Insights into Investment
and Income Tax
"COFFEE?" ROY OFFERED US, with a warm smile.
"Hell, I d-d-don't even d-d-drink c-coffee, but I'll have one," Tom replied, teeth chattering. Cathy and I just nodded our heads, shivering and stamping our feet.
"I can't remember a colder day for this time of year. That wind chills you right to the bone . . . you can see your breath . . . and in your case, Tom, it's not a pretty sight," James Murray quipped, to the great amusement of Clyde. "What the heck is the temperature?" Cathy grimaced. "Minus somethin'," Clyde stated authoritatively. "Hey, Clyde, I didn't realize you studied meteorology at school," Tom said facetiously.
"No, I hate that metric stuff," Clyde fired back. We can only hope that he was kidding.
"Roy, before we get started with today's lesson, I want to tell you that something you said last month had a profound effect on me," Cathy announced.
"You mean it took five months for me to say something that had a profound effect on you?" Roy laughed. "I must be doing something wrong."
Insights into Investment and Income Tax
"That's not what I meant and you know it. Serious—"
"Let me guess what it was," Tom interrupted. "A dollar saved is two dollars earned."
"You must be psychic!"
"Not psychic—psycho," Jimmy called from the back room.
"That same statement had quite an impact on me, too," Tom explained. "I hadn't thought about it before, but Roy was definitely right. Most of us will do anything to earn a few extra bucks, but very few of us will spend even a couple of hours looking for the best deal on, say, a new set of golf clubs.
"Golf clubs come to mind for a reason. Last week, I headed out to buy a new set of irons. I knew exactly what make and model I wanted but, instead of just walking into the local pro shop and paying whatever was asked, I decided to check around. I found the same set of clubs for one hundred and eighty dollars less at a different pro shop. Shopping around for only three hours saved me almost two hundred bucks. Not bad . . . not bad at all."
"And remember," I commented, "saving one hundred and eighty dollars is the same as earning a bonus of three hundred and sixty dollars."
"Well, in my case, not quite," Tom corrected me. "For me, saving a hundred and eighty dollars is the same as earning a bonus of about three hundred. But my three hours of comparison shopping still earned me a hundred dollars an hour. It's taken twenty-nine years, but I think I've finally learned the value of being thrifty."
"Thriftiness remains a virtue," Roy summarized.
"What's today's topic, Roy?" Cathy asked eagerly. "I seem to recall that October's lesson was to be on investing." Insights into Investment and Income Tax
are going to discuss how to reduce our annual income-tax bills." Naturally, this remark met with a more favorable response.
"Why are we discussing investing and income tax on the same day?" I wondered. "Do they dovetail well from a teaching standpoint?"
"The reason that we're discussing them together is quite complex, but here it is . . ." Roy paused and looked pensive. "In terms of time, they each take approximately one haircut to cover."
"That is deep," Tom deadpanned.
"I don't know much about investing, Roy, but I do know that even a teacher as skilled as you can't cover all the ins and outs of investing during one haircut—not even if the client is Rapunzel."
"You're right, Cathy," Roy conceded. "To cover the ins and outs of all the different types of investments in that short a time would be impossible. But that's OK, because one of the chief prerequisites of a financial plan is that its successful implementation not be dependent on expert investment management by the plannee. Why? Because most of us aren't capable of performing in-depth investment analysis and, what's more, most of us don't even want to become capable!"
"Amen," I said fervently.
"Successful investing is elusive. If it weren't, everybody would be shopping on Rodeo Drive. Few have the time it takes to properly analyze different investment alternatives. Those who do have the time to assess the risks and rewards of a given investment must also have both strong mathematical ability and sufficient knowledge to enable them to apply that ability wisely. That might involve Insights into Investment and Income Tax
lot of time and specialized knowledge, but also tremendous discipline and an eye for value—an eye that is often more intuitive than informed."
"I would go one step further, James, and say that, without discipline and an eye for value, an investor is doomed to dismal failure. I know several well-trained, well-informed investors who consistently lose money. They lack either the required discipline or the eye for value. Conversely, I know people who lack specialized knowledge but still have successful investment records because of their discipline and eye for value.
"Remember in May when James pointed out that, to make money in the stock market, you have to 'buy low, sell high'?" Roy asked us.
