Uncategorized – The Good Humored Accountant

February 26, 2026

Tied the Knot? Your Taxes Just Got Interesting!

So you got married. Now what? Easy there, this isn’t that type of article. We will keep our marriage advice and recommendations strictly to the tax realm

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But seriously though, I’m sure, right at the top of your concerns is how getting married will impact your taxes. The first thing is that you can’t file as single status anymore. If you are married on December 31st, you have to file with one of the married status designations – jointly or separately. What’s the difference you ask? With a married filing jointly (MFJ) status, you file one return together, reporting both of yours and your spouse’s income and deductions together. Under married filing separately (MFS), you will each file a separate return, reporting your share of income and deductions on your own separate returns.

Next Question: why does it matter? There are a couple of different reasons why it matters. MFJ filing status generally has better tax rates across the board than MFS. If you are looking at only tax savings, MFJ is almost always the way to go because you will pay less combined tax. If you take a look at the tax brackets and how they increase as income increases, MFJ gets broader tax brackets that go up more slowly than MFS. MFJ also gets a higher standard deduction than you would get as MFS. MFS also has to choose the same deduction method – standard or itemized- regardless of which one works best for each taxpayer.

So why would someone choose MFS then? It is usually for a reason that falls outside pure dollars and cents. When you file MFJ, both you and your spouse are liable for the full tax obligation and what is reported on the return. It isn’t split 50/50, you both are legally required to be sure the full amount is paid. If there is potential fraud on the return, both taxpayer and spouse can be liable. Maybe that isn’t what you want. Sometimes, taxpayers will choose to file separately for student loan repayment reasons to keep payments lower based on income. If one spouse had significant medical expenses, it could make sense to file separately if that spouse would have a lower AGI, allowing more of those medical expenses to be deducted since expenses have to be over 7.5% of your AGI. MFS is often a good option for spouses who are going through a divorce that is not finalized yet. It largely allows each spouse to file a return mostly independent of the other.

This choice can also be important for how it impacts many of the tax credit we discussed in our last installment. Do a quick dive HERE . In general, the earned income credit is eliminated for MFS taxpayers, since all income could in theory be on one spouse’s return while one taxpayer reports below poverty level income. The Child and Dependent Care Credit is also virtually eliminated with a few narrow exceptions. Education credits and Adoption credits are also largely disallowed

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So, think carefully when choosing to file separately if you are married. The tax man can bite you.

Here are some real like examples of when married filing separately might make sense: One Spouse has significant medical expenses – perhaps one taxpayer is undergoing cancer treatments and has significant out-of-pocket medical expenses of $25,000+ but has low taxable income from being unable to work. Since medical expenses are an itemized deduction and only expenses in excess of 7.5% of AGI qualify, this might be a place where married filing separately makes sense, to maximize itemized deductions.

You want to keep tax liability legally separate: Perhaps one spouse owes significant back taxes, has defaulted on student loans, or has a tax lien. Filing separately allows the spouse of the taxpayer to maintain separate legal liability and protect her/his refund from the IRS. If the couple were to file jointly, the IRS would claim any refund entitled to the spouse to satisfy the outstanding debts.

So, how do you change your filing status? If you are going from joint to separate, you can simply file 2 separate tax returns reporting each share of your income and deductions. You split any items that are reported jointly, in most cases. You will also need to both choose the same deduction method as mentioned earlier – either you both take the standard deduction or you both itemize your deductions. If you are going from separate to joint status, you file one return, check the MFJ box and report all of your income and deductions together on one return. To go back and change prior years, you have to file amended tax returns. Generally, you can go back and amend from MFS and change to a joint return, however, you are not permitted to amend a joint return and change to MFS once the due date of the original return has passed.

In conclusion choosing how you will file your tax returns is an important decision that can make a major financial difference but at the same time, can also expose you to risks, depending on your circumstances. As a general rule, married filing jointly produces a better tax result but there could be other financial and legal factors that may drive your decision to file separately. As usual, this is a blog and not tax advice. If you have questions about what filing status makes the most sense for you, consult a tax professional who is experienced in these conversations. They will be able to help you weigh the various factors and put to numbers to paper regarding what make the most sense for your particular set of circumstances.

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January 27, 2026

Top Tax Credits to Save You Money This Year

In our previous installment we talked about the difference between tax deductions and tax credits. You can check that out here {Blog Post Link}. In short summary, tax credits reduce your tax liability dollar for dollar where deductions reduce the income your tax is calculated on. The world of tax credits is vast and varied. In this particular post we will hit on some of the most popular/claimed credits, how much they can make a difference, and some of the qualifications to claim them. This will be a primer and is certainly not an exhaustive list. Even I don’t want to sit and read an exhaustive list of tax credits. I might do it, but it isn’t the most interesting reading in the world.

