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4 Big Legal Changes That Will Hit Your Wallet in 2018

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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With all eyes on the GOP’s sweeping plans for tax reform, it’s easy to lose sight of other policy changes that could have an impact on your wallet.

In 2018, there are at least three key policy changes to keep tabs on — adjustments to Social Security benefits, 401(k) contribution limit changes, and the preservation of one of the year’s most controversial financial rules.

Here’s what you need to know:

More Social Security benefits

For Social Security beneficiaries, there is a lot to be excited about in 2018.

The cost-of living-adjustment, which determines the amount of money people receive from the system, is rising by 2 percent, the largest increase in five years. This means a growth in benefits for the more than 61 million recipients currently who currently utilize Social Security in America.

Additionally, the maximum payout—which is the amount you can receive once you’re eligible for 100 percent of your benefits—is also increasing, with the figure growing from $2,687 per month to $2,788 per month.

Greater 401(k) contributions

Saving for retirement will also be a little easier in the coming years, as the Internal Revenue Service announced that the annual limit for 401(k) contributors will increase by $500 in 2018.

Previously, anyone participating in a 401(k) or 403(b) plan, the majority of 457 plans, or the  Thrift Savings Plan could set aside $18,000 per year, but the number will grow to $18,500. To see how much this change might affect your retirement funds, you can use this calculator to track how your 401(k) funds will grow over time.

Mandatory arbitration contracts

Earlier this year, the Consumer Financial Protection Bureau (CFPB) issued a regulation banning mandatory arbitration clauses, the often-controversial sections of consumer contracts that effectively prevent customers from filing class-action suits against a company they are doing business with, such as a bank.

However, this law, which was set to come into effect in 2018, has been overturned by Congress, meaning the rule will remain in effect.

Martin Lynch, the compliance manager and director of education for Cambridge Credit Counseling Corp. in Agawam, Mass., says the repeal of the CFPB’s rule is a major defeat for consumers because forced arbitration is often used to scare customers out of taking action against the corporate world.

“That’s not fair, almost by definition,” says Lynch, who is also a member of the board of directors for the Financial Counseling Association of America. “It’s why the concept of consumer protection exists in the first place.”

Still to be determined: The GOP tax bill

It seemed as though 2017 might be yet another slow year for tax legislation. Then earlier this month Republican lawmakers moved to pass what is could be the biggest American tax overhaul since the 1980s.

While the U.S. House of Representatives and Senate still have to agree on a singular version of the new bill, which likely include close to $1.5 trillion in total tax cuts — $900 billion of which will be for businesses alone — they’re rushing to meet President Donald Trump’s Christmas deadline.

“If any or all of the proposed changes get enacted, we will have a lot to be concerned with,” says Cindy Hockenberry, director of tax research and government relations for the National Association of Tax Professionals.

So how will the Republican tax bill—in its current form—most affect consumers? Next year, not very much. The plan’s changes, which technically go into effect on Jan. 1, 2018, will be mostly marginal until 2019 because Americans will mostly be able to file their taxes in April under the current rules.

Being aware of these changes can help you plan in advance because filing taxes in the coming years might be extremely different, depending on your income bracket and your usual deductions. While the bill—officially named the Tax Cuts and Jobs Act—is not yet finalized, here are the parts of the bill’s current form that consumers are likely to feel the most:

  • Your income tax bracket could change: The House version of new law would reduce the number of standard tax brackets from seven to four, meaning many Americans would pay a new percentage of their income in 2019. You can check out this chart of the proposed percentages to see how your taxes might change.
  • Your state and local tax deductions will probably go away: The Senate plan would eliminate the State and Local Tax (SALT) deduction. This means that if you typically itemize your taxes—instead of just taking the standard deduction— you will be unable to write off taxes paid to state and local governments on your federal filing.
  • You will no longer be able to deduct a personal exemption: Currently, you can take a $4,050 “personal exemption” from your return that doesn’t count toward your taxable income. Under both the House and Senate bills, this option would disappear, however the standard deduction you can take each year would almost double—increasing from $6,350 to $12,200 under the House bill.

Hockenberry, who is based in Appleton, Wis., says the most important part of the plan is its proposed elimination of the personal exemption and a number of itemized deductions. Some Americans might have to pay more each year, she added, because the increase in the standard deduction might not be enough to make up for these changes, causing some consumers’ taxable income to grow.

Dillon Thompson
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Dillon Thompson is a writer at MagnifyMoney. You can email Dillon here

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How to Maximize Your FSA and Transit Benefit Before You Lose It

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

By Brittney Laryea & Shen Lu

 

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The end of the calendar year is generally an important time to pay attention to your workplace benefits accounts. You may already have gotten an email from the head of your workplace’s HR department about making your elections for the coming year and maybe even made them already. While you’re at it, take a look at the balances in your flexible spending accounts and transportation benefits accounts — they may need your attention.

Workplace benefit accounts like your health flexible spending account (FSA) and transportation benefits accounts help you save money on the important line items in your budget like your healthcare bills and getting yourself to and from work. Since the accounts are funded with pre-tax dollars, you could help your dollars go up to 40% further on common expenses — like getting a checkup or a bus pass — that help you keep and maintain your job. However, if you don’t quite know how to best use these accounts, you could actually end up losing the money you have socked away in your benefits accounts.

Read on or click ahead to learn the ins and outs of using these benefits accounts and what you can do, if anything, to save your money when you’re in danger of losing it.

Flexible spending accounts

What is a flexible spending account?

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A flexible spending account (FSA) is an employer sponsored reimbursement plan. It allows you to set aside pre-tax money and spend it on eligible medical expenses.

For 2018, you can contribute up to $2,650 to your health FSAs, up from the 2017’s limit of $2,600.

In an ideal world, you’ll avoid losing income by using up all your funds for eligible medical expenses by deadline. But the reality is that it’s tricky to budget for medical expenses for the next year (generally you can only adjust your contribution from each paycheck during open enrollment or during a qualifying life event, such as marriage or birth of a child). Many find themselves with excessive balance in their medical FSA at the end of the year.

It’s actually not that flexible given its “use it or lose it” rule — you have to use all the funds by the deadline, otherwise you lose the money. Several plan advisers confirmed to MagnifyMoney that many people underutilize their medical benefits. FSAStore.com, a one-stop-shop website stocked with FSA-eligible products, reported that each year, hundreds of millions of dollars was forfeited back to employers simply because consumers do not deplete the funds in their accounts.

So how can you make the best use of your medical FSA and avoid wasting money? We have done research and asked experts for you.

How can I use my health FSA funds?

First off, the medical FSA reimburses you for you or your dependent’s expenses that are not paid by your health insurance.

The eligible expenses include copayments, coinsurance and deductibles, prescription costs, vision and dental expenses and many over-the-counter (OTC) items — prescribed or unprescribed. But note that you cannot pay your monthly insurance premiums with the FSA.

If you have money left over in your FSA, you may want to consider getting new prescription glasses, prescription sunglasses and contact lenses. Those are some of the most common big-ticket items you can purchase with your FSA.

You can also stock up on things like first aid kits, contact solution, bandages and sunscreen that you may use year-round.

Your FSA plan provider will have a list of eligible over-the-counter items you can purchase at the pharmacy with your FSA, such as this one. Many of the pharmacy sites have sections of their sites that list all the FSA eligible items.

Another possible way to use the money would be scheduling check-ups with all your physicians. Your annual physicals and other preventative care are covered by your health plan, but if you need special medical treatment, you can use the remaining funds for copays, coinsurance or prescriptions.

Many FSA providers recommend you visit FSAStore.com.

How much should I contribute to my health FSA?

Becky Seefeldt, director of marketing at Benefit Resource, a benefits programs provider, said the average 2017 contribution was $1,250, based on the company’s 300,000 participants. That’s roughly half of the maximum amount one could contribute for the year. For those who over-contribute to their FSAs, by the end of the year, Seefeldt said, they usually have less than $100 left in their account.

Experts suggest you contribute conservatively because there is a chance that the unspent money might be forfeited. But everyone has a different situation; it’s hard to give a single guideline that fits all.

You really need to do the math when budgeting your contribution for the next plan year during open enrollment.

Nicole Wruck, a national health practice leader at Alight Solutions, told MagnifyMoney that most of the company’s clients over-contribute every year. She suggests consumers keep track of their health care expenses they had over the last year and plan accordingly for the coming year.

You will need to do the math based on the factors below:

  • What did you spend on prescription drugs?
  • What did you spend at the doctor, or the dentist, or the eye doctor?
  • Do you have any upcoming things planned in the next year that might make you experience some additional costs? For example, are you or your dependent expecting a baby? Will you need new glasses?

To help yourself run the numbers, you will want to study your health care plans. Know your deductibles — the amount you pay for health care services before your health insurance begins to kick in — as well as your copays and coinsurance. Learn what your out-of-pocket maximum is — the most you have to pay for health care services in a plan year. After you hit your out-of-pocket max, your insurance company covers your healthcare costs for the rest of the year.

