I learn something new about taxes every time I do them and I try to share those lessons with you each year in a tax report.
Extensions
2019 was a weird tax year, wasn't it? I mean, you're probably used to seeing this sort of post around April, but this year with COVID my federal and all of my state tax returns were not even due until July 15th. And I couldn't even make that deadline since I was still waiting on 2 or 3 K-1s at that time. That said, I'm a big fan of extensions. You still have to do most of your tax return by April so you know about what you're going to owe. The money is still all due in April, and if you underpay you'll have to pay interest on the difference. But you really have until October 15th to file the actual returns. Don't feel bad about using that delay. It takes a lot of stress off, and your accountant has far more availability for you after April.
Corporate Taxes
This was apparently my last year doing my own corporate taxes. Our new COO says we're too big to be having the founder do the tax returns, and there are better uses for my time. He's right, of course. The new accountant says there are a couple of small things wrong on past returns and will file them again just to correct them (who knew that you weren't supposed to count “blue sky” or “goodwill” when doing Schedule L) even if they don't make a difference in taxes paid. It is nice not to be doing payroll and forms 941 manually anymore, which was a big change for 2020. She was impressed with my ability to max out the 199A deduction, though. She may be doing our personal return next year, too. It will be nice to get a little time back and not have to fight the printer so much, but the hard part about taxes was always keeping track of everything anyway and you don't get out of that just by having someone else prepare it. Honestly though, my favorite part of having an accountant is just being able to get questions answered like “Do I really have to file in this state just because this syndication sent me a K-1 for it?”
Multiple State Tax Returns
Speaking of which, I filed five state tax returns this year, the most ever for me—Utah, Colorado, Minnesota, Michigan, and North Carolina. Minnesota and North Carolina were my least favorite, by the way, and it has really made me appreciate Utah a lot more than I used to. I thought it was going to be the syndicated real estate investments that forced me to file in all these states, but, in reality, it was those other businesses that really did me in. My physician partnership merged with one in Colorado, PoF moved from Minnesota to Michigan, and TPP is in North Carolina. Wish I could talk those guys into setting up a Wyoming LLC!
Kid Returns
A few of the WCI models earning their pay up in the Sawtooth Wilderness.
I had to file for all four of my kids this year. None of them owe any income taxes (including the one with a real job) for their modeling income from WCI or their investments, but their UTMAs are just big enough to require me to file both federal and state tax returns for them. I suppose I could just put them on my return, maybe I'll try that next year. If they make less than $12,2oo in earned income or $1,100 in unearned income you don't have to pay any taxes on their income and they don't have to file a separate return. Above those amounts, tax will be due and they HAVE to file their own. However, the threshold to file a return for them (or report their income on your return ) is just $350 in unearned income, and their UTMAs invested in TSM and TISM kicked off about twice that in 2019 dividends. Thus the returns. It did provide a teaching opportunity, though, which was good. I hope the IRS doesn't mind that the 5-year-old just signed her first name and really can't make a good “F”. It was a cute tax return.
Seriously Long Return
By the time I was done, the Turbotax file I saved was 368 pages. Just my federal return, the pages I actually sent to the IRS, was 45 pages. I always find it interesting to thumb through the paper return and see which forms I filed and why:
- 1040 (2 pages): The basic tax return
- Schedule 1: Includes info from Schedules C and E on income, and my HSA and partnership retirement plan deductions
- Schedule 2: Totals up my payroll taxes (including the PPACA taxes)
- Schedule 3: Totals up my foreign tax credit, residential energy credit (remember that renovation) and lists my quarterly estimated payments and the amount I paid with the extension
- Schedule A: Includes deductions for taxes paid and all of our charitable contributions
- Schedule B: Reports all the interest and dividend income we had
- Schedule C # 1 (2 pages): WCI has an advertiser who refused to pay the business and insisted on paying me directly, requiring a separate business. Very annoying.
- Schedule C # 2 (2 pages): The kids don't actually work for WCI, because as a corporation, it would have to pay payroll taxes on their income. But a sole proprietorship owned by a parent that contracts with WCI does not.
