Basic Financial Planning for Newlyweds




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Common MISCONCEPTIONS and MISCUES Pertaining to Individual Income Taxes


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Over the years, our friends at have prepared income tax returns for thousands of young professionals. Below, they have prepared a list of some of the common misconceptions and miscues that they have come across over and over again.

M&M #1: Newlyweds who, upon returning to work after their honeymoon, immediately change their withholding to "Married - 2 allowances"

The issues:

  • Married couples comprised of two working spouses each earning a similar amount of money will owe MORE in taxes than if they had remained single. This is known as the marriage penalty.

  • An individual will have LESS taxes withheld by claiming to be married since the withholding tables for married people assume that only one spouse works. When both spouses work and have taxes withheld as if they are married, that couple will generally owe quite a bit of taxes at the end of the year.
  • An individual will have LESS taxes withheld with each additional allowance that is claimed. Claiming 2 allowances may seem to make sense (1 for you and 1 for your spouse), but by claiming 2 allowances, you will only be increasing the amount of taxes owed at the end of the year.

Believe it or not, it's not uncommon for married couples who earn a total of $80,000 during the year to owed $4,000 in federal income taxes on April 15th!!

The solution:

If you and your spouse both work and earn a similar amount of money, and you don't own a home, you should each file a new Form W-4 with your employer claiming "Married but withhold at the higher single rate" with 1 allowance. You should also work through a tax projection during the year to make sure that enough taxes are being withheld.  (Try our free on-line tax software.)

M&M #2: People who purchase a vacation home to get an additional tax deduction.

The issues:

  • Taxpayers can deduct mortgage interest paid on their principal residence and a second home. Boats and mobile homes count as a second home as long as they have sleeping, cooking and bathroom facilities. The only limitation is that mortgage interest can only be deducted on the first $1,000,000 borrowed to purchase and improve both homes.

  • Real estate taxes paid during the year can be deducted on all residences owned.
  • If the vacation home is used more than 14 days by the taxpayers, and rented out the remainder of the year, rental losses generally can not be deducted.

The problem is that, if the vacation home is not used on a regular basis over a number of years, the after-tax cost of paying the mortgage and maintaining the property far exceeds the cost that would have been incurred to rent a similar property for the few weeks during the year that it might be used.

The solution:

If the vacation home is at a place that you would frequent on a regular basis even if you didn't own the home, such as a ski mountain, a lake, or the beach, then you might consider purchasing the home. Otherwise, even though you may save some taxes by owning a second home, you should probably forego purchasing one. Instead, take the money that would have been spent on the home's down payment and monthly mortgage and maintenance costs, pay for the vacations that you would like to go on, and wisely invest the rest.

M&M #3: Automobile salespeople who inform people that they will realize a substantially higher tax savings by leasing a car than by purchasing the same car.

The issues:

  • Individuals who drive their automobiles in connection with work are entitled to claim a deduction on their tax returns. Business miles include driving between work places and driving from your home to a temporary place of business. Commuting between your home and a regular place of business NEVER qualifies as deductible business miles.

  • The automobile deduction is based on the ratio of business miles driven during the year divided by total miles driven during the year. The higher that percentage, the greater the percentage of your automobile expenses that can be written off. For most people, this percentage turns out to be quite LOW.
  • Individuals who are self-employed will deduct their automobile expenses against their gross self-employment income on the Schedule C. Individuals who are compensated as employees will deduct their automobile expenses as a miscellaneous itemized deduction on the Schedule A. As you may be aware, miscellaneous itemized deductions are only deductible to the extent that they exceed 2% of adjusted gross income.
  • People who benefit the most by leasing are self-employed individuals who use their automobiles predominantly for business. Most other taxpayers end up only being eligible to deduct a small percentage of their automobile expenses (which include the cost of the lease, insurance, gas, repairs and maintenance, parking at your home, and other costs) and therefore, DO NOT REALIZE MUCH OF A TAX SAVINGS AT ALL.