Visiting your doctors can also help. Sometimes your year-end doctor visits can help you estimate your next year’s out-of-pocket medical expense. For instance, if your dentist tells you that you will need orthodontic treatment in the near future, then consider maxing out your FSA for the next plan year to cover the big dentist bills your insurance company won’t pay.

What happens to leftover funds at the end of the plan year?

Traditionally, you would have to use up all your remaining funds by Dec. 31. But there are two options employers can adopt to make the rules more lenient now.

The roll-over option. It allows up to $500 in your FSA per year to roll over into the next plan year, so participants don’t have to rush to use the remaining funds. Seefeldt said about 40 percent of employers now adopt the roll-over option.

An extended grace period. This gives participants an additional two and half months — through March 15 — to use up the money from the previous year. At the end of the grace period, all unspent funds will be forfeited to the employer.

Depending on how your company decides to do with the FSAs, you may have a little bit more leeway to use your funds by the year end. Check with your human resource department and your FSA plan provider to find out which option is available to you.

What happens if I leave the company before I use all my FSA funds?

If your eligible expenses incurred before you left the company, you may be able to request reimbursement through your company’s claim submission deadline.

If you leave the company in the middle of the year but you have used more funds in your flexible spending account than contributed. You may not be required to pay back your company.

You have access to the total amount you have allocated for the year after your first medical FSA deposit, regardless of the balance in your flexible spending account. You are reimbursed based on your company’s pay schedule as you submit claims.

For example, if you elected to put $2,000 into your FSA throughout the year, and you have a $2,000 dental expense in May, your FSA would reimburse you for the whole $2,000, even though you’ve only contributed about $833 by then.

If you jump ship in August, you may not have to pay back the rest of your contribution. Your company will cover it: It agrees to take the potential financial risk when it signs up for the FSA program. Don’t feel too guilty just yet — your company may be able to offset the financial loss with the unspent funds forfeited from other employees.

Now, if you have money left unused in your FSA, first, try to use it as much as you can before you part ways. But If you can’t use it up by your last day, you may have a chance to extend your FSA benefits if you choose to enroll in COBRA.

COBRA allows former employees, retirees, spouses and dependents to get temporary continuation of health benefits at group rates. FSA is one of the COBRA-eligible benefits.

Generally, you have until the end of plan year to use up money left in your FSA through your prior employer, but it’s most common for someone to take their FSA COBRA for one or two months and use the funds quickly, Seefeldt said. Under COBRA, you can continue to make your health plan contributions (but pay an additional 2 percent administrative fee) before the new plan kicks in, according to the Society for Human Resource Management.

Say you leave your company in August but there is $400 left in your FSA, and you plan to continue your health insurance coverage through your previous employer for two months before your new insurance plan kicks in, you can keep submitting expenses up to $400 in that period of time but pay an administrative fee that’s 2 percent of your monthly premium. But you are not required to purchase the health coverage in order to use your FSA balance.

Again, money in your FSA cannot be used to pay your premiums. But you can use it to cover eligible medical costs.

If you’re not eligible to continue your FSA through COBRA, try to use up the money before your job ends so that you won’t leave it on the table.

Transportation benefit accounts

What are commuter benefits?

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Transportation benefit accounts, also known as commuter benefits accounts, let employees use pre-tax dollars to pay for the costs of commuting. The accounts are meant to act as an incentive for employees to use eco-friendly transportation options like carpools, mass transit or bikes on their commute to the workplace.

Commuter benefits help many workers save on their transportation costs. But, it’s possible just as many workers aren’t completely sure how their transit benefit account works, or how to make the most of it.

How can I use my commuter benefits?

If you drive to a park-and-ride, catch mass transit or ride a bike to get to work, you may be able to use pre-tax dollars contributed to a commuter benefits account to cover some or all of the cost of your commute. However, if you ride solo to work or don’t use a bike or mass transit options available to you, you won’t be able to use commuter benefits to, let’s say, pay for the gas your personal vehicle burns during your bumper-to-bumper commute each morning.

However, you may be able to take advantage of parking benefits, which we’ll explain below.

You can use the money in a transportation benefits account to pay for any of the following eligible expenses:

  • A ride in a “commuter highway vehicle” to or from home and work.
    • This is another way of saying carpooling. Riding to work in a commuter highway vehicle counts if the vehicle can seat at least 6 passengers, according to the IRS. You might not have to go through the hassle of organizing a carpool with your coworkers or neighbors to use your transportation funds this way. Some commuter benefits programs allow you to carpool using rideshare apps like Lyft or Uber, too. All you’d need to do is use your commuter benefits card to pay for UberPOOL or Lyft Line rides and join the carpool when it arrives to pick you up.
  • A transit pass.
    • A transit pass is any pass, token or other tool that permits you to ride mass transit — like a train, ferry or bus — to work.
  • Qualified parking.
    • If you need to pay to park on or near your workplace, or you have to pay for parking in order to catch a ride on public transit for work or you pay for parking for any other work-related reason, you can use your transportation benefits to cover the charge.
  • Qualified bicycle commuting reimbursement.
    • You can use up to $20 per month in transportation benefits to purchase a bicycle, make improvements or repairs to the bike, and pay for bike storage as long as you use the bicycle for regular travel between home and your workplace. Be warned: If you use your transportation benefit to be reimbursed for commuting via bicycle at some point during the month, per IRS rule, you won’t be able to use the transportation funds for any of the three aforementioned eligible expenses in that particular month.

How much should I contribute to my transit benefit?

How much you contribute to your commuter benefits account will depend on how much you spend on transportation to and from work each month. Look at your monthly commuting expenses. Do the math to figure out what you would need to contribute from each paycheck to cover the cost of your commute to work. To avoid over-contributing to your transportation benefits account, be sure to to pull out a calculator.

Step 1: Estimate how much you spend on transportation expenses — monthly parking pass, bus pass, etc. — each pay period.

Estimating your commuter benefits should be easier than, say, trying to guess how many doctor’s visits or prescriptions you’ll need to cover in the coming year. “With a commuter benefit you are making an estimate,” says Joseph Priselac, Jr., CEO P&A Group, a Buffalo, N.Y.-based employee benefits administration company. “As long as you have a job and you know you’re going to keep going to it, you know how much you will spend.”

Step 2: Elect to contribute that amount for the year. The amount you elect will be divided by the total number of remaining pay periods for the year. The benefit will be deducted from each paycheck and placed in your transportation account for your use when you need it. If you change your annual contribution, the remaining number of deductions will be adjusted accordingly to reflect the change. If, for example, you elect $1,200 for the year and are paid monthly, $100 pre-tax will be deducted from your paycheck to your transportation account.

Beware of contribution limits

Commuter benefits: In 2017, the maximum monthly pre-tax contribution limit for commuter benefits is $255, or $3,060 in a year. Moving forward, the IRS may decide to change that limit. The federal agency reviews and sets the limit annually. If you bike to work, you max out at $20 per month.

Parking benefits: An additional $255 per month. If you’ve got to ride mass transit to get to work and pay for parking, Priselac says that limit is technically doubled, since you can max out $255 for parking and another $255 for mass transit passes each month.

Unless you are certain sure you will use up the maximum in transportation spending for the year, don’t simply contribute the maximum amount you can to your transportation benefits account.

What if I want to reduce my contribution?

If, for whatever reason, you decide you don’t need to contribute as much or you want to contribute more to your transit benefit fund during the year, that’s not a problem.

Unlike an FSA, for which your contribution election can’t be changed during the year, “you can change your election anytime you want,” says Priselac.

To clarify, you can change your commuter benefits election as often as your company allows. For some, that may be once per pay period, for others, it may be once per quarter. It’s one of the few benefits you can change mid-year. Consult with your employer’s human resources department to find out how often you are able to change your election.

“If you’re not sure how much you will be spending, start by contributing a small amount,” says Caspar Yen, Senior Director of Product Management at Zenefits, a human resources software company. “There’s no need to over contribute to play it safe.”

That said, if you feel you’ve contributed too much to your commuter benefits account to use up within the period, you can stop the deductions and use up the balance you’ve accumulated until it runs out, then restart your contributions. Just be sure to keep an eye on your transportation benefits balance so you know when to restart your contributions.

What happens to leftover funds at the end of the year?

Transit benefits rollover each year so long as you are still with the company and the company still offers the benefit. That means you don’t have to rush to use leftover funds at the end of the year.

This is in contrast to a flexible spending account, which has a ‘use it or lose it’ rule, which we covered above.

In a sense, there is no ‘plan year’ for transportation benefits, although your company may ask that you confirm you’d like to stay enrolled in the program each year when you elect your annual benefit contributions. Transportation benefits accounts roll over each pay period and should roll over into the coming period at the end of the year. That means there’s no danger of losing any of the money you’ve contributed so far, as long as you remain employed with that particular employer.

What if I quit my job or get laid off?

“As long as you are still working there and you have work related transit expenses the money stays,” says Priselac.

But if you quit your job or are laid off you could lose some or all of the money remaining in your transportation benefits account. If you’ve been over-contributing, any money you don’t use up will be lost to you, and returned to your employer.