"It doesn't take a genius to figure that out," I replied.
"No? Then why do most market investors do the exact opposite? They buy high and sell low—a foolish approach if ever there was one."
"They lack self-discipline," Tom answered with a shrug. "Stocks are low when almost nobody wants them. So, to buy low, you have to buy at just the time when most people are saying it's not smart to do so."
"Exactly," Roy confirmed. "It may be the only law that has never been broken: the law of supply and demand. When a stock's price is low, it's down for only one reason: There are too few buyers and too many potential sellers. In other words, the stock is relatively unwanted. To buy in that kind of environment takes a courage that few of us have."
"It's the same on the sell side," I broke in. "You're sup-posed to sell high. When is a stock high? It's high when everyone wants it. It's high when demand is high and supply is low. It's not easy to sell a stock when all your coworkers Insights into Investment and Income Tax
another sheep . . . and you're probably heading toward the slaughter," Roy warned us.
'"Buy low, sell high' is impossible without self-discipline, or 'courage,' as Roy calls it," James Murray summed up.
"How about 'Buy high, sell higher'?" Tom suggested.
"Certainly it's possible but, for obvious reasons, buying low is a much less risky proposition. Many people have lost small fortunes buying late in a market rally, buying high, that is, because they convinced themselves that 'this time it will be different.' That fateful phrase has cost a lot of people a lot of money. Attempting to buy high, sell higher, is simply a fool's game," was Roy's vigorously stated philosophy.
"I'd be worried about 'Buy low, sell lower,'" I admitted. "I mean, after all, aren't most stocks low just before they drop off the board?"
"True, Dave," Roy responded supportively. "Just before a gas tank hits empty, it does pass through low. That's why, along with discipline, to be a prosperous investor you must also have that eye for value. You have to recognize the difference between an investment, say a common stock, that's undervalued and one that just isn't healthy. Many unwanted, hence low-priced, investments are unwanted for good reason."
"What about real estate? There it seems that, for the most part, buying low and buying value aren't as important. The operative expression seems to be, 'Buy at any price, sell higher.'"
"Quite honestly, Tom, I can't put up a strong argument against your point. Up until recently, with the exception of some one-industry towns, real-estate prices have been on a Insights into Investment and Income Tax
which home values rise only slightly. That being said, I'd like to add the following: Most real-estate investors have enjoyed solid returns throughout the last half-century, but the ones who have exercised discipline and bought value have been even more successful. Yeah, the guy who bought an overpriced duplex toward the end of an economic boom probably did sell it for a good profit several years later. However, the canny investor who located a bargain property and bought it during a recession would have reaped even greater rewards.
"Also, and I urge you to heed my words here, in my opinion the halcyon days of guaranteed easy money in real estate are coming to an end. As I mentioned in our conversation on home ownership, no trend is permanent. There's no law that says real estate can't decrease in value. I grant you that, over the long term, well-selected real estate should always perform well. Note the term 'well-selected.' If you use discipline and common sense and buy value, real estate will treat you well. But I don't think that buying property without regard to location, timing, and value will continue to be a profitable strategy." Roy was quite adamant about this prediction.
"What worries me, Roy, is that I don't think I have the qualities you're talking about. I certainly don't have the knowledge, and I have no reason to believe I have either investing courage or an eye for value—especially the latter."
"Don't worry, Dave," Roy reassured me. "As I said earlier, one of the prerequisites for a sound productive financial plan is that its successful implementation not require tremendous investment management skills on the part of the plannee."
Insights into Investment and Income Tax
forced savings, dollar cost averaging, conservative tax-as-sisted retirement funds, proper insurance coverage—you know, all the boring things that make people wealthy. What in the plan calls for any complicated investment decisions? Before you answer, remember that your short-term savings for things like cars and trips are to be invested in guaranteed products."
"I see your point, Roy, but what if, down the road, Sue and I have a lump sum to invest—say, an inheritance or royalties from a travel guide that Sue might write?"
"And what about me?" Tom cut in. "Because I'm buying real estate with my ten percent fund, I'm forced to make investment decisions. I don't have the safety net of dollar cost averaging."
