comment.

My total loss from this tax change is about $5800 from all of my positions (so far). I’m just going to take the losses on the chin.

I won’t be selling them out immediately. I will take whatever dividends that I can get at the rate before tax changes are kicked in, and wait for market to reach some consensus. I will probably put the proceeds into either US trusts or partnerships, the other two categories that I have recommended in my high dividend stock lists. I am still lucky in the way that I have diversified my dividend streams into different country and different kinds of business. Otherwise, my losses will be much worse.

I hope that crude oil stops falling here. If it does, rise of crude would help lift these trusts somewhat. But if you want to play the crude oil, you could put the proceeds into many other alternatives. Bottomline, diversification has always been the saving grace in a down market (and also a dragger in an up market). It’s about how greedy you are and how much risk you want to take.

Certainly a BAD day for all Canadian trust investors. I wish that they could have preserved the trust structures for certain types of business.

Pay Yourself First Under Withholding Tax

Some people don’t have the financial discipline to carry out a plan of under-withholding taxes. Some people don’t have the financial cushion to carry it out to make a difference. However, if you have both, you can use under-withholding to your advantage.

Is under-withholding illegal? No. Unlike estimated tax payments, which go towards a specific quarter and due on the 15 of April, July, October, and January for the following year, the tax withheld from your paycheck is calculated as if the entire withheld amount is contributed throughout the entire year. What does that mean exactly? It means that whether you pay your tax out of your paycheck in January or December, they’re treated exactly the same by IRS, as if every 1/12 of the amount was paid evenly every month throughout the entire year. Knowing this, why would you want to pay IRS in January when you can pay IRS in December? You can almost put the amount in a 11 month CD, and get some 4% to 5.x% interest out of it.

I personally have carried out this practice for several years now. I under-withhold my taxes throughout the entire year, and I start to check on the exact amount of taxes that I should be paying in around October. The bigger amount you under-withhold, the earlier before year end that you should check on your taxes. The reason is that if you don’t start planning early enough, you may not pay enough taxes for the whole year, even if you send your entire paycheck to IRS for the last month in December. Essentially, you want to pay just enough taxes in a year, as not to trigger a tax penalty, and you want to pay more of your taxes near the end of year, instead of the beginning of the year. Calculating how much taxes you should pay can be very complicated. It’s also different for people whose adjusted gross income in the last year exceeded $150K. But you can easily figure out the underpayment taxes using my 2006 tax calculator. The calculation of underpayment taxes have taken into accounts for all of the conditions listed by IRS. It is the amount of additional taxes that you need to pay in order to avoid any tax penalty assessment. You don’t need to work through any IRS rules. Just enter all the numbers, and it will tell you how much more in taxes you need to withhold or pay.

To under-withhold or pay additional amount of taxes from your paycheck, you can simply fill out a W-4 form and give it to your payroll department. Besides under-witholding your taxes, another trick that you can play is over-contributing to your 401K, so that you can put in most of the contribution dollars upto the maximum earlier in the year, instead of later. For more details, you can find them at my other post “How I earn extra 1.45% return without risk in my 401k account”.

To summarize and put your cash flow into timeline, here is the picture of “paying yourself first” if you have utilized both early 401k contribution and under-withholding taxes:

  1. If you make early 401k contribution, the first 3 to 4 months are the months when you will be paying into your own 401k account. Your net cash from paycheck will be tiny. You will be paying mostly the payroll taxes (social security and medicare taxes), but not much income taxes.
  2. Then from March/April to probably October, these are your golden months for cash flow. Since you’re done with your 401k contribution, plus that you are under-withholding income taxes, your net cash from paycheck will look really good. But obviously, it’s not the time for you to spend those cash. Rather, you should be saving or investing those cash and prepare for the upcoming November/December and also till next year of April if you’re doing early 401k contribution every year.
  3. November and especially December will literally be the dry months. If you have executed your under-withholding plan perfectly, you should be paying your entire paycheck towards IRS at the end of year. That means that there is $0 or close to $0 cash flow from your paycheck. You will need to be surviving from cash accumulated in the previous boom months of either January through October, or March/April through October if you contribute early to 401k.