The good news is that some benefit programs will give employees a grace period to submit reimbursements requests for any transportation expenses incurred during their employment — even if they quit.

If you know you may no longer be with the company or the company is planning to terminate its program, there’s one thing you can do to save your money.

“Before leaving a company, employees can make a large eligible purchase,” says Yen.

In the Bay Area, for example, an employee can purchase a clipper card with up to $300 in credits. If the transit method you take offers individual tickets, you could purchase a large number. Or, if you are able to load your transit pass with cash, you could place a large amount on your pass.

For example, those in the New York City metro area might load a large amount of money onto their MetroCard and use it up until it’s depleted.

Whenever you’re making a decision about benefits, it helps to talk to your HR department or the benefit provider, just to be sure you understand the rules. Mistakes you make when choosing benefits can end up costing you a lot of money, so ask questions and avoid leaving your decisions to the last minute of open enrollment.

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4 Ways the House Tax Bill Could Affect College Affordability

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Congress is working around the clock to get a new tax bill to President Trump’s desk before the year is out. In addition to a host of tax cuts, both the Senate and House GOP tax plans include several proposals that could make saving and paying for higher education more costly for families. Considering Americans hold a collective $1.36 trillion in student loan debt and 11.2 percent of that balance is either delinquent or in default that’s not-so-good news for millions of Americans.

Both plans  include proposed ideas that could impact how students and families finance higher education. The House plan, for instance, includes proposed provisions that would affect the benefits parents, students and school employees like graduate students receive, which could ultimately impact the price students pay.

In a Nov. 6 letter to the House Ways and Means Committee opposing the provisions, the American Council on Education and 50 other higher education associations states that  “the committee’s summary of the bill showed that its provisions would increase the cost to students attending college by more than $65 billion between 2018 and 2027.” They reaffirmed their opposition in a Nov. 15 letter.

The council and other higher education associations weren’t satisfied with the Senate’s version of the Tax Cuts and Jobs Act, either. In a Nov. 14 letter, the council says it’s pleased the Senate bill retains some student benefits eliminated in the House version, but remains concerned about other positions that it says would ultimately make attaining a college education more expensive and “erode the financial stability of public and private, two-year and four-year colleges and universities.”

Where are the bills now?

Updated: U.S. senators voted 51-49, to pass a revised, 479-page version of the Tax Cuts and Jobs Act in an early morning vote Dec. 2. The vote was almost entirely along party lines. Only one Republican senator, Bob Corker (Tenn.), voted against the tax bill, citing concerns about adding to the federal deficit. No Democrats backed the bill. Analysis of the bill as-passed is ongoing. However, the Joint Committee on Taxation posted its most-recent analysis of the Tax Cuts and Jobs Act to its Twitter account just after the bill’s passing Saturday.

The House version of the Tax Cuts and Jobs Act passed by a 227-205 vote on Nov. 16, just before the chamber’s Thanksgiving holiday. No Democrats backed the bill. The two chambers will now need to hash out many differences between the proposed tax plans before sending legislation to the president’s desk by year’s end.

In its plan, the Senate committee says the goal of tax reform in relation to education is to simplify education tax benefits. MagnifyMoney took a look at a few of the major proposed changes to the tax code that would impact college affordability most.

Streamline tax credits

The House tax bill proposes to repeal the Hope Scholarship Credit and Lifetime Learning Credit while slightly expanding the American Opportunity Tax Credit. The new American Opportunity Tax Credit (AOTC) would credit the first $2,000 of higher education expenses (like tuition, fees and course materials) and offer a 25 percent tax credit for the next $2,000 of higher education expenses. That’s the same as it is now, with one addition: The new AOTC also offers a maximum $500 credit for fifth-year students.

The bigger change is the elimination of the other credits. Currently, if students don’t elect the American Opportunity Tax Credit, they can instead claim the Hope Scholarship Credit for expenses up to $1,500 credit applied to tuition and fees during the first two years of education; or, they may choose the Lifetime Learning Credit that awards up to 20 percent of the first $10,000 of qualified education expenses for an unlimited number of years.

Basically, in creating the new American Opportunity Tax Credit, the House bill eliminates the tax benefit for nontraditional, part-time, or graduate students who may spend longer than five years in the pursuit of a higher-ed degree. According to the Joint Committee on Taxation, consolidating the AOTC would increase tax revenue by $17.5 billion from 2018 to 2027, and increase spending by $0.2 billion over the same period.

The Senate bill does not change any of these credits.

Make tuition reductions taxable

The House bill proposes eliminating a tax exclusion for qualified tuition reductions, which allows college and university employees who receive discounted tuition to omit the reduction from their taxable income.

A repeal would generally increase the taxable income for many campus employees. Most notably, eliminating the exclusion would negatively impact graduate students students who, under the House’s proposed tax bill, would have any waived tuition added to their taxable income.

Many graduate students receive a stipend in exchange for work done for the university, like teaching courses or working on research projects. The stipend offsets student’s overall cost of attendance and may be worth tens of thousands of dollars. As part of the package, many students see all or part of their tuition waived.

Students already pay taxes on the stipend. Under the House tax plan, students would have to report the waived tuition as income, too, although they never actually see the funds. Since a year’s worth of a graduate education can cost tens of thousands of dollars, the addition could move the student up into higher tax brackets and significantly increase the amount of income tax they have to pay.

The Senate bill doesn’t alter the exclusion.

Eliminate the student loan interest deduction

Under the House tax bill, students who made payments on their federal or private student loans during the tax year would no longer be able to deduct interest they paid on the loans.

Current tax code allows those repaying student loans to deduct up to $2,500 of student loan interest paid each year. To claim the deduction, a taxpayer cannot earn more than $80,000 ($160,00 for married couples filing jointly). The deduction is reduced based on income for earners above $65,000, up to an $80,000 limit. (The phaseout is between $130,000 and $160,000 who are married and filing joint returns.)

Nearly 12 million Americans were spared paying an average $1,068 when they were credited with the deduction in 2014, according to the Center for American Progress, an independent nonpartisan policy institute. If a student turns to student loans or other expensive borrowing options to make up for the deduction, he or she could  experience more financial strain after graduation.

The Senate tax bill retains the student loan interest deduction.

Repeal the tax exclusion for employer-provided educational assistance

Some employers provide workers educational assistance to help deflect the cost of earning a degree or completing continuing education courses at the undergraduate or graduate level. Currently, Americans receiving such assistance are able to exclude up to $5,250 of it from their taxable income.

Under the House tax plan, the education-related funds employees receive would be taxed as income, increasing the amount some would pay in taxes if they enroll in such a program.

A spokesperson for American Student Assistance says if the final tax bill includes the repeal, it may point to a bleak future for the spread of student loan repayment assistance benefits, currently offered by only 4 percent of American companies.

Take care not to confuse education assistance with another, growing employer benefit: student loan repayment assistance. The student loan repayment benefit is new and structured differently from company to company, but generally, it grants some employees money to help repay their student loans.

The Senate plan does not repeal the employer-provided educational assistance exclusion.

Brittney Laryea
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Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Republican Tax Reform: Is Your 401(K) Tax Break on the Chopping Block?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Republican lawmakers are under pressure to put out new tax reform legislation by year’s end, but to make that happen, they need ways to pay for the hefty tax cuts proposed so far.

A proposal from President Trump calls for tax cuts for taxpayers at every income level, a reduction in the corporate income tax to 20 percent from 35 percent, and the end of the estate and alternative minimum taxes, among other things.

So far, implemented as is, the plan would add $1.5 trillion to the federal deficit, according to the Tax Policy Center. The deficit is the amount by which total government spending exceeds tax revenues for the fiscal year.

Such calculations have Republicans scrambling to figure out a way to achieve tax reform without adding to the deficit.

This week, Republicans lawmakers were rumored to be considering offsetting the cost of their tax cuts by reducing the 401(k) contribution limit for workers. (Trump swiftly denounced that plan on Twitter.)

At the moment, workers under 50 are able to contribute up to $18,000 in pre-tax dollars each year to a 401(k) retirement account. The amount is tax-deductible and reduces the overall amount the worker pays in annual federal income tax. The tax-deductible contribution limits are set to rise to $18,500 and $24,500, respectively, in 2018.

The Wall Street Journal reports Republican house leaders were considering a plan that would cut annual tax-deductible contribution limits on 401(k)s and, possibly, IRAs, down to just $2,400.

Workers would need to place any amount they’d like to save above that limit in a Roth IRA, which would be a boon to the federal government. Contributions made to Roth accounts are taxed immediately, not when the benefit is drawn out as with 401(k)s, so it would be one way to drive up tax revenue in the face of tax cuts.

On Oct. 23, Trump tweeted, “There will be NO change to your 401(k).”


Started by the IRS in 1978, retirement savings plans like the 401(k) and Individual Retirement Account (IRA) have been financial staples among middle-class families. And as pension plans have been phased out over time, defined contribution plans like the 401(k) plan have taken their place as a principal retirement vehicle for those families.

The proposed limit could prove costly to many Americans, as they are likely contributing above $2,400 annually to a 401(k) retirement account. According to Fidelity Investments, the average 12-month savings rate for 401(k) accounts in 2016 reached a record high of $10,200.