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To kick things off, we will start with maybe one of the most mis-claimed or misunderstood credits – the Earned Income Credit (EITC). The EITC is a tax credit intended to provide benefit to lower income tax payers and can actually be refundable. What does “refundable” mean? It means that even is your don’t actually owe tax or have withholding, you can still get a tax refund of this credit. {Sweet} The credit is based on a percentage of your earnings and factors in other financial information, like your filing status, how many dependents you have, what kinds of income that you have, and some other specific tax items. If you make over $68,075 and file a joint return or $61,555 filing as single/head of household, you won’t be eligible for this one. For 2025, the maximum credit is about $8,000 and is also fully refundable. To claim the credit, you can file a Schedule EIC along with your annual Form 1040 – you know, your annual tax form.

Another popular credit is the Child Tax Credit (CTC). The CTC is easy to identify. It is a flat per dollar amount per child that you have under the age of 17.

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In July of 2025, President Trump’s One Big Beautiful Bill (OBBB) – could we have any more abbreviations? – increased the 2025 credit amount to $2,200 per eligible child, indexed the credit to increase with inflation, and added some requirements about the parent and child having valid social security numbers. You must have earned income to claim the credit and if you make over $200,000 as a single filer or $400K for jointly filers, you aren’t able to claim the credit.

Next up on the list of credits you never knew you wanted to know about are Educational Tax Credits. There are 2 different credits designed to support taxpayers with post-secondary education costs – the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Both credits are designed to help with higher education costs. The AOTC is the more generous credit of the 2, designed to help only with the first 4 years of college tuition. You must be at least a half-time student and the student can be you, a spouse or a dependent. The maximum credit amount is $2,500, with 100% of the first $2000 being eligible for the credit and 25% of the next $2,000. Up to 40% of the credit can also be refundable. For the LLC, the qualifications are lower. The eligible student is required to only be enrolled in one course during the calendar year. The LLC is available for all years of post-secondary education, including masters and beyond courses, for an unlimited number of years. The maximum credit annually is $2,000 but is calculated at 20% of your tuition costs up to $10,000. It is not refundable. As with most credits, if you make over $90K as a single filer or $180K married filing jointly, you can’t claim the credits.

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The last group of credits we will discuss are energy credits that help the environment. You can claim small credits related to energy efficient improvements to your main home as long as that home is in the US. The credits are based on how much you spend and are generally capped at $200-$500 but various items can qualify like new windows, insulation, interior and exterior doors, HVAC systems, or hot water heaters. If you decide to install larger energy items, like solar panels or a geothermal heating system, you can actually claim a tax credit up to 30% of the cost of the improvement. You want to be sure you check and make sure whatever you are doing meets the requirements, but don’t miss out since they can make a difference.

This list is by no means exhaustive and primarily touches on a few common credits available to individuals. Business owners have access to a host of other credits like the Research & Development Tax Credit, various employer/employee related credits, retirement plan credits and many others.

You may be thinking, “Great – now what do I do?” How do I get these credits? Are they on a card or something? To claim these credits, you file and report the required info on various forms as a part of your annual Form 1040 tax return. Each credit type will have a corresponding form or Schedule and outline what information you need to include in order to properly claim and support the credit. Be sure that you maintain any documentation necessary to support your credit claim in the event the IRS asks for it, particularly if regarding the EV vehicle credit. This isn’t one we talked much about due to changing laws, but as with all credit, be sure you can back up the claim.

A few things to keep in mind, if you think you may be eligible to claim any tax credit, be sure that you either consult a qualified professional or thoroughly review the instructions to be sure you meet requirements of the credit. You don’t want to be claiming credits that you don’t actually qualify for. If the IRS catches it, your credit claim could get denied and you might end up owing penalties too. Nobody wants that. This wraps up our discussion on credits. Be sure when filing your return that you are maximizing everything available to you. Don’t let the G’men be keeping your money.

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November 24, 2025

What is a Tax “Write-Off” Anyway? Is It the Same as a Tax Credit?

For this friendly tax installment, we are going to reverse course from being in the tax weeds and bring it back to things that are basic. This installment is going to cover Tax Deductions and Tax Credits, what the difference is, and how they work.

I’m sure you have heard of a tax “write off”

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Maybe you have a friend that offers to pay for meals and says, “I can just write it off” or something to that effect. What does that even mean? Can you invite me to these lunches?

A more technical term for a tax write off is a tax deduction. All right, got it. Tax Deduction = Tax write off. Now what?

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Tax deductions are generally quite broad and cover a wide array of expenses given your specific set of tax circumstances. First we will start with how your tax is determined. Calculating tax starts with your income – the amount of money you earn, not necessarily the cash that hits your account. Once you have your income tabulated, you subtract or “deduct” expenses that are allowed under our tax laws to reduce your income. This is sometimes referred to as net income or taxable income. Your tax is then calculated based on your taxable income. So deductions reduce the amount of income that you are required to pay tax on.

Some common deductions for most individuals who are employees might be retirement plan contributions, HSA account contributions, student loan interest, or itemized deductions. Many individuals take advantage of the increased “standard deduction” rather than itemize those deductions. Taxpayers who own a business are permitted to deduct from their gross business income a much broader range of expenses – travel, payroll, advertising, and other expenses deemed to be necessary trade or business expenses.