Too complicated for you? Hey, if you know any ways to save or earn more money without any work, please let me know. To get something in return, you always need to pay at least a little bit of effort, whether it’s planning your cash flow, reading books or articles, etc.

Here is an article “Get next year’s tax refund now” from MSN money that talks about under-withholding taxes. It should supplement and reinforce this “tax saving” tip.

Home Office Tax Deduction

When I started blogging, I talked to my accounting friend who is a CPA about taking home office tax deduction. Besides the trouble of maintaining and documenting the exclusitivity of the business usage, and sending a warning flag for audits, he advised me not to take any such deductions for the following financial reasons:

  1. If you own your home, the expense items that you can claim for such deductions are mostly mortgage interest, property taxes, insurance, and utilities. The biggest items are usually mortgage interest, and then property taxes, both of which can already be fully deducted through itemized deduction on the schedule A for your personal tax. Unless you rent, and have very big utilities bills, the total deductible amount that is otherwise not available in personal taxes, will not be very significant, especially after pro-rating of business usage area to the total.
  2. Any amount of depreciation of the home office will need to be re-captured as business gain at the time of the sale of your home. If no business conversion of the home is taken, your gain is tax-free if it’s $250K for singles, and $500K for couples. Those business gain can be defered through more complicated loopholes of 1031 exchange. But this 1031 exchange that involves both home & business will not be as straightforward as a regular 1031 exchange.
  3. Home office deduction is limited to your net business positive earning. You simply cannot use home office deduction and increase your business loss to offset against your other income like salary wages. Although you can carry forward the deductions that you cannot take in the current year, it is of no use if your business cannot produce significant income to take advantage of those deduction. You can check out form 8829 for home office deduction and Schedule C for business income.

Here are some other useful links for more information:

  1. Directly from IRS: home office deduction.
  2. From Quicken: Factors to Consider Before Taking Home Office Deduction. This article is very informative.
  3. A very good online calculator for home office deduction.

Foreign Taxes Withheld Problem

A reader John has asked me about how to get the withheld taxes out of the paid dividends back, in my post of “My Dividend Investing ($11775.91 for 2005)”. He said that he has 28% withheld. 28% is a very weird withholding percentage. For all of my stocks, I had 15% withheld for foreign paid dividends. Because I am not sure about his US status (citizenship/green card or foreign). I will explain both.

For all foreigners who have brokerage accounts in the US, I believe 28% or 30% withholding is assessed on all dividends. If the account has an expired W-8 form, any stock sale proceeds in your brokerage account will also be withheld for tax at the same rate. To get that tax back, non-US citizens or anyone who doesn’t have a tax ID in their account MUST register for a tax ID by going to social security agency, and use that tax ID to file tax using 1040NR and reclaim your tax withheld. You also need to contact your brokerage house and make sure that they send you the documentations (1099 form) to prove that you had taxes withheld in your account. Please do make sure that your W8 or W8-BEN form is updated or else you will get lots of money withheld even when you don’t have any gain.

If you are a US citizen or green card holder, but getting foreign taxes withheld by other countries, it is pretty simple to get them back at the tax time. As long as your total withholding is below $300 for single, and below $600 for married joint status, you can put that number (sum of all the numbers in box 6 from your 1099-DIV and 1099-INT) into line#47 of form 1040 as the foreign tax credit, and get all of your money back at the time of filing tax. If you exceed the limit, then you will need to file form 1116 which is quite complex. There are certain types of dividends, for example oil trust, that you cannot get any foreign taxes back. My current tax calculator does not provide calculations for foreign tax credit using form 1116, but it will be implemented soon. You can still enter the number, and the taxes will be calculated correctly.

Let me know if anyone has more questions related to this.