The notion of cutting back the amount workers can contribute, tax-free, to retirement accounts is understandably unsettling to many workers and members of the asset management community. That’s in part because, as Trump has noted on Twitter, 401(k) contributions allow many middle-class Americans a tax break.

Here’s how it works. For this example, we based our estimates on 2016 income tax brackets.

Let’s say Robin is  head of her household and drew a base salary of about $55,000 in 2016, placing her in the 25% tax bracket. She deferred 15% of her pre-tax income, or $8,250, to her 401(k) retirement account. Her $8,250 contribution reduces her annual taxable income to $46,750.

That newly calculated income not only dropped Robin to the 15% tax bracket, but she also saved nearly $1,700 in federal income taxes.

The administration’s tax plan reduces the seven existing tax brackets to just three — 12,  25 and 35 percent (with a possible fourth tax bracket for the highest-earning individuals). But the plan did not specify income ranges. As of this writing, it is unclear which incomes would fall into which bracket.

For the purposes of this example, let’s assume that Robin’s income would still land her in the 25 percent income tax bracket.

With a  401(k) contribution limit reduced to $2,400, she would have been taxed on $52,600 at a 25 percent tax rate. That would have increased the amount she paid in federal income tax to $7,297.50 from $6,350 in 2016.

Moving forward

It’s unclear if the new tax bill will actually include a reduction in 401(k) contribution limits. But one thing that is clear is this: If the tax-reform measures are to pass, funding for more than $1.5 trillion in lost revenue to tax cuts over the next decade has to come from somewhere.

The plan proposes to reduce the tax burden on middle-class Americans by doubling the standard deduction Americans can make when filing their federal income taxes to $12,000 for individuals and $24,000 for married couples filing jointly. However, it would eliminate the option to itemize deductions instead of using the standard deduction. The proposed plan would also increase the child tax credit — currently $1,000 — by an unspecified amount and create a $500 tax credit for nonchild dependents, like elderly family members. These and other tax cuts may translate to big losses in federal tax revenue.

An independent analysis by the Tax Policy Center, a nonpartisan think tank, claims the new tax plan would reduce federal revenues by $6.2 trillion over the first decade, while federal debt could rise by at least $7 trillion in the same period.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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File Taxes Jointly or Separately: What to Do When You’re Married with Student Loans

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Married couples with student loans must make a difficult decision when they file their tax returns. They can choose to file jointly, which often leads to a lower tax bill. Or they can file separately, which may result in a higher tax bill, but smaller student loan payments. So which decision will save the most money?

First, let’s discuss the difference between the two filing statuses available to married couples.

Married filing jointly

Married couples always have the option to file jointly. In most cases, this filing status results in a lower tax bill. The IRS strongly encourages couples to file joint returns by extending several tax breaks to joint filers, including a larger standard deduction and higher income thresholds for certain taxes and deductions.

Married filing separately

Because married couples are not required to file jointly, they can choose to file separately, where each spouse is taxed separately on the income he or she earned. However, this filing status typically results in a higher tax rate and the loss of certain deductions and credits. However, if one or both of the spouses have student loans with income-based repayment plans, filing separately could be beneficial if it results in lower student loan payments.

For help figuring out which filing status is better for married couples with student loans, we reached out to Mark Kantrowitz, publisher and Vice President of Strategy at Cappex.com. Kantrowitz knows quite a bit about student loans and taxes. He’s testified before Congress and federal and state agencies on several occasions, including testimony before the Senate Banking Committee that led to the passage of the Ensuring Continued Access to Student Loans Act of 2008. He’s also written 11 books, including four bestsellers about scholarships, the FAFSA, and student financial aid.

Two Advantages to Filing Taxes Jointly:

  • Most education benefits are available only if married taxpayers file a joint return. This can affect the American opportunity tax credit, the lifetime learning credit, the tuition and fees deduction (which Congress let expire as of January 1, 2017, but is still available for 2016 returns), and the student loan interest deduction.
  • Couples taking the maximum student loan interest deduction of $2,500 in a 25% tax bracket would save $625 in taxes. But this “above the line” deduction also reduces Adjusted Gross Income (AGI), which could yield additional tax benefits (e.g., greater benefits for deductions that are phased out based on AGI, lower thresholds for certain itemized deductions such as medical expenses, and miscellaneous itemized deductions).

However, there is a potential downside to filing jointly for couples with student loans.

Income-driven repayment plans use your income to determine your minimum monthly payment. Generally, your payment amount under an income-based repayment plan is a percentage of your discretionary income (the difference between your AGI and 150% of the poverty guideline amount for your state of residence and family size, divided by 12).

  • If you are a new borrower on or after July 1, 2014, payments are generally limited to 10% of your discretionary income but never more than the 10-year Standard Repayment Plan amount.
  • If you are not a new borrower on or after July 1, 2014, payments are generally limited to 15% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount.

Because filing jointly will increase your discretionary income if your spouse is also earning money, your required student loan payment will typically increase as well. In some cases, the difference is negligible; in others, this can add up to a pretty significant cost difference.

“Calculating the trade-offs of income-driven repayment plans versus the student loan interest deduction and other benefits is challenging,” Kantrowitz says, “in part because the monthly payment under income-driven repayment depends on the borrower’s future income trajectory and inflation, not just the inclusion/exclusion of spousal income.”

Fortunately, some tools can help you run the numbers.

An example: Meet Joe and Sally

Here’s a simple scenario that shows how a change in filing status can save on taxes but cost more on student loans:

  • Joe and Sally are married with no children.
  • They live in Florida (no state income tax).
  • Joe is making $35,000 per year and has $15,000 of student loan debt with a 6.8% interest rate.
  • Sally is making $75,000 per year and has $60,000 of student loan debt with a 6.8% interest rate.

First, we can estimate Joe and Sally’s tax liability for filing jointly versus separately. TurboTax’s TaxCaster tool makes this pretty easy. Here’s what we get when run their numbers using 2016 tax rates:

  • Filing jointly, Joe and Sally would owe $13,249 in federal taxes.
  • Filing separately, they would owe $15,178.

So they would save just over $1,900 in federal taxes by filing jointly. But how would filing jointly affect their student loan payments?

We can use a student loan repayment estimator like the one provided by the office of Federal Student Aid to find out. Here’s what we get when we run the numbers and choose the Income-Based Repayment option, assuming they are new borrowers on or after July 1, 2014:

  • Filing jointly, Joe’s minimum required monthly student loan payment under a standard repayment plan would be $143, and Sally’s would be $571, for a total of $714 per month.
  • Filing separately, Joe’s minimum required monthly student loan payment would be $141, and Sally’s would be $474, for a total of $615 per month.

Over the course of a year, Joe and Sally would only save $1,188 on their student loan payments by filing separately. Even with the additional loan payments they would have to make, filing jointly would save them $712 more than filing separately.

What’s best for your situation?

Every situation is different. The simple example above comes out in favor of filing jointly, but you will need to run your own numbers to figure out what is right for you. Here are additional tips to help you figure it out:

  1. Know how much you owe. Make a list of all loan balances, interest rates, and the type of each student loan you have. You can find your federal student loans on the National Student Loan Data System. You can find information on your private student loans by looking at a recent statement.
  2. Estimate your student loan payment options. Using a student loan repayment estimator like the one mentioned above, determine your required payments when filing separately versus jointly.
  3. Calculate your tax liability. Use a tool like TurboTax’s TaxCaster or 1040.com’s Free Tax Calculator to calculate your federal and state tax liability when filing separately versus jointly.
  4. Be aware of long-term consequences. Filing separately might result in lower monthly payments today but more interest paid over time. If you make it to the 20- or 25-year forgiveness point, that could have tax implications down the line. Kantrowitz points out that “forgiveness is taxable under current law, causing a smaller tax debt to substitute for education debt. The main exception is borrowers who will qualify for public student loan forgiveness, which occurs after 10 years and is tax-free under current law.” Keep those long-term consequences in mind as you make a decision.
  5. Consider steps to lower your AGI. Your eligibility for income-driven student loan repayment plans depends on your AGI, which is essentially your total income minus certain deductions. You can reduce this number, and potentially lower both your tax bill and your required student loan payment, by doing things like contributing to a 401(k), IRA, or Health Savings Account.
  6. Keep the big picture in mind. These decisions are just one part of your overall financial situation. Keep your eyes on your big long-term goals and make your decision based on what helps you reach those goals fastest.

Other unique situations

There are a few unique situations that make deciding whether to file jointly or separately a little more complicated. Do any of these situations apply to you?

Divorce and legal separation

Sometimes, determining marital status to file tax returns isn’t cut and dried. What happens when you and your spouse are separated or going through a divorce at year end? In this case, your filing status depends on your marital status on the last day of the tax year.

You are considered married if you are separated but haven’t obtained a final decree of divorce or separate maintenance agreement by the last day of the tax year. In this case, you can choose to file married filing jointly or married filing separately.