Great, so if I can deduct it, that means the government is paying for it right, by reducing my tax, right?

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Going back to the above, your deductions reduce the income used for calculating your tax not your actual tax directly. If you spend $3,000 as a deduction, that does not translate to $3,000 in less tax. You have to look at your tax rate. If you are in the 20% marginal tax bracket, then that deduction would save you $600 in tax ($3,000 x .2). If you are in a higher bracket, then your deduction will reduce your tax more. You can think of deductions as buying things at a discount that is variable from taxpayer to taxpayer based on your tax bracket. You still have to spend the money, you just save some in tax later when you file your return.

So what are tax credits then? Is that even a real thing?

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Tax credits actually directly reduce your tax owed instead of the income on which your tax is calculated. They are factored in after the tax is calculated and reduce it dollar for dollar. You may be thinking “Well that sounds way better, lets just do that instead”.

That’s because it is better, but tax credits are limited by the government on purpose for this reason. You have to be eligible to qualify for them, and they are limited to specific circumstances. For example some prominent credits for individuals are the child tax credit, the earned income credit, the dependent care credit, and the American Opportunity tax credit. Each of theses credit will reduce your tax directly by the amount of the credit. Most of them have income limitations and/or other qualifications so that the credit is limited to the targeted groups. However, definitely take legal advantage of them if you can.

Business owners have other credits available to them as well on a host of things. The research and developmental expenditures credit is a big one meant to incentivize businesses to engage in new technology development or processes. In recent years, many environmental based credits have been opened up for both businesses and individuals to encourage investments in technologies or products deemed good for the environment.

One credit that has been in the news lately is the Employee Retention Credit. While in theory it was a great credit for business owners to retain employees throughout the pandemic, it was so throughly abused by fraudsters that the IRS shut the credit down and stopped processing new claims.

So, now you know the difference between tax credits and tax deductions. Tax credits are in effect much better but on the down side, much more limited in applicability. While tax deductions don’t reduce tax by the same degree as a credit, they are so much broader in availability that they can not be neglected.

I hope this helps the next time you are chatting with you friends about taxes (everyone does this right?) You will be able to throughly the discuss the merits of writing off that Starbucks Latte or new iPad.

As always, if you have specific questions about expenses that could be deductible or credits of which you could take partake, consult a qualified tax professional. This is a blog, not tax advice.

November 17, 2025

Reducing Taxes – Standard vs. Itemized Deductions

What’s the difference and why should you care?

So it is tax filing time. You have all your income documents and withholding ready to go. You are cranking through ready to wrap this up and get back to the things you like doing, which taxes are definitely not a part of, and you get to this question: Would you like to use the Standard Deduction or Itemize your Deductions?

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You may be tempted to select whichever option gets you done the fastest. Stop! Unless it is April 15th (or October 15th) at 11:59pm, the fastest choice may not be the best choice. Why you ask? Have no fear, faithful reader, I am here to set you down the right path.

Why it Matters

The short answer is that either one of the options save you money. Deductions reduce your taxes. How? They reduce the amount of money on which you have to pay tax. If you make $50K, a tax deduction of $10K would have you pay tax on $40K, which might save you $1,000 in tax if you didn’t have the deduction. Tax Credits work a little differently and I have dig into that in this fancy post here.

The Standard Deduction

So what is the “standard” deduction. Your mama always said you were special, and you are. The standard deduction is a base level tax deduction offered to all taxpayers. The amounts fluctuate primarily based on your filing status. We can cover filing status in another post. Often your age can increase the standard deduction you are eligible to claim as well. You are permitted to claim the standard deduction no matter how much money you make. The amount changes from year to year. The 2017 Tax Cuts and Jobs Act basically doubled the standard deduction amounts and reduced a lot of the need for itemized deduction filing.

Itemizing Deduction

The alternative to utilizing the standard deduction is to itemize out your deductions. The IRS Code allows taxpayers to deduct 5 broad categories of deductions, when combined, are your Itemized Deductions: Medical Expense, State and Local Taxes, Interest Expenses, Charitable Contributions, and Miscellaneous. There are nuances and details to all of these deductions that would need to be covered in separate posts like Explaining the Mortgage Interest Deduction. When Itemizing your deductions, you add the totals of each of these five categories and the total is your deduction. With itemizing deductions, your income matters. With the passage of the One Big Beautiful Bill, it reintroduced certain income limitations that factor into how much of your itemized deductions that you are permitted to deduct.

Pros and Cons

The biggest benefit of the standard deduction is that it is the simplest which also means quickest. You take the deduction allotted to your filing status. The downside is that you could be leaving money on the table. Conversely, the biggest benefit of itemizing your deductions is that you could save more tax dollars. The con of itemizing is the additional time it takes to gather documentation of your expenses and calculate each deductible amount. Depending on how you file your return, there could also be additional filing cost if your tax preparer charges extra to prepare Schedule A, the extra form you file to report your deductions, or your tax software may charge more to calculate it.