"That's right, Tom, you don't," Roy answered, seem-ingly ignoring the fact that I had posed a question first. "I pointed out in May that when you elect to buy real estate with your ten percent fund, timing does become an issue. Both the discipline and eye for value we spoke of earlier are important and, for reasons I just explained, will probably become even more so in years to come. That's the bad news. The good news is that you do seem to demonstrate those qualities. You've bought a property in an area that hadn't been subject to a tremendous run-up in prices and, what's more, you've bought a property that James described as one of the better values he had seen."
"I'm flattered that you feel that way, Roy. Unfortu-nately, my purchase had more to do with luck than wisdom. I didn't—"
"Yes, you did!" Roy stopped Tom abruptly. "You did recognize that that property represented good value. I re-member you saying that, with the size of the lot, the Insights into Investment and Income Tax
estate investors. Quite a few people seem to have a knack for locating potentially profitable properties. Boy, how's that for alliteration?"
"Pretty powerful," Cathy quipped.
"Another intelligent thing you did, Tom," Roy contin-ued, "was to consult James for an opinion. His success is a testimony to his ability to spot the right property."
"Getting back to humble little me," I tried again. "What about my lowly question? I don't have Tom's eye for value and, even if I did, I probably wouldn't use it. I don't want to be an investor; I want to be a teacher."
"Yes, even though our plans are designed to diminish, if not eliminate, the necessity for investment skills, there could possibly be times when you are faced with an in-vestment decision. Your example of an inheritance was a good one, Dave." Roy stopped speaking long enough to get the attention of Jimmy, who was half-asleep.
"Jimmy, if someone finds himself or herself with excess cash from an inheritance, or from any other source, including savings from cash flow, what's the wisest in-vestment he or she could make?"
"Pay off non-deductible debt," Jimmy shot back.
"No doubt about it," James Murray seconded.
"There's simply no better investment alternative for the average American than to pay off his or her nondeductible debt, meaning debt where the interest is not a tax-deductible expense."
"So, our mortgages are deductible debts since we can write off the interest?" I attempted to confirm my under-standing.
"Right. On the other hand, what we're talking about here are debts such as car loans and credit-card balances. You're Insights into Investment and Income Tax
certificate of deposit, what rate would the CD have to pay for that choice to result in a break-even proposition?"
Roy's question drew no immediate response.
"Twenty percent," Cathy finally blurted out. "If I bought a CD yielding twenty percent, because I'm in the forty percent tax bracket, I would earn twelve percent after tax. That's the same value of return I'm earning by paying off a twelve percent car loan."
"Bravo! Do you two understand?"
Tom and I nodded our heads.
"Something just struck me," Tom said thoughtfully. "If paying off a twelve percent car loan equates with earning a twenty percent interest return, just think what interest you would have to get to break even with the paying off of a credit-card debt. Some of those cards are charging as much as eighteen percent interest on outstanding balances. You'd have to earn an over thirty percent interest return just to come out even!"
"Now, I ask you, is that complex mathematics? No, of course not," Roy answered his own question. "Yet incredi-ble numbers of Americans who have outstanding non-deductible loans also own bonds and CDs that pay fully taxable interest. It often doesn't make sense. Mr. X buys a ten-thousand-dollar CD paying around seven and a half percent. After paying tax, he's lucky if he keeps five and a half percent. At the same time, he continues to pay off his furniture loan at eleven percent with after-tax dollars. C'mon!" he scoffed.
"Knowledgeable investors agree that a three percent after-tax real rate of return is very good. Incidentally, what do I mean by 'after-tax real rate of return'?" Roy quizzed.
"The absolute rate of interest, less the amount paid in Insights into Investment and Income Tax
after-tax dollars. Let's say inflation is three percent. The after-tax real rate of return becomes, therefore, nine per-cent—thrice what is considered to be quite acceptable."
"Instead of paying off our non-deductible loans, isn't it true that we can refinance them through a home-equity loan and make them deductible?" Cathy questioned.
"Someone's been doing some reading," Tom noted enviously.
"Cathy, let's save the discussion of that strategy for our section on income taxes."
"I have a question too, Roy. Should you always pay off the highest-interest-rate non-deductible loan first?"