The solution:

Before being sold on a leased automobile, you need to calculate the after-tax cost of leasing versus owning. If you drive very few business miles during the year, you will probably find that leasing ends up being significantly more expensive than owning. Unless you're self-employed and use the car predominantly for business, leasing makes sense for people who 1) have very little money for the down payment on a car and 2) intend on upgrading to a better car when the lease period ends. Otherwise, purchasing the automobile is generally a better all around financial decision.

M&M #4: Parents with only 1 child in day care who do not take advantage of the dependent care benefit offered by their employer.

The issues:

  • Parents who take advantage of the dependent care benefit offered as part of their employer's benefit package are allowed to pay the first $5,000 of child care expenses with pre-tax dollars. A person in the 28% tax bracket who is not over the social security max will save $1,782.50 in federal and social security taxes by paying for day care with pre-tax dollars. ($5,000 * [28% + 7.65%])

  • Parents who do not take advantage of this benefit are entitled to claim a tax credit equal to 20% of the first $2,400 of child care expenses paid each year; a tax savings of only $480. (Parents with two or more children in day care are allowed to base their credit on the first $4,800 of expenses paid.)

The solution:

Find out from your company's human resource department whether the dependent care benefit is offered and how you should go about signing up for this benefit. Keep in mind, however, that parents taking advantage of this benefit must report the name, address, and employer identification number of the child care provider to the I.R.S. on a Form 2441 attached to their federal Form 1040.

M&M #5: Taxpayers who sign up to participate in their employer's 401(k) plan or 403(b) plan at the end of the year and put away very little money prior to December 31st.

The issues:

  • If you're married and neither your nor your spouse is covered under an employer sponsored retirement plan during the year, you are each entitled to make a deductible contribution of $2,000 to an Individual Retirement Account (IRA).

  • The IRA generally becomes non-deductible if as little as $1 is contributed to a 401(k) plan or 403(b) plan during the year.

An individual signed up for his employer's 403(b) plan during December and had $200 withheld from his salary and contributed to the plan. This individual is no longer entitled to make a DEDUCTIBLE IRA contribution of $2,000 for that tax year. This individual saved $56 in federal income taxes on the $200 contribution to the 403(b) plan, but lost out on the $560 tax savings in connection with a $2,000 IRA.

The solution:

Sign up to participate in your employer's 401(k) plan or 403(b) plan early in the year and try your best to contribute more than $2,000 during the year. If you have any money left over at the end of the year, you should try to contribute up to $2,000 to a Roth IRA; as long as you meet the income limitations. The combination of contributing to your employer's 401(k) or 403(b) plan and making an annual $2,000 contribution to a Roth IRA can't be beat!!

M&M #6: Individuals who buys stocks with retirement money and mutual funds with non-retirement money.

The issues:

  • Capital gains on stocks held for more than 12 months are taxed at a maximum rate of 15%. Capital gains are only taxed the year that the investments are sold. Unrealized appreciation is not taxed.

  • Capital losses on stocks held in non-retirement accounts can be used to offset other capital gains earned during the year. If capital losses exceed capital gains, an individual can deduct as much as $3,000 in losses against all other income earned during the year. No deduction is allowed for capital losses on stocks held in retirement accounts.
  • Distributions from retirement accounts are taxed at your marginal tax rate; generally 25%, 28% or 35%. Distributions before reaching the age of 59 1/2 are usually subject to a 10% penalty for premature distributions as well. The 20% capital gains rate does NOT apply to retirement money, even if the retirement accounts only held stocks.
  • Dividends from mutual funds are taxed partly as ordinary income and partly as capital gains, depending on how the income was earned within the fund. Most mutual funds pay out dividends every year. Sometimes, these dividends can be quite large.

The solution:

If your strategy is to buy and hold good stocks, you should purchase those stocks in your non-retirement accounts to take advantage of the 20% capital gains tax rate. Any mutual funds that you purchase, especially those that pay out a big dividend each year, should be held in your retirement accounts.

If your strategy is to purchase only mutual funds or only stocks, you should hold those investments that pay the smallest dividend within your non-retirement accounts and hold the dividend paying investments within your retirement accounts.

Individuals who continually turn over their portfolio and never own a stock for more than a few months will probably do better in the long run by buying and selling those stocks within their retirement accounts. These individuals need to remember, however, that losses realized on transactions within retirement accounts are not deductible.

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