So How Do You Decide?

You may be feeling like you want to pull your hair out at this point. when comes to figuring out which deduction to you use. Usually, you just take the biggest…except when you don’t.

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It doesn’t always come down to picking the biggest. In most cases, it will. There are a couple of other items to keep in mind though. If your filing status is married filing separately, you are required to use the same deduction method as your spouse. You both have to either take the standard deduction or itemize. You can’t split. Another item to consider is state tax filings. In some instances, it could provide a better combined federal and state result to take a lower itemized deduction on the federal return so that you can take a larger itemized deduction on the state return. States generally follow IRS guidelines, but individual state standard deductions vary greatly, and they often have different thresholds for limitations on itemized deductions.

The IRS has tools to help you in calculating your itemized deductions and most tax softwares will help you optimize which is best on the federal return.

Summary

Here is a quick checklist to help you in your decision:

Filing Status – to determine the amount of your standard deduction

Information for potential itemized deductions:

Form 1098 for mortgage interest and maybe real estate taxes

W-2 for State income taxes paid

Documentation for major charitable deductions

How does your state standard deduction or itemized deduction vary from the federal?

There is your basic primer on taking the standard deduction or choosing to itemize. As always, this is a blog post and not intended to be considered tax advice. Taxes are highly dependent on your own personal situation and this post is just to point you in the right direction. Please consult and engage with a tax professional for recommendations regarding your own personal specific circumstances.

Until next time…

February 27, 2024

Estimated Tax Payments: What are they and How to be sure you aren’t behind?

One question that I get a lot from clients relates to confusion regarding estimated taxes. I get this question most often from taxpayers who have been employees for most of their careers and for whatever reason find themselves self-employed, either full-time or by just having a side gig.

Generally the questions fall around: “Do I have to pay quarterly estimates?”, “When are they due?”, and “How much do I have to pay?”

I’m going to lay down a “brief” primer on estimated taxes and why, primarily self-employed people, have to pay them.

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The Feds require all taxpayers to pay in both Income Tax and FICA taxes throughout the year as you earn your income. Taxpayers who are classified as employees (those that work for “the man”) have both of these taxes withheld by their employer before they ever get paid .

This is a pretty crazy development that we accept as the governed in that you agree to work with an employer for money and before you even receive it, the government carves out their share first. I don’t want to stand too long on this soap box. So, employees have their taxes withheld and remitted to the government by their employer every pay period, generally.

For those who are self-employed, the government does not yet have a practical way to get their hands on the funds nor appropriately assess how much to withhold since self-employed taxpayers pay tax on their net income (income after expenses) rather than their gross income (cash that comes in the door). Since self-employed taxpayers don’t have withholdings they are required to make tax payments every quarter for what they expect to owe. This is how we get the term “Quarterly Estimated Tax Payments”.

Taxpayers are required to reasonably estimate how much tax they think they will owe when filing a tax return after the year closes. Again this process is more difficult for a self-employed person rather than the employee. A self-employed taxpayer may know how much gross income they have in a quarter, but the net income may be completely different depending on what expenses they incurred to generate that income. These expenses reduce the amount of income they are required to pay tax on. FICA taxes complicate matters further. For employees, the FICA tax responsibility is shared between the employee and the employer, with each group remitting half of the tax. In reality, the employee bares the cost of the full tax, they just don’t feel it. Therefore it is accepted. One half of the tax is paid through direct withholding of the employee’s wages, the other half is indirectly paid by the employee in the form of suppressed gross wages that they never see because it is a cost of employment to the company. This unseen half is remitted to the Feds by the employer. For the self-employed, they are directly responsible for both the employee and employer portions and this is reported to the IRS annually as a part of their income tax return.

Since knowing what you are going to earn on a net basis may be difficult to predict, the IRS “offers” what are referred to as “safe harbor” calculations whereby, if you pay these safe harbors amounts, you will not be assessed any penalties for the underpayment of tax, even if you owe when you file your tax return.

The most commonly used safe harbor is related to the prior year tax. If your adjusted gross income (a tax return calculation) is less than $150,000, then as long as your estimated tax payments total at least 100% of the tax owed in the prior year, you will not be assessed a penalty for underpayment of tax, even if you owe $1,000,000. If your AGI for the prior year is over $150,000, then you have to pay 110% of the prior year tax to be eligible for this safe harbor.

The other safe harbor is much more subjective. You have to pay in 90% of the tax for the current year to avoid penalties for underpayment of tax.

So, when are your quarterly taxes due?

Payments are due to be sent by calendar year taxpayers (most everyone) on the following schedule:

April 15th

June 15th

September 15th

January 15th (following year)

These dates are adjusted forward if they happen to fall on a holiday or weekend.

Underpayment penalties are assessed on a daily basis, for each day and amount of tax that you are underpaid. When you file your return, the IRS generally assumes that you earned your income steadily throughout the year. If you have a highly seasonal business where the bulk of your earnings occurs in the 3rd or 4th quarter, you can fill out the schedule as part of the Form 2210 for calculating underpayment penalties. This will tell the IRS, “Hey, I didn’t earn my income evenly and I’m not underpaid.”