"Dave, it should be common sense that, if you have some money available to pay down non-deductible loans, you should pay down the one with the highest interest rate. Yet, many people put two thousand dollars down on a ten percent car loan and leave their eighteen percent credit-card balance untouched. Yikes! Yes, always pay off the loan with the highest associated interest rate," Roy answered diplomatically.
"There are a couple of other major considerations here," James Murray cut in. "Paying down non-deductible debt not only offers an excellent rate of return, but also is guaranteed, and there is a zero PITA factor. In addition, as Roy mentioned last month, reducing debt also reduces stress. I may not be a big fan of paying off your mortgage early—I still think there are better investment choices— but I sure agree that paying off non-deductible debt is one of the best investment alternatives."
"Well, I'm glad that it's a wise move, because it's cer-tainly the strategy that I feel most comfortable with— no heavy analysis, zero PITA factor, and, hey, eventually it'll Insights into Investment and Income Tax
disposable income. In my mind, the freed-up cash flow is the most satisfying benefit of paying off debts."
"And to think we didn't even mention it, James," the wealthy barber chortled.
"What if we reach a point where we have money to in-vest and we have no debt?"
Cathy's red face betrayed the fact that, with her lucrative income, the question was not hypothetical.
"Jimmy?" Roy redirected the question.
"Years ago, I found myself in just that position. I had accumulated several thousand dollars and I had no debt— not even a mortgage. I went to Roy and asked him for some specific investment advice. You won't believe what he told me to do. 'Spend the money!' He told me to spend it! Now, that's my type of financial planner," Jimmy concluded, giving Roy the thumbs-up sign.
"His fifteen percent fund was growing nicely, as was his retirement fund. He had no debt. He had no need for additional life insurance. His daughter's education was secure. In short, all his financial goals were being met. I suggested that he go out and buy something he'd always wanted ... a toupee, perhaps."
Roy's advice to Jimmy didn't surprise me at all. In April, Roy had stressed that a well-designed financial plan should meet our future goals without dramatically lowering our current standard of living. In view of that, Roy's suggestion to "spend it" made perfect sense. Why shouldn't people live to the fullest once their financial futures are well taken care of?
"If you find yourself in the enviable position of having more money than you care to spend, I strongly recommend that, rather than investing it all at once, which would require Insights into Investment and Income Tax
the five thousand will eventually run out, and then you'll have to revert to your normal monthly saving amount. In the meantime, though, you will have invested your money wisely, taking advantage of the same strategies we've discussed before and, once again, you will have avoided having to time an investment purchase precisely."
It was hard for me to get excited about Roy's last bit of advice. Although I'm sure that I'm now on the road to prosperity, the point at which I'll have more money than I care to spend is still years away.
Roy whisked me off as I stepped down from the barber chair. "On to income taxes?" I anticipated.
"I have a question first," Tom slowed us down. "Don't we ever get to buy a penny stock or something that's fun like that?"
"Mark Twain once wrote, 'There are two times in a man's life when he should not speculate: when he can't afford it, and when he can.' If you want to play the market, buy commodities or buy options on gold, but don't do it under the guise of financial planning. Yes, it can be fun. Yes, it can be exciting and, yes, on rare occasions, it can be profitable. The same things can also be said of a trip to Las Vegas. And, I should add, Las Vegas serves free drinks and is full of long-legged showgirls. Go to Vegas." Roy does have an effective way of driving a point home.
"Now on to our favorite subject: income tax.
"A dollar saved is two dollars earned," Roy repeated this familiar refrain.
"That was last month's lesson, Roy. We're covering in-come tax now, remember?" Tom joshed.
"A dollar saved is two dollars earned, whether it's a dollar saved through coupons or through reduced tax," Insights into Investment and Income Tax
"What James means is that, normally, to save a dollar we must make some sacrifice, but when we save a tax dollar, there's no associated sacrifice. Tax savings are savings of the best kind," Roy clarified. "Because of that, it's important that each of you does your best to minimize your tax bill. . . your legal best, that is. Tax evasion is il-legal and is not recommended. In fact, the almost epidemic proportions that tax evasion has reached, through non-reporting of all sources of income, is one of our country's major economic woes.
"On the other hand, tax avoidance, the minimizing of one's tax bill through the proper handling of one's financial affairs, is an important part of financial planning."