You and your spouse are considered unmarried for the entire year if you obtained a final decree of divorce or are legally separated under a separate maintenance agreement by the last day of the tax year. You must follow your state tax law to determine if you are divorced or legally separated. In this case, your filing status would be single or head of household.

Pay as You Earn repayment plans

Pay as You Earn (PAYE) is a repayment plan with monthly payments that are limited to 10% of your discretionary income. To qualify and to continue to make income-based payments under this plan, you must have a partial financial hardship and have borrowed your first federal student loan after October 1, 2007. Kantrowitz says the PAYE plan bases repayment on the combined income of married couples, regardless of tax filing status.

Unpaid taxes, child support, or defaulted federal student loans

If you or your spouse have unpaid back taxes, child support, or defaulted federal student loans, joint income tax refunds may be diverted to pay for those items through the Treasury Offset Program. “Spouses can appeal to retain their share of the federal income tax refund,” Kantrowitz says, “but it is simpler if they file separate returns.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Tax

What to Do When You Owe Taxes to the IRS

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Owing a debt you can’t pay is a situation nobody wants to find themselves in, and it can be especially stressful when that debt is owed to the IRS. Many people fear the IRS and not without reason.

The IRS has collection powers that many creditors don’t have, including garnishing wages, seizing bank accounts, and even putting liens on property. Yet many people occasionally face a situation where they have a tax debt they just can’t pay. There are many options for dealing with tax debt, but ignoring it and hoping it goes away is not one of them. If you find yourself in this unfortunate situation, check out these tips for facing tax debts.

Filing for a filing extension will not give you more time to pay back the debt

Some people mistakenly believe that if they extend their tax return, they’ll have additional time to pay the amount due with their return. But an extension is just an extension of time to file, not to pay. You are still obligated to calculate the amount you’ll owe and pay that by April 15, even if you’re not yet ready to file.

Pay as much of the debt as possible by the filing deadline

When you file an extension but don’t pay 90% of the tax you owe for that year, the IRS will charge a failure-to-pay penalty. The penalty is generally 0.5% per month on the balance of your unpaid balance, and it starts accruing the day after taxes are due. It can grow to as much as 25% of your unpaid taxes.

In addition, interest will accrue on any unpaid tax from the due date of the return until you pay your balance in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%.

If you can’t pay the amount you owe, filing your return without making a payment won’t avoid penalties and interest, but it’s important to know that filing an extension won’t help you avoid them either. Just file on time and pay as much as you can to reduce penalty and interest charges.

Now that you’ve filed your return and know how much tax you owe, it’s time to consider your options for paying the balance due.

How to pay your tax debt

By credit card

If you don’t have the money to pay the amount due immediately, the IRS does accept credit cards, but be wary of paying your tax debt with plastic. Although the IRS doesn’t charge a fee to pay by credit card, the company that processes your payment will charge a fee ranging from 1.87% to 2.00% of the payment amount. Plus, you’ll need to consider the interest your credit card company will charge until you pay off the balance.

The IRS will charge a far lower interest rate than your credit card, which means you can pay off the debt much quicker.

Enroll in an IRS repayment plan

Paying a tax debt via credit card may not be an option if the amount due exceeds your credit limit, or it may not be the best choice if your credit card has a high interest rate. In that case, you may be able to work out a payment arrangement with the IRS. Just be aware that your account will continue to accrue penalties and interest until the balance is paid in full.

Here are three types of IRS repayment plans:

Short-term extension to pay

If the amount you owe is relatively small and you believe you can pay it off within 120 days, call the IRS and ask for a short-term extension of time to pay. This is not a formal payment plan. The IRS will just make a note on your account that you’ve been granted additional time to pay the full amount. During this period, they will not take any collection action against you.

Installment agreement

If you aren’t able to pay your debt in full within 120 days, Scott Taylor, a CPA with Piercy Bowler Taylor & Kern in Las Vegas, Nev., recommends that you contact the IRS to arrange an installment agreement. An installment agreement is basically a monthly payment plan. You can apply online for an installment agreement if you owe $50,000 or less in combined tax, penalties, and interest. For balances over that amount, you will need to complete Form 9465 and Form 433-F and send them in by mail.

With an installment agreement, you decide how much money you will pay each month and on what date you’ll make the payment. As long as your debt will be paid off within three years and you owe less than $10,000, the IRS has to accept your payment plan.

Fees

Keep in mind that the IRS also charges user fees for installment agreements. “Unfortunately for taxpayers, the fees have gone up as of January 2017,” Taylor says. The cost to set up an installment agreement is $225. If you apply online and choose to have the monthly payments directly debited from a bank account, the fee drops to $31.

If your ability to pay the agreed upon amount changes later on, you’ll need to call the IRS immediately. When you miss a payment, your agreement goes into default and the IRS can start taking collection action. For example, if your agreement calls for a $300 payment and you lose your job and aren’t able to make the payment, call the IRS before you miss a payment. They may be able to reduce your monthly payment amount to reflect your current financial situation.

Partial payment installment agreement

What if you owe so much that you can’t pay it off in a reasonable period of time? In that case, you may be eligible for a partial payment installment agreement. Like a regular installment agreement, you will make regular, agreed upon payments for a set period of time. However, the payments will not pay off the entire debt. After the agreement period ends, the remaining debt will be forgiven.

As you can imagine, the IRS doesn’t take debt forgiveness lightly, so applying for a partial payment installment agreement is more complicated than applying for a regular installment agreement. Instead of letting you decide how much you can afford to pay each month, the IRS will calculate your monthly payment by taking into account your outstanding balance, the remaining statute of limitations for collecting the debt, and the reasonable potential of collection.

To request a partial payment installment agreement, it’s best to consult a tax professional with experience handling tax debts. Before the IRS approves a partial payment installment agreement, you will need to have filed all of your tax returns and be current on your income tax withholding or estimated payments.

How to settle your tax debt (offer in compromise)

You’ve probably heard the television commercials promising to help you “settle your tax debt for pennies on the dollar.” These ads refer to an offer in compromise (OIC), and they’re not as easy to get as those ads would have you believe.

With an OIC, you agree to a lump-sum or short-term payment plan to pay off a portion of your debt in exchange for the IRS forgiving the remainder of the debt.

To qualify, you must prove that you are unable to pay off the entire debt through an installment agreement or other means. It can be difficult to meet the income and asset guidelines to qualify for an OIC, so it’s best suited for taxpayers with low income and very few assets.

You can check to see if you are eligible for an OIC by using the IRS’s pre-qualifier tool. To apply, you’ll need to complete Form 656 and Form 433-A and submit them along with an application fee of $186. You’ll also be asked to provide documentation to support the financial information provided in the forms.

Again, it’s a good idea to get help from a tax professional with experience working with OICs to help you complete the forms and walk you through the complex process. Be wary of tax resolution firms making promises that sound too good to be true. Check with the Better Business Bureau and the state attorney general’s office for complaints before you pay a retainer.

Tax debt discharge

There is a 10-year statute of limitations on tax debt collection, so if you are having serious financial issues and can’t pay at all, letting that statute run out may be an option. To do this, you’ll need to get your tax debt in currently-not-collectible (CNC) status by demonstrating that you cannot pay both reasonable living expenses and your tax debt.

To request CNC status, the IRS will ask you to provide financial information on Form 433-A or Form 433-F and provide documentation to support amounts listed on the statement. If you have any assets that the IRS believes could be sold to pay your debt, they may not grant CNC status.

While your account is in CNC status, the IRS will not pursue collection, but if you are owed any tax refunds on returns filed while your account is in CNC status, the IRS may keep your refunds and apply them to your debt. They may also file a Notice of Federal Tax Lien, which can affect your credit score and your ability to sell your property.

The IRS will review your income annually to see if your situation has improved. If you maintain CNC status until the 10-year statute of limitations runs out, you may no longer be required to make payments, regardless of whether your financial situation improves later on.

What if you don’t agree with the amount due?

If you owe a lot more than you expected, take a moment to review your completed return carefully to look for errors. Make sure you didn’t accidentally enter the same income twice or forget an important deduction, and make sure you answered all of the questions correctly. One missed question or checkbox can cause you to miss out on valuable tax benefits. Also, compare this year’s return to last year. If your tax bill went up drastically even though your situation hasn’t really changed, find out why.

Occasionally, taxpayers receive notices from the IRS indicating an amount due that they don’t agree with. Don’t feel like you have to pay an amount you don’t believe you owe just because it comes on IRS letterhead. Taylor says each notice will include a section detailing how to respond.

“The IRS may have made an error in matching up 1099s or W-2s, and the amount owed needs to be adjusted,” he says, and he recommends that you send a letter via certified mail in response, with a full explanation. “A CPA can help you with this letter, but if you follow the guidelines provided by the IRS, you should be able to respond appropriately and have the fees resolved or adjusted.”

IRS collection enforcement

If your taxes are not paid on time and you do not communicate with the IRS, they can issue a Notice of Levy. An IRS levy permits the legal seizure of your property. They may garnish your wages or seize your bank account, vehicles, real estate, or other personal property to satisfy the debt.