Still with me?

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I hope this helps you keep up with your tax payments when you start your own business or even a side hustle. When you want more info on tax impacts of side hustles check out my prior post HERE

Leave your tax questions or a personal story about estimated taxes down in the comments below. We will what kind of future post I can cook to answer them. Thanks for reading!

May 13, 2022February 20, 2024

3 Simple Ideas to Prevent your Side Hustle from Being a Tax Debacle

It seems everyone is looking for a little extra cash these days, particularly with the price of gas going up just a tick.

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One common option people are turning toward is the side hustle, taking underutilized skills or time outside of their day job and generating some extra cash.

Having some extra cash is great, but at some point, you get around to the question: do I have to pay taxes on my side hustle money?

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Survey Says – Yes, its taxable. That is the IRS default position on most income. As an example and not an idea endorsed here, the IRS maintains that even income derived from illegal activities is still subject reporting and income tax. The number one story told to all accountants in every fraud course, is that it was the accountants who took down Al Capone for tax evasion on his illegally earned income, not the actual racketeering or murder.

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So 3 things we are going go over today:

Income and Expense Tracking
Self-Employment Tax
Tax Form Reporting

I will sell you the whole seat, but all you will need is the edge.

Income and Expense Tracking. Reporting income from a side hustle is different than dealing with income you may receive from a job where you are employee. You will need to have a method for keeping up with payments you receive from you customers, even if it as simple as a piece of paper. Sometimes, it is easy and done digitally, like for Uber drivers, but at the end of the day you are responsible for reporting all of your income. If your side hustle is service related and you collect $600 or more from a single customer, that customer is required to send you a form 1099-NEC (Non-Employment Compensation). This will aid in helping you, but it will still be your responsibility.

On the flip side, you need a method to keep track of your expenses. Possible options could be as simple as paper or Excel, or there are numerous, easy to use accounting software packages to help you. (If you sell an accounting software and would like to sponsor this post, I am accepting sponsorships.) Keeping track of your expenses is extremely important as they will help minimize your tax burden. Have you ever heard the term “write off”? This is what that is.

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Self-Employment Tax. Income from side hustles falls into a different category of income than employment income. Side hustle income that we are talking about here is generally going to be considered self-employment income. Rather than being employed by a company that hires you as an employee, you are working for yourself. All businesses large and small are required to pay taxes based on the wages paid to their employees. These taxes go to fund Social Security and Medicare programs and are equal to 15% of your wages, up to various limits. I’m not going to bore you with limit discussions here but they exist. When you are an employee, this 15% tax is shared by you and the company you work for. The piece you pay directly is withheld from your paycheck and then company pays their other half to the IRS . When you are self-employed, you have to pay both side of the tax, out of the gross income you have collected from your customers. We could go into a discussion about how you really pay both sides of the tax as employee as well, via a reduced gross salary to account for your true cost of employment by the company but that is a soapbox for another day. Long story, but the self-employment tax can feel like a big bite of your earnings. The good news is that is it calculated on you net income (gross income minus expense) rather than your gross income. This is where those expenses come in handy we mentioned earlier.

Reporting. If you haven’t set up an organized company (See here for more on that), you will need to file a Schedule C with your income tax return. The Schedule C reports both your gross income and expenses while calculating your net taxable income. You will pay both income tax and self-employment tax based on the net income from your Schedule C. When you get paid from a company as employee, you most often have your all of your taxes withheld, both income and employment, before you ever even get paid. With Side hustle money, nothing has been withheld. This will unfortunately make your end of the year tax bill higher. A good rule of thumb in order to make sure you have some money set aside to pay your taxes at the year-end is to save about 25% of your gross income, until you have a good idea how much tax you have to pay.

Side hustles are great way to earn some additional cash, especially with companies like Uber, Door Dash, and other gig economy based apps in the marketplace. Even sites like Etsy are helping people use their skills to create fun unique items and bring them to a bigger market. Being prepared to deal with potential issues, like taxes, before they become a problem, will make that extra cash even better, rather than it becoming a big headache come filing season. Until next time:

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May 6, 2022May 9, 2022

Unrealized Gain – Why taxing them is a terrible idea

Recently, an idea has been proposed by our political “leaders” (cough, overlords, cough) that the unrealized capital gains of “billionaires” should be subject to a minimum level of income tax because they “aren’t paying their fair share” on these record levels of profits. See Comments by Secretary Yellen. Today class, we are going to be discussing why this is a bad idea and complete

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As everyone who wants money knows, the best place to get money is from those that already have it. And who has so much money that they don’t even notice the Benjis falling out of their pockets? Billionaires. Problem and solution, right? What’s the big deal? This article is going to, at first glance, come off like I’m trying to protect billionaires, who admittedly have a lot people smarter than I am to do that, but as you will see, I’m talking about issues that affect all of us. Also, in an effort to be honest with my tens of faithful readers, full disclosure, I am not a billionaire.