"I hate to keep playing the devil's advocate," I broke in somewhat sheepishly, "but I have even less interest in becoming a tax expert than I did in becoming a knowl-edgeable investor. The mere mention of the word 'ac-counting' makes me shudder."
"Once again, your nervousness is unfounded," Roy assured me.
"We've said that one of the prerequisites of a sound and productive financial plan is that its successful imple-mentation not be dependent on expert investment man-agement by the plannee. Another prerequisite is that the successful implementation not be dependent upon the plannee becoming a tax expert." Tom offered an almost perfect imitation of the wealthy barber.
"You must have studied financial planning under a brilliant mentor, Tom." Roy laughed. "What Tom just said is very true. Producing and following a sound financial plan should not be dependent upon the plannee being a tax expert, not just because becoming a tax authority is an Insights into Investment and Income Tax
services will be relatively low. However, if your affairs are more complex, our captain of industry, Cathy, being a good example, then tax advice certainly will be more ex-pensive—but obviously, more warranted, too."
"If our affairs are that simple, why don't we just do our returns ourselves?" was Tom's logical question.
"Tax reform was supposed to simplify the tax system, but it's generally agreed that it hasn't. If anything, recent changes in the tax law have made planning and filing even more complicated. Even a straightforward return might well benefit from a professional look-see. As I just said, if your return is really that uncomplicated the advice won't cost much anyway."
"Remember, Tom," James Murray added, "from now on your tax return isn't going to be as simple as Roy thinks. You're now an owner of a rental property. Depreciation, mortgage interest, rental income, property taxes . . . need I say more? Even you, Dave, don't really fit in the 'straightforward' category, with Sue being self-employed. Can you write off an office in the house? What about your computer? Perhaps some of your car expenses are deductible?"
Tom and I looked at each other and nodded.
"You see," Roy picked up from James Murray, "there aren't too many filers who couldn't benefit from some professional guidance."
"Well, that was a short section," Cathy kidded. "What's on the agenda next month?"
"You don't think you're getting off that easily, do you?" Roy replied with a wink. "I do have a few tax ideas I'd like to pass on to you—personal favorites, if you will. Shouldn't take more than an hour or so."
Insights into Investment and Income Tax
"Precisely," Roy confirmed. "Tax-deductibility of con-tributions and tax-deferred growth in the first case, and the mortgage-interest and property-tax deductions combined with appreciation that probably will be free of capital-gains taxes down the road in the second. Not bad . . . not bad at all . . . especially considering that, while taking advantage of all of those tax breaks, we're accomplishing, as was just mentioned, two very important financial planning goals. Need I say more?"
Certainly, he didn't have to say more to me because Sue and I were, by then, not just aware of the tax incentives but, more important, we had already begun to take advantage of them through my 403(b) plan, her Keogh, and our new home purchase. As I thought of the steps we had recently taken, I realized just how far we'd come in a few short months. Good financial planning really isn't that complex nor, fortunately, that burdensome.
"Even though I recommend that each of you seek pro-fessional tax advice, I still think it's a good idea for you to fill out your own forms," Roy interrupted my daydreaming with his apparently contradictory suggestion. "Why? Because it's an excellent learning experience. Filling out your own return is one of the best ways, if not the best, to find out what areas of your record-keeping need improve-ment. I would also recommend that you always complete the 1040 long form. When you use the short form you are guaranteeing that you'll be paying the absolute maximum tax which can be paid on your level of income. Completing the long form will, perhaps, save you tax dollars, and definitely will familiarize you with the many available tax deductions. Even if yours don't add up to more than the standard deduction, at least the long form may point out Insights into Investment and Income Tax
"When you think about it, filing the long form can never result in more tax owing, only less," I remarked.
"Very good point, Dave," Roy congratulated me. "Now, I want to refer to something Cathy mentioned earlier: home-equity loans.
"Interest on consumer loans is non-deductible, which means, as we've discussed, that paying off those loans as quickly as possible is a very prudent move. Cathy suggested that instead of paying them off a person could convert them, through refinancing, to one of the still-deductible forms of debt such as a home-equity loan. It's a good point.