Taylor says IRS notices will only come via U.S. mail, so be sure you check your mail and read all IRS notices. “It seems like a simple thing,” Taylor says, “but with many financial and personal transactions occurring online, many people ignore their mailbox for long periods of time.”

Whatever your situation, Taylor says it’s important to remain in contact with the IRS to show your intent is to pay your debt. “Don’t ever ignore IRS notices,” Taylor says. “The IRS is willing to coordinate payment plans, and the consequences of ignoring them are always difficult to adjust.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Life Events, Tax

What is a Required Minimum Distribution?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

For workers or retirees who have not begun to withdraw funds from their retirement accounts by age 70½, the IRS requires that they start withdrawing funds. The RMD requirement applies to all tax advantaged retirement accounts, from traditional IRAs and 401(k)s to 403(b)s and SEP IRAs. The RMD does not apply to Roth IRAs or Roth 401(k)s.

Here’s a full list of retirement accounts subject to the RMD rule:

  • Traditional IRAs
  • SEP IRAs
  • SIMPLE IRAs
  • 401(k)s
  • 403(b)s
  • 457(b)s
  • profit-sharing plans
  • other defined contribution plans

How do I figure out how much to withdraw?

Just like filing your taxes, it falls on your shoulders to remember to take the RMD once you reach 70½. You can do the math yourself (we’ll explain below) to figure out what your required minimum distribution will be, or you can ask for help from a tax professional or financial adviser.

To calculate your RMD, you need to know exactly how much you’ve got saved up in each account as of Dec. 31 of the previous year. Next, use this table from the IRS to find your “distribution period” score, which is based on your life expectancy.

Most people can calculate their RMD by dividing their total retirement account balances by the distribution period that corresponds with their age.

Let’s say you turned 70½ in Dec. 2016 and had a balance of $1 million in your eligible retirement accounts on Dec. 31. You would then find the distribution period that corresponds to your age in Table III.

According to the table, your distribution period number is 27.4. When you divide $1 million by 27.4, you get an RMD of $36,496.35. That is the minimum withdrawal you must make from that account by April 1, 2017.

When do I have to start taking an RMD?

If you are already retired, you are required to take distributions by April 1 of the year after you turn 70½.

If you are still working at age 70½ and you carry a traditional 401(k) or 403(b) account with your employer, you do not have to take an RMD unless you own 5% or more of the company. However, if you are still working at age 70½ and you have individual retirement accounts outside of your employer retirement account, you will need to make an RMD from those IRAs.

You do not have to take your RMD as one lump-sum payment. The IRS will allow you to take out the funds in chunks throughout the year, which allows your money to keep growing tax free. As long as the total meets the RMD for the year, you’re in the clear.

What happens if I don’t take my RMD?

If you don’t take your RMD during the year after you turn 70½, you’ll be slapped with a 50% excise tax on the amount that was not distributed when you file taxes.

For example, if your RMD was $10,000, but you only took out $5,000, you will be assessed the 50% tax on the $5,000 that you did not withdraw.

You can delay your first RMD. If you choose to do so, you’ll be required to take two in the next year, which will affect your gross income.

 

What if I don’t need to live off of the distribution?

You are required to take your RMD beginning at 70½ , but you that doesn’t mean you have to spend it.

“A lot of clients believe that they must take an RMD and spend it. In reality, all the IRS cares about is that you remove it from the account, declare it as income, and pay taxes on it,” says Riverside, Calif.- based financial planner Breanna Reish.

You are actually free to use the money however you’d like.

One way to meet your RMD requirement is by making a qualified charitable distribution paid directly from the IRA to a qualified charity. The charitable distribution can satisfy all or part of the amount you are required to take from you IRA.

What if I have multiple retirement accounts?

If you have more than one retirement account, things can get a little more complicated. You still need to take an RMD, but you don’t have to take one out of each account. You’ll need to add up the amount you have in all of your qualifying retirement accounts, then use that figure to determine your RMD using Table III.

Again, it’s probably a good idea to seek advice from a tax or financial adviser professional who can help make the wisest decision for your finances.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Why You Should Apply the 72-hour Rule to Your Tax Refund

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Why You Should Apply the 72-hour Rule to Your Tax Refund

Ka-ching! Your tax refund just hit your checking account. Time to apply the 72-hour rule.

Whether your refund is in the thousands or hundreds, the urge to spend the funds might instantly become overwhelming. Maybe you already had an idea of what you want to spend the money on and you’re all set to hand over your refund for it. Or, maybe the money means you finally have enough to make a large purchase you’d otherwise need to save for.

Whatever your reason, don’t spend your refund quite yet. If it’s not an immediate emergency (read: root canal, car accident, flood, etc.), let the cash burn a hole in your pocket for about 72 hours.

Journalist and money expert Carl Richards came up with the “72-hour rule” to kick his habit of buying every book he wanted on Amazon, ending up with a pile of unread books. Now, he says he lets a book sit in his shopping cart for at least 72 hours before hitting “buy,” and he’s saving money only buying books he will actually read. You can apply a similar practice to your spending habits.

Why wait 72 hours?

Our brains respond positively to instant gratification. It’s why so many of us find it difficult to save money or lose weight. We want the item or food now, and when there’s nothing stopping us, why wait?

You need the space between receiving the money and spending it to think. The shorter that space is, the less time you have to think and the more likely you are to spend the funds impulsively.

“People often look at their tax refund as found money like lottery winnings or inheritance. The temptation to spend surprise money on something fun or frivolous is strong,” says Denver, Colo.-based Certified Financial Planner Kristi Sullivan.

You want to avoid doing that. Your tax refund isn’t lottery winnings or an inheritance. It’s your hard-earned money being returned to you with no interest gained.

Tax refunds averaged $2,860 in 2016, according to the IRS. This year, a SunTrust survey found about 1 in 4 Americans already planned to spend their refund money on a large purchase before they even received the funds. That proportion rises to 36% among millennials and 40% among Gen-Xers, according to SunTrust.

That’s no bueno, considering the average citizen admits they can’t pull together $400 in case of an emergency.

James Kinney, a certified financial planner based in Bridgewater Township, N.J., says “hitting the pause button on spending impulses gives the rational brain time to think” of more practical ways to use the money like getting out of debt, contributing to a college savings fund, or adding to your savings.

Although he acknowledges when you’re living paycheck to paycheck, it’s a little harder to resist a sudden — albeit predictable — boost to this month’s budget.

“People feel constrained by their paycheck all through the year, then suddenly this windfall of money gives them the ability to splurge. The temptation can be hard to resist,” says Kinney.

Here are a few ways you can manage the temptation, and the time.

While you wait…

Weigh your wants vs. needs

The waiting period is supposed to help you to spend your tax refund responsibly, right? Consider all of the expenses the money could go toward. Should you buy the new iPad or pay off your credit card? How about that car loan? Time to weigh your options.

Sullivan says that means you should pit your “wants” against your “needs.”

“A need that you haven’t already bought is rare. Wants are everywhere. Time to reflect might have you making a more mature decision with your money,” says Sullivan.

Do some soul searching to see where your financial priorities lie. You might find your need to pay off your credit card this month to avoid paying more in interest outweighs how badly you want that new gadget. Think about it.

Review your finances

Since your tax refund might consume your every thought for three days, you might as well use the time to think about your overall financial picture.

“Sit down and think about other pressing financial issues, and how you plan on paying for them,” says David Frisch, a Melville, N.Y.-based financial planner. He suggests you review bank statements, brokerage accounts, long-term goals, and other financial considerations, then give some thought to whether or not you’re on track to achieve them.

For example, if you realize you don’t have enough in your emergency fund to cover three to six months of expenses, you might decide to put the money there instead of spending it. Or, if your refund could completely pay off a high-interest debt like a credit card, you might decide to free yourself from the debt burden.

Make sure you don’t get a huge refund every year

Most Americans receive a refund because the government withheld too much in taxes. The government uses information you gave them to decide how much of your paycheck to withhold each pay period.

“Changing your withholding will give you more of your money during the year so that you will not get a large refund that you might be tempted to spend frivolously,” says Alfred Giovetti, president of the National Society of Accountants.

You can change information on your withholding forms on your own if you’d like. Use this IRS calculator to determine your proper withholding and figure out what information you need to correct on your W-4 form. Then, contact your employer’s human resources department to turn in a new W-4 with the correct information.

If you’d rather have some assistance, you can contact a professional. Work with your accountant or financial adviser to change information on your W-4 and its equivalent withholding form for the state in which you reside.

“Plan with a good tax accountant to get a small refund or a small liability by changing your withholding, so that you do not rely on the refund as ‘mad money,’” says Giovetti.

Treat yourself

We admit, waiting sucks, but it doesn’t have to be complete torture. Sullivan suggests taking the edge off with a small reward for each day you wait.

“It could be an ice cream cone, a long phone chat with a friend, an hour reading a trashy novel, or whatever makes you happy,” she says.

Just make sure the reward you choose isn’t too expensive, and you should avoid getting into more debt. Your “reward” could serve as a break while you comb through your finances.