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If any of you feel very strongly about rectifying this, you can Venmo me at #accountantsneedmoneytoo.

Since I don’t have much faith in our public school system, we are first going to discuss a few terms we will be using quite a bit so that we all have a working knowledge in common. We will be talking about capital gains in this article and there categories of them – unrealized, realized, and recognized. Unrealized gains occur when the value of an asset, whether it be a publicly traded stock, piece of real estate, business interest or piece of art, increases in value above what you bought that asset for plus any additional expenses incurred in maintaining it. Your cost plus expenses is called basis. The difference between the increased value of the asset and your basis is the unrealized gain. For example, if you bought a house 10 years ago for $250,000 and then you added a sweet fire pit and pool to the back yard, for $100,000. Your basis is now $350,000. Since our real estate market is white hot (for now), if an appraiser says your property is now worth $2,000,000, you would have an unrealized gain of $1,650,000 but not have any actual cash in your hands.

Realized gains and recognized gains often occur together but not necessarily. A realized gain occurs when you actually sell that house and get cash (or other property) in your pocket. Say you only sell it for $1,800,000. Your realized gain is $1,450,000. Your recognized gain is what you have to tax on after your gain is realized. If you read a great blog post like this one: Sell your house and pay $0 tax, your recognized gain to calculate tax on would only be $950,000. The proposed tax change seeks to collapse these categories and have just the unrealized gain of $1,650,000 be taxable.

Why it is a bad idea

Fluctuating Nature of Value. One of the main reasons recognized gain is tied to the realization of gain is that realization of gain defines the value by converting your asset into dollars, generally. Assets are only worth what another buyer is willing to pay and until you actually transfer the asset, that value is subject to fluctuation.

We all know that stock values go up and down based general economic factors as well as circumstances specific to each company, real estate prices continuously fluctuate, and interest in a private business can change depending on a wide variety of factors. How would the fluctuating value of the assets affect payment of the tax from year to year? If the value of your asset goes down but you paid tax based on the value 12 months ago, are you able to request a refund the next year?

Another reason recognized gain (taxable gain) is tied with realized gain is that you actually have a liquid, trade-able asset (cash) to pay the tax, rather than something that may be without a ready market, like real estate. If tax is calculated on your unrealized gain, you don’t have a way to pay the tax since all of the value is still locked in the asset. This sounds like a great deal either for banks for financing or transactions markets as it could force liquidation of the very asset for the which you are paying tax.

Not applicable to just billionaires. This “billionaire” tax isn’t applied to just billionaires, even though, if it was, I would still have an issue with it. The tax would be applied to anyone worth $100 million dollars. I get it, these folks aren’t hurting for cash either, but calling it a billionaire tax and applying it to people with 10% of that level wealth is at best disingenuous and seems like an out right lie to make the public OK with the law. On to the next point.

Trickle down effects. Not talking about the economic effects on this one. This blog is about tax. Did you know our current income taxing system when it was ratified in 1913 (let’s not even bring up the income tax during the Civil War) was designed to “force the wealthy to take a on a fairer share of the federal tax burden”? Less than 4 percent of American families made an annual income of $3,000 or more, the floor to even be eligible for the tax¹. After deductions permitted, the pool of taxpayers was even smaller. Does this sound like anything you may have heard of? As we know it now, the general income tax affects at least 50% of American households. Our government has an incredibly poor history of instituting a tax under the guise that it will only affect a few and then expanding it once it is passed. See nearly every federal tax currently in existence. It seems foolhardy to expect that this tax would stay limited to the “few who need to pay their fair share”. If this is your expectation, History would like a word.

Establishing Value. Establishing value and basis in order to calculate these unrealized gains will be annual valuation headaches at best and nightmares at worst. Sure, some things like a publicly traded stock are easier to determine value, but what about the other component, the basis? For some stocks it will be quite simple, but for others, who maybe were owned privately before being taken public, have been paid in various types of restricted stock options or other types transaction, establishing basis can be involved. What about business interests that aren’t publicly traded. Will annual valuations by qualified professionals be required? Same for real estate and collectibles. Will annual appraisals of theses assets be necessary to determine the fair market value each year? Will basis be increased since tax has been paid on the gain moving forward? These are accounting questions primarily (adjusts nerd glasses) but they can get expensive and time consuming very quickly.

How does the Government know. I saved this point for last but considered putting it first. How does the Federal Government know who the $100 millionaires are? Sure, some investments are required to be disclosed to regulatory agencies, but not nearly all of them. Currently, the IRS is privy to primarily income documentation and reporting since that is what our tax is based on. Sure, income can give you an idea of who might be liable for the tax, but it has little to do with unrealized gains. That is the entire reason the government has proposed this idea in the first place. Will all taxpayers be required to assert that they are not liable for this tax via disclosure of their asset holdings and values? Will the IRS actively be reviewing this treasure trove of new data? They are limited in their ability to audit as it is. This would seem like a huge invasion of privacy of every tax payer in order to assess a tax that will initially be levied on less than 1% of Americans. These actions fall right in line with the previous proposal of requiring banks to report all transaction in excess of $600 to the government. That went over really well.