"Let's assume that Cathy's condominium is now worth one hundred and fifty thousand dollars and the mortgage is for one hundred grand. Let's also assume she has a car loan at the bank for ten thousand dollars and owes two thousand on her credit card—"
"Only two thousand," Tom cracked.
"The interest on her car and credit-card loans would not be tax-deductible because they are consumer loans. However, if Cathy were to refinance by taking out a home-equity loan of twelve thousand, things would change dramatically. She would use the twelve thousand, of course, to pay off the other two loans."
"So, big deal," I broke in. "She still owes twelve thou-sand, she just owes it to a different lender."
"True," Roy replied patiently, "but the interest on the twelve-thousand-dollar loan is now tax-deductible! If the interest was fifteen hundred dollars a year, which is about right, that deduction would generate for someone in Cathy's bracket a tax savings of more than five hundred dollars!"
"Five hundred bucks is a lot of money for making a few phone calls and filling out some forms," James Murray Insights into Investment and Income Tax
"Two other points," Tom rushed in. "One: In addition to converting her non-deductible consumer loan to a de-ductible home-equity loan, Cathy lowered her interest expense by refinancing a credit-card debt."
Roy patted his blossoming pupil on the back.
"Two: I'm not sure that I think all of this is fair. Those who don't own homes don't have any equity to access!"
"First, don't use 'access' as a verb and second, your point is a good one. In fact, it's one more reason why home ownership is, with few exceptions, a good move— the equity that you're building gives you access to tax-efficient financing. However, it's important to note that refinancing using a home-equity loan isn't the only way of restructuring your debts to make consumer-loan interest tax-deductible. You could also take out a second mortgage—"
"Yeah, but I don't own—"
"Hold on, Tom. Or you could use the following strategy: Borrow money against the equity in your rental property and pay off your consumer loans with it. Because your rental property is an investment, the interest is tax-deductible!"
"I don't have any equity in my rental property. Remember?"
Not even Roy had an answer for that.
"I have another thought you should keep in mind," Roy continued. "Because interest on debt incurred for in-vestment reasons is tax-deductible and consumer debt isn't, always make a concerted effort to structure your affairs so that your loans are against your investments, not your consumer goods. If that involves selling off some in-vestments, paying off the consumer loans with the proceeds, then reborrowing to buy back the investment, so be it. In Insights into Investment and Income Tax
"Commissions and taxes," he repeated in disbelief.
"Are there any limits to how much interest we can deduct?" Cathy wondered.
"You can deduct the interest on the mortgages of your first and second homes as long as the mortgages don't ex-ceed the price you originally paid for the homes plus the cost of any improvements. I think there's also a million-dollar cap."
"Oh, darn," I cried.
"The interest on home-equity loans may be deducted as long as the loan doesn't exceed the lesser of the fair market value of the residence less any mortgages, or one hundred thousand dollars . . . pretty generous, really. Incidentally, a point I should have made earlier about home-equity loans is this: The undisciplined should beware! Having the ability to write a check against your home-equity line of credit is a dangerous privilege—one that's been abused by many people. Spending money frivolously and making poor investments can sometimes cause people to get in over their heads with their credit cards—not good. However, making those same mistakes on a grander scale can lead to the loss of your home ... I think you get my point. Some states don't even allow home-equity loans—perhaps for good reason!
"When it comes to the deductibility of interest on in-vestment loans there are a number of variables—you'd better consult an accountant." The way Roy stated this sounded more like a warning than a suggestion.
"Assuming that we can structure our affairs in such a way that the interest on our consumer loans is tax-deductible, should we still pay off the loans?"
"Well, Cathy, it's really the same dilemma as whether or not paying off your mortgage is a good idea. I think the Insights into Investment and Income Tax
factor, an eventually freed-up cash flow, and reduced stress—you have a pretty attractive package. Besides which, even deductible interest, if you're paying enough of it, can kill your standard of living."
"Live within your means," my sister quietly reminded herself.
"There's another very interesting tax strategy I'd like to discuss: the batching of deductions. Let's assume that Dave and Sue, after itemizing, are just over the standard deduction—"
"We'll be way over, Roy, now that we have deductible mortgage interest," I corrected the wealthy barber.
"Are you cognizant of the meaning of the word 'assume,' Dave?"