- Schedule D: Carries forward all those great losses from tax loss harvesting, and I had a gain this year on that one stock I owned for a couple of weeks.
- Form 8949 # 1: Records the stock transaction
- Form 8949 # 2: Records a $2 transaction from that old Prosper account
- Schedule E: Records most of our income, that from partnerships and S Corps
- Schedule SE: Calculates our self-employment tax. Not too much really, since most was paid with our WCI W-2s, but I still have to pay the Medicare tax from my clinical work.
- Form 1116 (2 pages): Calculates the foreign tax credit. I owned the Vanguard Total International Stock Market Fund in our taxable account.
- Form 8606 # 1 (2 pages): My Backdoor Roth IRA
- Form 8606 # 2 (2 pages): Katie's Backdoor Roth IRA
- Form 8889 (2 pages): Calculates our HSA deduction
- 8995-A, including Schedule B (5 pages): Calculates our 199A deduction
- Form 8959: Calculates one of our Obamacare taxes, the one on salaries
- Form 8960: Calculates our other Obamacare tax, the one on investment income
- Form 8582 (3 pages): This one adds up our real estate losses. Unfortunately, we don't have Professional Real Estate Status, so that didn't help this year, but we can carry them forward.
- Form 8283 (3 pages): Adds up our noncash charitable contributions
- Form 5695: Calculates our residential energy credit. $500 beats a kick in the teeth.
- Form 4562 (2 pages): I couldn't quite figure out why this one was in our tax return, but it certainly didn't lower our tax bill. Turbotax filled out lines 1 and 3. I think it came from something I put in on the K-1 for my clinical partnership. Probably the 20 business miles I claimed or something. It's a Turbotax mystery.
- Schedule E Worksheet: Lists my clinical deductions.
- Schedule E Continuation statement: All those real estate syndications don't fit on Schedule E.
- Form 8995-A, 8582, and Schedule E Worksheet Statements: Too much stuff in each list to fit in the little boxes I guess.
Total: 45 pages. First world problem I suppose.
Tax-Inefficient Investments
One interesting lesson from this year's tax return was that our interest and dividends are not as tax efficient as they could be. Only about 3/4 of our interest was tax-exempt (I ended up moving money between the Vanguard tax-exempt MMF and our high yield savings account depending on after-tax yields and less than half of our dividends were qualified. The non-qualified ones are due to debt real estate in our taxable account…pretty inefficient that stuff is. Probably ought to consider using a self-directed Roth IRA for at least some of that, but our tax-protected space is getting to be a smaller and smaller percentage of our portfolio every year. Pretty soon I'l be faced with choosing between TIPS, REITs, and debt real estate in our increasingly limited tax-protected space.
The Big Deductions
Our biggest deduction used to be our tax-deferred retirement account contributions. That is no longer the case. They have fallen into third place now. We're deferring less income by doing Mega Backdoor Roth IRA contributions, so that deduction is much smaller than it used to be. More importantly, two other deductions have gotten much bigger. Our largest deduction is our 199A (pass-thru business) deduction. We planned a big part of our financial lives around this deduction and it really paid off. Our second biggest deduction is our charitable contributions. We gave away about twice what we spent last year, not including the home renovation, so that adds up to a lot. The Donor Advised Fund (DAF) really simplified the process even though it just functioned as a conduit for the donations.
My Capital Gains Strategy Is Awesome
When our taxable investments go down in value, we harvest the losses. This allows us to wipe out any incidental capital gains we may realize (remember that one stock?) and deduct $3,000 from our ordinary income. We were carrying over a pretty good amount at the end of 2019, and harvested a ton more in March during the pandemic crash. You would think we now have more losses than we could ever possibly use, but if we ever sell WCI every bit of those losses could come in handy. When our taxable investments go up in value, we donate them to charity via the DAF. No capital gains taxes. Actually, negative capital gains taxes. Very efficient way to invest in taxable. If you donate a lot to charity, you should almost never be paying capital gains taxes.
Aggregating Businesses Can Really Help with the 199A Deduction
I have some businesses that don't have employees and others that do. But they are all doing the same “WCI kind of stuff”. By aggregating them into one business for 199A purposes, I can use the salaries from some to cover the income from others so that the deduction isn't reduced by the salary limitation. Maybe not applicable to most of my readers, but still a nice little benefit. I'm really going to miss this deduction when it goes away in a few more years.