The Mueller Report See GIF - Find & Share on GIPHY

The Federal Government was designed to have limited ability to invade the privacy of the individual. The income tax already provides a greater window than many would like. This new unrealized gain tax would bust down the wall like the Kool-Aid man demanding that you give him your data.

Excited Oh Yeah GIF - Find & Share on GIPHY

So this ended up a pretty long post: In summary, it’s a bad idea for the following reasons:

Fluctuating asset values and liquidity to pay the tax
Not just billionaires
Trickle down effects
Establish value headaches
Huge privacy issues

For a shorter summary, see comments by Iceman.

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September 2, 2020

How to Crush the CPA Exam – One Man’s Guide

In my world of accounting, The Exam looms over new entrants to the profession or really anyone who hasn’t passed it yet. And I have seen a lot of really smart people struggle to get over this hurdle. It can be discouraging and maddening when you spend all of your time studying and then don’t find the success you crave. I’m here to help.

To be clear, I don’t have any magic to pass the exam. There isn’t a substitute for knowing the material. It requires a vast amount of studying. This post is about a couple of things that helped me score just enough points to be called a CPA. Feel the glory.

Develop skills in test taking

Tip #1 Break it down

Growing up in the age before Windows,

episode 4 before the empire GIF by Star Wars

(just kidding Widows is great), the Nintendo Entertainment System reigned supreme and computer games were only a shadow of what gamers experience now. They required using the Doss system (a blinking cursor) and a floppy disk (aka the save icon) to access your game through a string of typed commands that made no sense to me at the time, or now for that matter. Me being the cool kid I was growing up, could perform this sorcery whether I understood it or not. I had 4 primitive games, Win Lose or Draw ( which I still suck at), Wheel of Fortune (with a red headed Vanna White), Classic Concentration, and Jeopardy, Jr. I invested much more time in the latter 2 games than the former. Everyone knows Jeopardy and that is where we will spend most of our time but Classic Concentration was a great game consisting of a grid of tiles overlaid on a Rebus puzzle. Look it up. The goal was to solve the underlying puzzle that was uncovered as you match tiles in a game of memory. I have won enough virtual Chrysler Lebarons to start a dealership. Anyway, I learned a lot about test taking through these games.

Here is a secret to Jeopardy and a lot of tests in general… it isn’t always about knowing the exact fact that answers the question. I learned this so well growing up playing Jeopardy that it changed how I look at most questions and subsequently made me really good at trivia games. Seriously, I have played trivia games where it was me against whoever else was in the room, 3 or 15. I don’t lose.

When you are presented with a question in Jeopardy and the CPA exam as well, there are almost always clues within the question that can aid you in getting to the right answer, if you break the question down and sort through what you know, even if it isn’t necessarily the answer to question. Here’s an example from Jeopardy:

The Category is “Playwrights”, the question: His marriage to Marilyn Monroe inspired his play “After the Fall”

What can we learn about the answer from this question? It combines literature and pop culture. We are looking for a playwright, who wrote a play “After the Fall” and he was married to Marilyn Monroe. I know next to nothing about playwrights and have never heard of the play mentioned but I did know Marilyn Monroe had 3 husbands and that Joe Dimaggio (one of the 3) wasn’t a playwright. My pool of possible answers is down to 2 names now instead of hundreds of playwrights. I happened to know one other person she was married to, Arthur Miller, and that is the answer. By breaking down the question, I was able to get the answer without necessarily knowing the fact.

How does this principle apply? The CPA exam takes a bit of pride in that it requires you to select the “most correct” answer, meaning multiple answers could potentially apply but one answer does a better job than the others. Using the above methodology, you can sort out what you know and apply it to the question to eliminate answers and narrow your pool of potential answers. If you eliminate 1 answer as obviously incorrect, you increase your odds of guessing the correct answer by 8% from 1 in 4 to 1 in 3. That may not sound like a huge difference but getting 3 or 4 more questions right could make the difference between a 70 and a 75. If you can eliminate another answer, you increase your odds another 17% to 1 in 2. That is a huge increase. So break it down and take a guess.

Tip #2 Get Some Sleep

You can google numerous studies on the benefits of sleep. Sometimes it can feel like you need to cram, cram, cram and trade sleep for study. But without proper sleep, your ability to recall that information is severely limited and you haven’t adequately rested your body and mind. It is during sleep that your brain converts those last minute cram sessions into information that can be recalled. I have been known for having an above average memory (probably due to playing Classic Concentration) and I have noticed a significant difference in its function depending on the sleep that I get particularly over multiple days. It isn’t recommended taking the CPA Exam while drunk. Likewise, it isn’t recommended taking it exhausted. If you are embarking on a career in public accounting, you will have plenty of “opportunities” to pass up sleep and work instead. Take the sleep now.