No doubt Tom was thinking of throwing in his standard smart reply to Roy's question but the word "cognizant" slowed him down a little.
"A potentially clever maneuver would be to itemize your return every other year and to time your deductible expenses, as much as possible, to fall within those alternate years. By doing so, you would be limited to claiming only the standard deduction every second year, slightly less than you would have been entitled to claim in those years by itemizing, but in the 'itemizing years' you could save significant tax dollars."
"I'm not sure I follow," I admitted.
"Let's say 1998 was one of the years you were not going to itemize. In December of that year, hold off making charitable contributions, making your monthly mortgage payment, and paying local taxes, if allowed, until early 1999. Then in December of '99 make sure you make the 1999 donations, make your mortgage payment, and pay that Insights into Investment and Income Tax
is suited to your situation, the bottom line is that you'll save hundreds of dollars in taxes and only have to go through the work of itemizing every second year!"
Roy was clearly deriving greater pleasure from dis-pensing this information than we were from receiving it.
"There are two related strategies that apply to mis-cellaneous deductions and medical expenses. Because both of these areas are only deductible to the extent that they exceed two percent and seven and a half percent of your adjusted gross income respectively, it may pay to bunch your expenses into certain years. By doing so—"
"We get it, Roy," Tom spoke for all of us. "Isn't all of this evidence of why it's so important to use the services of a professional?"
"Yes." Roy's one-word response indicated his frustration at having been cut off during a section he obviously took delight in.
"Seems like a lot of work," Cathy added. "Plus, I can't believe the IRS would be too excited about 'creative bunching.'"
"All right, all right. . . Let's move on," Roy conceded, a beaten but not broken man. "Another way to legitimately reduce your taxes is by going into business. In fact, many financial writers push this as the best way to save taxes. They point to the vast number of normally non-deductible expenses that may become deductible, or partially deductible, if you own your own business: your automobile, your computer, your travel, your phone, your entertainment, your children—yes, you heard me correctly—your magazine subscriptions, your VCR, et cetera. What is often not pointed out is that to become deductible these expenses must be incurred for business reasons. What is also seldom Insights into Investment and Income Tax
because it has transformed traditional personal expenses into legitimate tax deductions doesn't wash with me. There are a number of valid reasons to start up your own business, including the pursuit of profit, a desire for independence, a chance to meet people, and a sense of accomplishment. Potential tax savings, on the other hand, are not sufficient reason to start a business; they are instead a benefit of starting a business. It's very important that you always keep that distinction in mind. This is America—you should start a business if, and only if, you feel you have a product or service of value to produce.
"Now, let me get down off my soap box and add that starting your own business can, indeed, result in significant tax advantages, largely through the form of increased deductions. The key here is . . ." Roy paused to let us guess. "Seek professional help!" I asserted confidently.
"Right on! For example, in your case, Dave, with Sue being a self-employed freelancer, in other words, owning her own business, there are many legitimate tax deductions she can claim that I'll bet you don't even know about."
"I realized that earlier, when James fired those questions at me about writing off some of my house, car, and computer expenses. Trust me, Roy, I'll check into it right away," I promised.
"OK, final tax point: Do some reading. I'm not trying to turn you into accountants or to bore you to death, but taking some time to at least skim a few of the books I'm about to recommend would be a good idea. Tax experts agree that the major mistake tax filers make is a basic one: They don't use all the available deductions. Yes, the professional advice you'll be getting will help, but so will the following books: Julian Block's Year-Round Tax Strategies, any tax Insights into Investment and Income Tax
"Thanks for the advice," Tom interrupted. "Whew, can you believe how time flies? We'd best be going, Dave."
Normally I'd chastise Tom for being so rude, but in this case I was thankful—three tax guides is my limit. Actually, it's considerably over my limit.
"So, what's on the agenda for our last month, Roy?" Cathy wondered.
"There are four or five topics you still need a bit of in-formation about. Then, of course, Clyde will present each of you with a hand-engraved, gold-trimmed diploma denoting your graduate status from the Miller School of Financial Planning. The diploma can either be wall-mounted or it can stand on a table—"
"Enterprising pupils probably scrape off the gold and sell it at the bank," interrupted Tom.
"I may have taught that lesson on thrift too well," Roy muttered, shaking his head.