Health Care Is Really Expensive Stuff
In 2019, we pretty much paid cash for all of our health care since we have a high deductible plan and despite spending thousands, didn't hit that deductible. We also paid something like $1,300 a month in premiums and put $7,000 into an HSA. Then we paid twice that amount toward other peoples' health care in the form of additional Obamacare and Medicare taxes. It's hard for me to imagine this is the right way to pay for all this. I'm becoming a bigger fan of something like the Canadian or Australian system every year. It is embarrassing to be a part of this stupid, broken system.
Ownership Has Its Privileges
As I look at our income for this year, the vast majority comes from owning stuff. Owning our own business. Owning parts of the businesses of others. Owning shares of stock. Owning real estate investments. It is awesome to be in control of how much of your income you take as wages and how much of it you take as owner's distributions. While over 32% of our income went to the taxman, it could have been several percent higher without that control. In addition, a big chunk of our increase in net worth (home, business, stock appreciation and gains in tax-protected accounts) is not technically income, and thus was not taxed at all. Ownership has its privileges.
Knowledge Is Power
The more you know about our tax code, the more opportunities you will find to live a tax-efficient life. I will proudly pay every dollar I owe in taxes, but I'm not going to leave a tip. I recommend you don't either. I hope you found this helpful and that you learned something from your taxes this year.
What do you think? What were your biggest deductions this year? What did you learn doing your taxes this year? Comment below!
I find this look into someone else’s taxes interesting. Thanks for sharing what you learned. Let me share an international comparison from the point of view of someone living in Japan:
1. Not a tax but apropos of health insurance I pay at the highest rate as an employee and that comes out to the equivalent of around $7,000 for a family of 5 and a little over $1200 for a form of (obligatory) longterm care insurance. Not sure of the employer contribution but even if they match every penny (every yen) that’s less than we could find when we tried to price out a very crappy Obamacare policy in the US a few years ago without subsidies.
2. In Japan everyone is in the same tax bracket for investment income: 20.315% (the 0.315% comes from paying for the earthquake tsunami damage). That applies to me and to each of my kids who have almost no income besides those dividends. In the US I think it works out I would be in the 30%+ tax bracket for dividends if I lived in Utah or 40%+ in California. The US is much more progressive in investment taxation.
3. Japan makes up for it on earned income taxes. My marginal tax rate there was 55% and effective tax rate was a little under 50% counting local (10%) and national (the remainder) taxes in 2019. I think the reason for the narrow difference between marginal and effective tax rates is that the local tax worked like a cliff (everything taxed at 10%) and the relatively rapid way you climb the brackets as income increases. You might want to keep those percentages in mind when thinking about what may happen to US tax rates when politicians realize the new debt-to-gdp ratio.
2. There is no 30%+ tax bracket for dividends. In Utah, you could pay as much as 20% qualified dividend rate plus 3.8% PPACA tax plus 5% state. That’s close to 30, but not quite. Same thing in CA except the top state bracket is 13.3% (so total 37.1%). I don’t think they give a break on dividends either, but I don’t know for sure.
Thanks for sharing your Japanese experience.
Wow, that’s a complex tax return- don’t feel bad about turning it over to an accountant.
So what did she say about filing taxes in a state because you received a K1 for it? Does it have to be filed every year or only in the year of sale of the syndicated property?
Thanks,
PFB
Depended on the state. Every K-1 and state had a different answer. Even if you get a K-1, if you don’t have any income for that state you don’t have to file. In the case of my funds/syndications, I didn’t have to file in any of those states this year but will in the future. All the income there was covered with depreciation.
Got it, thanks!
Hi,
For 1099 income…..doe one need to get an EIN?
Is an EIN what makes someone a “sole proprietor”
Do you need an EIN to form a “solo 401K”?
THanks!
No.
No. Getting the 1099 is what does that.
Yes.
Thanks!
I have a Personal Corporation (PC) that I am thinking of closing. For it, I have a Business Bank Account and formed a Solo401K last year at TD AMeritrade (haven’t used it yet).