The takeaway

Take some time to think before spending whenever you receive unexpected income, and you might make better spending decisions. Maybe you need only 24 hours, instead of 72, or maybe you need a little longer to decide what to do with money, but the same lesson applies. If you’re considering a purchase that’s a “want” and not a “need,” think before you buy.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Tax Tips for Recent College Graduates

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Tax Tips for Recent College Graduates

When life changes, so do your taxes, and graduating from college brings several life changes that can affect your tax return. You may go from being claimed as a dependent by your parents to filing on your own for the first time. You may move out of state, collect a paycheck for the first time, and start paying off student loans. All of these events present opportunities to save — and costly pitfalls to avoid. To help you keep more of what you earn in this next phase of life, check out these tax tips for recent college graduates.

Figure out if your parents can still claim you as a dependent

If you just graduated, you may still be eligible to be claimed as a dependent on your parents’ tax return. Dependency rules are complex, but essentially, for your parents to claim you as a dependent:

  • you must be under age 24 at the end of the year,
  • you must be a full-time student (enrolled for the number of credit hours the school considers full time) for at least five months of the year,
  • you must have lived with your parents for more than half the year (you are deemed to live with your parents while you are temporarily living away from home for education), and
  • your parent must have provided more than half of your financial support for the year.

If you meet all of these tests, your parents can still claim you as a dependent and take advantage of the dependency exemptions and education credits.

Even if your parents claim you as a dependent, you may still be required to file your own return if you had more than $2,600 of unearned income (interest, dividends, and capital gains) or more than $7,850 of earned income (wages or self-employment income).

Get reimbursed for moving expenses if you moved in order to take a new job

If you moved for a new job after graduation, you might be able to deduct any unreimbursed moving expenses, as long as the new job is at least 50 miles away from your old home. Those expenses include costs to pack and ship your belongings and lodging expenses along the way, but not meals. You can also take a deduction for 17 cents per mile driven for 2017 (down from 19 cents per mile in 2016).

If you moved out of state, you might have to file two state returns if you had taxable income in both states. Many students have a part-time job while in school and take a full-time job in another state after graduation. Rules vary drastically by state. In some states, you will have to claim 100% of your income on your resident state return, then receive a credit for any taxes paid to another state. In this case, you may be better off working with a professional who can help guide you through filing in both states.

Make sure you’re withholding the right amount from your paycheck

When you start your new job, the human resources department will ask you to complete a Form W-4 to indicate how much of your paycheck you’d like your employer to take out for taxes. Working through the questions on the form is simple enough, but it doesn’t take into account how much of the year you’ll be working.

Most new graduates end up having too much federal tax withheld in their first year, effectively giving the government an interest-free loan, says Bradley Greenberg, a CPA and partner at Kessler Orlean Silver & Co. in Deerfield, Ill.

That’s because graduates rarely start new jobs right at the start of a new year. You may graduate in May and start working in June, or graduate in December but not find a job until February. Yet you are taxed as if you have been earning that pay for the entire year.

“The withholding tables are designed with the assumption that one makes the same amount of money for each pay period of the year, regardless of how many pay periods were worked,” Greenberg says. “For example, a June graduate starting a job on July 1 for $50,000 will have the same taxes withheld per pay period as a colleague with the same salary, marital status, and number of exemptions, but who worked the entire year.”

Greenberg recommends two courses of action for new graduates:

  1. Set up your withholding in your first year of employment so less tax is withheld. Then make sure you adjust it on the following January 1, so you don’t have too little tax withheld in your first full year of employment, or
  2. View this as a savings plan and file your taxes as early as possible next year to get your refund from the IRS.

Take advantage of student tax credits

If your parents can no longer claim you as a dependent, you may be eligible to claim valuable tax credits for any tuition you paid during the year. There are two tax credits for higher education costs: the Lifetime Learning Credit and the American Opportunity Credit.

For 2016, there is also the tuition and fees deduction (Congress failed to renew this deduction, which expired on December 31, 2016, so it is not available for 2017). The rules and income limits for each credit and the deduction vary, but the IRS offers an interactive tool on their website to help you determine which tax break applies to you.

If you used student loans to pay for your education, you can take a deduction for up to $2,500 of interest paid on a qualified student loan. If your parents made loan payments on your behalf, you are in luck. Typically, you can only deduct interest if you actually paid the debt, but when parents pay back student loans, the IRS treats it as if the money was given to the child, who then repaid the debt.

Don’t ignore your 401(k) or health savings account at work

New college graduates may be financially strapped and hesitant to divert part of their paycheck into a retirement plan or health savings account, but opting out means missing out on substantial tax-saving and wealth-building opportunities.

If your employer offers a matching 401(k) contribution, as soon as you’re eligible you should contribute at least enough to get the employer match. Otherwise, you’re missing out on free money. If you select a traditional 401(k), you can save on next year’s taxes. That’s because any contributions you make will be tax free, and they will reduce the amount of your income subject to federal income tax as well as Social Security and Medicare (FICA) taxes.

For better or for worse, many employers now offer high-deductible health insurance plans. These plans often come with health savings accounts (HSAs). Any money you set aside in an HSA can be used for any qualifying medical expense, from co-pays to prescriptions. The best part is that money you put into your HSA is not taxed, so you can potentially save a lot by using your HSA for medical expenses rather than paying out of pocket.

HSA funds stay in the account until you use them and are portable, meaning you can take it with you even if you leave your job. If you have big medical bills down the road, the funds can come in handy. If not, think of them as another tax-advantaged way to save for retirement.

Bring in a professional if you think you need help

If this is your first time filing on your own, you may be wondering whether you should do it yourself or pay someone to prepare your return for you. If you have a simple return with just a Form W-2 and perhaps some interest income, you could save money by buying some tax software and doing it yourself. MagnifyMoney’s guide to the best tax software is a great place to start.

But if you have dependents, investments, or a small business, you may be better off going to a reputable accountant.

Doing your taxes is never fun, but for recent college graduates, they may not be as big a headache as you might have heard. Keep in mind that tax laws often change, and everyone’s situation is a little different. But taking the time to know which tax breaks apply to you can make your post-college life significantly easier.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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9 Essential Tax Tips for Entrepreneurs

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

9 Essential Tax Tips for Entrepreneurs

For many entrepreneurs, there is no topic more fraught than taxes. In fact, a 2015 survey of small business owners found that 40% say dealing with bookkeeping and taxes is the worst part of owning a small business and that they spend 80+ hours a year dealing with taxes and working with their accountants. Taxes can be time-consuming, confusing, and a drain on your finances if you don’t prepare well. So whether you choose to do your taxes on your own or hire a professional, this guide can provide some sound advice and hopefully make tax time a little less taxing.

 

#1 Select the Right Entity for Your Business

 

One of the first decisions you’ll make when setting up your business is whether to function as a sole proprietor, partnership, LLC, or corporation. In her recent blog post, Wendy Connick, an IRS enrolled agent and owner of Connick Financial Solutions, says “the type of business entity you choose will have a huge effect both on how you pay taxes and how much tax you pay. It’s wise to consider the pros and cons of each business structure before making a final decision.”

Sole proprietorship

A sole proprietorship is the simplest way to form a business, as it is not a legal entity. The business owner just needs to register the business name with the state and secure the proper local business licenses. The downside is that the sole proprietor is personally liable for the business’s debts.

Partnership

A partnership is similar to a sole proprietorship, but two or more people share ownership. Both partners contribute their money, labor, or skill to the business and share in its profits and losses.

Limited liability company (LLC)

An LLC provides more protection from liability than a sole proprietor or partnership but with the efficiency and flexibility of a partnership.

Corporation

A corporation is more complicated and usually recommended for larger companies with multiple employees. It is a legal entity owned by shareholders, so the corporation itself, not its shareholders, is legally liable for business debts.

Unlike other business entities, corporations pay income tax on their profits, so they are subject to “double taxation,” first on company profits and again on shareholder dividends.

To avoid double taxation, corporations can file an election with the IRS to be treated as an S Corporation. S Corporation income and losses “pass through” to the shareholder’s personal income tax return instead of being taxed at the corporate level.

Some small businesses and freelancers may save on self-employment taxes by registering as an S Corporation and paying themselves a salary. Sole proprietors, partners, and LLC members pay self-employment tax on their entire business net income, but S Corp shareholders only pay self-employment taxes on their wages. They can receive additional income from the corporation as a distribution, which is taxed at a lower rate.

Connick says “many small business owners start out as sole proprietors and adopt a different structure once the business gets big enough to make it worthwhile (which would typically be when the business is making over $50,000 a year).”

 

#2 Get an Employer Identification Number

 

All businesses, even sole proprietors should get an Employer Identification Number (EIN). Technically, sole proprietors can use their Social Security number (SSN) as the business’s identification number, but that means providing an SSN to any clients or vendors who need to issue a 1099, a move that can leave you more exposed to identity theft.

Applying for an EIN from the IRS is free and can usually be done in a matter of minutes using the IRS’s online form.

#3 Make Sure Your Business Isn’t Just a Hobby

 

You know you’re in business to make money, but would the IRS agree? If your company is operating at a loss, the IRS could reclassify your business as a hobby, resulting in some serious tax consequences.