Tip #3 Eat a Good Breakfast

Yes, even if “you don’t do breakfast”. To be clear, I don’t mean grab a poptart or egg McMuffin. Eat a legitimately good breakfast. Breakfast helps start your metabolism and get your brain working properly. If your only option is a bad breakfast or no breakfast, skip it then. But it doesn’t take long to scramble some eggs, toast some bread or eat some Greek yogurt. Eating a good breakfast will keep you from being hungry, which breaks your concentration, and will give you fuel for your brain to function. Despite your brain occupying 5%of your body weight, it can require 20% of your daily calorie usage. Feed it.

Tip #4 Take it as soon as you can

This is a tip that is universal but I realize may come too late for some. Take the test as quickly as you can after college. You will never be better equipped than right out of school to take this test. The CPA Exam covers a wide breadth of material, as did your accounting degree. Your job will not. Most likely you will focus in one area of accounting and the longer you wait, the more specialized you will become. Don’t misunderstand, experience and specialization are good for your career but not the test. The ability to study and the ability to take tests are largely learned. You won’t do this much in your career and those skills will atrophy.

As a young staff, in general, you will never have more time available to you than you do now to take this test. You may feel like you are busy and don’t have time but you are wrong. You will have busy season, but that will never go away. Then you may add a spouse, civic activity, and kids. After having a child, I can’t imagine trying to make time to study too. And that is just with one. Children are wonderful, and they take a ton of time. The more kids you have, the more time they you want to invest in them. I digress, but the point is, take the test as soon as you can after college.

Tip#5 Stay calm

Take a deep breath and focus on what you know. Noticing your breathing will help you to focus on what you can remember and move through the questions in a consistent way. Don’t get too bogged down on any one question. If you get hung, don’t overthink it, go with your gut.

It could be worse. “More Experienced” accountants love to tell the youngsters about how terrible the test used to be and how hard their experience was. In many respects, it was harder having to take all 4 parts over 2 days or whatever it was. But in our defense, there wasn’t as much material to cover in each section either. You’ve put in the work. Trust what you have done, and knock it out.

July 24, 2020

Getting Your Business Organized

Organization can mean different things from an accounting perspective. Most people would think it refers to how well you keep up with your receipts and tax docs. It does mean that but not in this post. In this post we are talking about how your business is organized, meaning, how it is setup and structured.

You may think, what is it the point of that? I have the next great industry disrupting doo-dad with orders to fill. Awesome. But how you have your business structure setup can have huge tax impacts now and in the future, depending on what you are doing.

One of the biggest reasons to organize your business is for protection. Certain types of entities (Corporations and Limited Liability Companies) can provide liability protection for you as the business owner. What is liability protection? Well, if someone gets hurt using your new doo-dad and they initiate legal action, in theory, your entity acts like Dikembe Mutombo protecting the rim and will protect your personal assets from creditors looking for restitution.

(Yes, I know that’s not Dikembe)

Thats a legal thing though and you may want to talk to an attorney about more details. Sometimes you can accomplish similar things using insurance.

There are multiple options to choose from: Sole Proprietorship, General Partnership, LLC, or Corporation. LLCs are can serve a lot of different functions if you are looking for flexibility, but taxation can get pretty tricky pretty quickly if you are operating in multiple states or trying to being in new capital. Corporations can be simpler but they aren’t as flexible and can subject your income to being taxed twice if you don’t plan properly.

Different entities fit different purposes. Right now, the top corporate rate is lower that the top individual rates, but that doesn’t mean you should automatically choose a corporation as your business structure. It is definitely a better fit than it used to be but if you get tripped up and get your income double taxed, the rate won’t be lower at all. There isn’t a one size fits all recommendation. Be sure to do your homework.

June 5, 2020

Getting rid of your house and Paying $0 in tax

As a professional practicing CPA (I know..I made poor life choices), I bet every other month I have a client ask a variant of the following question: “I’m selling my house. Do I have to pay tax on that?” Sometimes, the answer is “It depends on who you are asking”. If you ever ask someone from the government this question, the answer is nearly 9 times out of 10, you definitely have to pay tax. But I say in the immortal words of the great Lee Corso:

Inside the depths of the IRC (that’s tax speak for Internal Revenue Code) there lies a great exclusion from tax for the gain on the sale of your personal residence. Here is how it works. First off, you are only taxed on the gain you make off the sale, not your gross selling price. You are allowed to deduct things like:

brokerage commissions
home improvements
your original cost of the house

from the sales price. This net amount, the gain, is at most what you might pay tax on.

If you owned your house for at least 2 years and it was used as your personal residence for at least 2 out of the last 5 years, you can exclude up to $250,000 of gain income from taxation. If you owned the home jointly with your spouse, you both get the exclusion. That’s $500,000 of gain to be excluded from tax.

That’s the basics. Like everything in the IRC, there are a bunch of other details that can affect this “simple” exclusion like:

I own multiple personal residences
I didn’t own it 2 years
My spouse died
What is a personal residence?
I rent it out

If you run into questions like these, contact a professional for help. Don’t call the IRS. They’ll just tell you its taxable.