If I close the PC and instead get an EIN for the solo 401K, do I need to close the Business Bank Account and solo 401K and form new ones? Or do I just transfer them from the Tax ID number of the PC to the new EIN?
Thanks
You probably need a new bank account. If the solo401(k) is in the name of the PC, then you probably need a new one of those too.
Curious how you choose charities to give to (or individuals, campaigns, etc). No need for specifics on names just looking for how you decide what is worth your donation/money. Great post sir!
Hi Jonathan, This post gives good insight into how the Dahle’s make those kinds of decisions: https://www.whitecoatinvestor.com/giving-meeting/
Thanks Jill.
Interesting article. One question, you mentioned harvesting big losses during March at the height of the pandemic. Why would you sell just to get capital losses?
https://www.whitecoatinvestor.com/tax-loss-harvesting/
I have the same capital gains strategy as Jim.
Harvested about $170,000 in losses in March but remained invested by buying something similar. Donate the most appreciated assets to DAF towards the end of the year.
Cheers!
-PoF
Who is your accountant?
I’m looking for a new one and figured you probably picked the best one out there!
Thanks
As if I want my accountant to be any busier. No way. At any rate, mine was chosen due to her relationship with my COO, not because she’s “the best.” Doubt I need the best anyway. It’s not like I don’t know anything about taxes. At any rate, here’s my list of recommended folks if you’re looking for someone:
https://www.whitecoatinvestor.com/tax-strategists/
What do you mean when you say that donating appreciated assets is negative capital gains? It obviously avoids capital gains, but are you calling it a negative capital gains because of the additional deduction taken for the donation?
Yes.
Who says you can’t teach an old dog new tricks? I remember recent articles from WCI stating everyone should do their own taxes and debating the utility of DAF’s. And now you have a DAF and are considering having the accountant do your personal taxes!
As far as taxes go, for me the onerous part is collecting and organizing the data over the course of the year. Of course the data entry is not fun either.
It’s funny how we change. 10 year ago I would have never have considered doing anything but academic medicine. And here I am in private practice loving it. Change is good.
I think your memory is a bit faulty. Let’s go back and see……
Nope, didn’t say it there. Let’s try here:
Nope, didn’t say it there either. I made a pretty careful calculation of the value of my time though. My time is worth a heck of a lot more now than it was in 2014, which probably explains a lot. I couldn’t find anywhere on my blog where I said “everyone should do their own taxes.”
Let’s look at the DAF issue. Here’s the “Pro/Con” post I did with POF:
My position really hasn’t changed much. I still think it’s a jerk move to fund one but not distribute, but you can avoid that by distributing everything you put in there, which is what I do. I like the anonymity and ease of repeat donations, especially of appreciated stocks. At any rate, here’s a post I wrote all about it:
https://www.whitecoatinvestor.com/our-donor-advised-fund-a-personal-experience-with-vanguard-charitable/
What happened? Well, I came to place a lot higher value on the anonymity mostly. But I also use the DAF in a way that avoids the criticisms I leveled at most DAF users.
Thank you so much for your tax review, chock full of detailed insights!
I would please like to know if/how your parental sole proprietorship avoids paying payroll tax upon your kids’ earned income there?
My personal corp employs my kids too (kids are W-2), with the goal of funneling the kids’ earned income to their own Roth accounts without payment of personal income tax. The “cost” ends up, however, being payroll tax on their salaries. My spouse has her own separate sole proprietorship, so that is the basis for my question above.
Many thanks!
Yes it does. That’s how it works. If a non-corporation owned only by their parents pays minor children as employees, no payroll taxes are due. It would be better if they were employed by your wife’s company.
Hello
Quick question?
If I get a 1099 B do I need to enter in every stock transaction, most 1099B forms are reported to the IRS it does not say that in box 12 but it states basis will be reported to IRS
I want to enter it as a stock summary
https://smallbusiness.chron.com/enter-1099b-tax-return-65068.html
I don’t know, in the past I have automatically downloaded that stuff into my return and Turbotax puts it on to Schedule D for me. But I don’t have hundreds of stock transactions.