A business is allowed to offset taxable income with business expenses, but hobby expenses cannot be netted against hobby income. Instead, they are deducted as miscellaneous itemized deductions on Schedule A and limited to the amount of hobby income reported on Schedule C. This means a hobby business can never result in a net loss, and you may be prevented from deducting hobby expenses entirely if you don’t itemize deductions.

If you’ve been making money in your business for a while and just have one bad year, you don’t have to worry about the IRS reclassifying your business as a hobby. If you’ve been losing money for a while and especially if your business involves some element of personal pleasure or recreation (such as horse racing, filmmaking, or restoring old cars), you’ll want to make sure you’re treating your business like a business in case the IRS challenges your losses.

The IRS takes several factors into consideration:

  • Does the amount of time you put into the business suggest an intention of making a profit? Side projects are more likely to face scrutiny because you’re spending the majority of your time at another full-time job.
  • Do you depend on the income you receive from the business?
  • Were any losses beyond your control or occur in the startup phase? Losses due to poor management and overspending are less likely to hold up under examination.
  • Have you changed operation methods to improve profitability? Many business experience setbacks. If you learn from mistakes and try to correct your course, the IRS is more likely to agree that you have the intention of running a profitable business.
  • Do you have the knowledge and experience necessary to be successful in your field?

If you are concerned about an IRS challenge of your losses, there are a few steps you can take to treat your activity as a business:

  • Keep thorough business books and records.
  • Maintain separate business checking and credit accounts.
  • Obtain the proper business licenses, insurance, and certifications.
  • Develop and maintain a written business plan.
  • Document the hours spent working on your business, especially if it is a side project.

 

#4 Track Income and Expenses Carefully

 

Maintaining separate business checking and credit card accounts is not only a good way to demonstrate that your business is not a hobby, but it’s also an excellent way to simplify tracking business income and expenses.

Benjamin Sullivan, an IRS enrolled agent and a certified financial planner with Palisades Hudson Financial Group LLC in its Austin, Texas, office, says “small business owners can get a tax benefit from almost anything that is an ordinary and necessary business expense. Travel, meals, advertising, and insurance costs are just some of the popular deductions.”

Use small business bookkeeping software

Small business accounting software like FreshBooks, Xero, or QuickBooks Online can help you easily and quickly track your business revenues and expenses. They can usually be set up to import transactions from your business checking account automatically and let you snap pictures of receipts with your phone.

Whether you choose to use a software program or just a spreadsheet, establish a system for organizing records and receipts right from the beginning. “Little expenses can add up quite a bit over the course of a year,” Connick says, “but you can’t deduct them if you don’t know what they are.”

Special rules for travel, meals, and entertainment

It is especially crucial to maintain good records for business travel, meals, and entertainment expenses. The IRS allows taxpayers to deduct 100% of their business-related travel and 50% of the cost of business meals and entertainment expenses, whether you are taking a client out for a meal or traveling out of town. Because these categories are prone to abuse, the IRS requires documentation to substantiate that these expenses have a legitimate business purpose.

For meals and entertainment, in addition to a receipt that shows the amount, time, and place, taxpayers should also make a note of the individuals being entertained and the business purpose. Meeting this requirement can be as simple as jotting down a note on your receipt or in your calendar regarding who you dined with and the business matters discussed.

For travel expenses, hotel receipts must include a breakdown of the charges for lodging, meals, telephone, and other incidentals. Your hotel should be able to provide an itemized receipt at checkout.

Save cash instead of taxes

One trap that small business owners often fall into is spending money to save on taxes. At year end, many entrepreneurs look at business profits and think they need to spend their cash to avoid a big tax bill. Don’t spend a dollar to save forty cents in tax. If you truly need a new computer, extra supplies, or a new vehicle, buy it. Don’t spend money just to avoid a tax bill. Remember, taxes are a cost of doing business. If you’re paying taxes, you’re making money.

#5 Set Aside Money for Taxes

 

When you set up a separate business checking account, it’s also a good idea to set up a separate savings account to help you organize funds and set aside money for taxes.

Our tax system is a “pay as you go” system. When you receive a paycheck from an employer, money is regularly withheld on your behalf. When you are self-employed, making estimated tax payments is your responsibility. If you don’t pay in enough during the year to cover your income tax and self-employment tax, you may have to pay an underpayment penalty.

Estimated tax payments are due on the 15th day of April, June, September, and the following January. You have a few options for calculating what you owe each quarter:

Use Form 1040ES

This form includes a worksheet to help you estimate how much you owe for the current year. (Corporations use Form 1120-W to calculate estimated taxes.)

Look at last year’s return

If you’ve been in business for a while and there are no significant changes this year, you can aim to pay 100% of last year’s tax as a safe-harbor estimate (110% if your adjusted gross income for the prior year was more than $150,000).

Make a quarterly estimate

If your income fluctuates, you may prefer to make a quarterly calculation. Calculating estimated payments is complex. It depends on your tax bracket, deductions, credits, etc. In this case, it’s best to work with a tax professional who can consider all of the factors and recent changes in the tax law.

Sullivan says, “Tax planning isn’t a one-time exercise that should be done at the end of the year or at tax time. Instead, tax planning is an ongoing process of structuring your affairs in a tax-efficient manner.”

#6 Don’t Forget to Track Your Mileage

 

When you drive your personal vehicle for business, you have two options for deducting business automobile expenses: the standard mileage rate or actual expenses.

The IRS releases the standard mileage rate annually. The rate is $0.54 per mile for 2016. It goes down to $0.535 cents per mile for 2017. You simply multiply the standard mileage rate by the number of miles you drove for business during the year.

To use the actual expense method, total up all of the costs of operating your vehicle for the year, including insurance, repairs, oil, and gas, and multiply them by the percentage of business use. For example, if you drove 10,000 miles during the year and 5,000 of those miles were for business, your percentage of business use would be 50%. If it cost $7,000 to own and operate your vehicle, your deduction using the actual expense method would be $3,500 ($7,000 x 50%).

You can use whichever method gives you the largest deduction. However, if you want to use the standard mileage rate, you must choose it in the first year the car is used for business. In subsequent years, you can choose either method.

Whichever method you choose, you must track your business miles. You can do that with a paper log kept in your glove compartment or with an app such as MileIQ or TrackMyDrive. “Note that ‘business purpose’ is a pretty broad category,” Connick says. “If you drive to the supermarket and pick up some pens for your home office while buying groceries, the trip counts as business mileage.”

 

#7 Consider the Home Office Deduction

 

Some business owners avoid claiming the home office deduction, believing it to be an audit trigger. That may have been true in the past, but today’s technology has made home offices much more common. Connick suggests entrepreneurs shouldn’t fear the home office deduction if they meet the requirements. “It’s no longer audit bait,” she says, “especially if you use the safe harbor method to calculate your deduction.”

To take advantage of the home office deduction, you must use the area exclusively and regularly, either as your principal place of business or as a setting to meet with clients. The home office deduction is based on the percentage of your home used for the business. You can choose either the traditional method or the simplified method for deducting expenses.

Under the traditional method, you’ll calculate the percentage of your home that is used for business by dividing the square footage of your office by the square footage of your entire home. For example, if your home is 1,500 square feet and your office occupies 150 square feet, the business percentage is 10%. Then, you can deduct 10% of all of the expenses of owning and maintaining your home, including mortgage interest, real estate taxes, utilities, association dues, insurance, repairs, etc.

Under the simplified method, you’ll take a deduction of $5 per square foot, with a maximum of 300 square feet. So if your home office measures 150 square feet, the home office deduction would be $750 (150 x $5).

 

#8 Save for Retirement

 

For most self-employed people, the simplest option for retirement saving is an individual retirement account (IRA). Anyone can contribute to a traditional IRA, but with an annual contribution limit of just $5,500 ($6,500 if you are age 50 or older), you may want a retirement savings option that allows you to save more.

Connick says her number one tip for entrepreneurs is to open a SEP-IRA. “These retirement accounts are cheap to open and maintain,” she says. They also “have a high contribution limit, and contributions are fully tax deductible.” SEP-IRAs allow entrepreneurs to contribute up to 25% of their net earnings from self-employment, up to a maximum of $53,000 for 2016.

The deadline to contribute to a SEP-IRA is the due date of your return, including extensions. So 2016 contributions can be made until April 18, 2017, or October 15, 2017, if an extension is filed.

 

#9 Get Help from a Professional

 

Connick recommends that entrepreneurs hire a professional to do their taxes. “If you pick someone who knows their stuff,” she says, “you will likely save more than enough off your tax bill to pay for their fees. For that matter, tax preparation fees are deductible!”

When choosing a tax professional, look for someone with experience working with self-employed taxpayers. The IRS maintains an online directory of return preparers who have additional credentials, such as EAs, attorneys, and CPAs. Search the directory to find a professional near you with the credentials or qualifications you prefer.

If there is one thing all entrepreneurs can agree on, it’s that everybody dreads tax season. Having a basic understanding of tax law, maintaining organized records throughout the year, and working with a professional can help you make the most of this least wonderful time of the year.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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