IRA

How Long Should You Save Your Tax Returns and Financial Records?

The IRS says that you should normally keep your records for 3 years, and for some situations you should keep them for 6 to 7 years. However, I strongly disagree and here is what you should do and how to do it:

Tax returns: Do you want to know the prudent answer to how long you should save your tax returns? Until you are dead, and even then your heirs should probably keep them until years after the estate is settled. Why should you do this even though the IRS has 3 years to audit your returns and 6 years if you under report more than 25% of your income? Here are several real-world practical reasons:

  1. It is far too common that the State of New Jersey will send a letter to you stating that you never filed a tax return from more than 10 years ago. Additionally, if you are selling your business, trying to obtain a specific license, dissolving a business, or for any number of reasons, then the State will perform research to see if you filed all of your tax returns. Even though the State may be wrong, you will still generally need to file the returns.
  2. Information carries over from year to year. As your tax return becomes more complex, your income tax information tends to carry over for many years, such as investment losses and rental property purchases.
  3. A safe way of storing your tax returns is to keep both digital and hard copies.

Financial records/receipts: What if social security has incorrect information about your earnings from 25 years ago? If you have the actual records then you can prove your case more easily. This includes tax information, such as W-2’s and paystubs. Here are some timeframes based on the types of documents:

  1. Tax documents should be saved forever, just like you save your tax returns. This especially relates to business tax records. Brokerage statements should be included as part of your tax information as they contain purchase price information.
  2. Bank and credit cards statements can be discarded after a few years. However, if they contain tax information or are connected to a business or real estate, then you should save them forever.
  3. Utility bills can be discarded after about 6 months. Sometimes you need these to prove your residency, but the timeframe needed is generally a few months.
  4. ATM and purchase receipts can be discarded once you view the transaction on your bank statement or online. However, when purchasing from a restaurant, you should make sure that the amount after a tip is accounted for actually settles, which can take several days.
  5. Receipts for improvements to your home or for large business purchases should be saved forever.
  6. If you are short on physical space then save your records electronically, but make sure that you have a cloud backup.

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5 Financial Truths

There is a lot of information out there about finances, and it’s hard to figure out what is exactly true or not true. Always seek the truth, especially from someone that is not trying to sell you something. Here are some examples:

College: We are led to believe that all of our children must go to college to be successful and make a lot of money. While I am a big believer in education and college, it is not the only route and it is not for everybody. With the high cost of college, the decision to attend college should not be automatic. There are alternatives, such as becoming a tradesman, learning a special skill that does not require college, starting a business, sales positions, military or government positions that do not require college, stay at home parent (yes, this is a vocation), etc.

Retirement savings: Saving for retirement is a good thing, however, it should be balanced with both short and mid-range needs. For example, if you allocate virtually all of your savings towards retirement accounts and ignore having a cash cushion, then your risk of financial catastrophe increases. If a financial crisis arises or a large purchase needs to be made, then you will have to withdraw from your retirement accounts, which is one of the worst financial decisions to make due to both income taxes and penalties on the withdrawals. Furthermore, if you do not have withholdings taken from your distributions, then you will probably end up with a tax problem once you file your return. The prudent action is to have a cash cushion of 3 to 6 months of expenses for emergencies and to save for mid-range goals, such as a house purchase.

Debts: Debt truly is a double-edged sword. There are some who advocate staying away from debts at all costs and others who encourage you to leverage yourself to make more money. The truth is that debt should be used wisely and sparingly, if necessary and as a last resort, and it should not cripple you. If you are able to avoid debt, then that is excellent, as debts increase your risk and they also encourage risky behavior and increased spending in many cases.  To prove this point, why do you think McDonald’s started to accept credit cards, why do auto loans have 7 year terms, and why can young adults take out massive loans for college?  It is to get you to spend more than you would have otherwise.  As you mature financially you should seek to decrease your debts.

Most people would not be able to afford a house without obtaining a mortgage, and if they waited to purchase a house and rented instead, then they would most likely be worse off financially over the long term. Also, some businesses may need to incur debts to purchase expensive equipment, inventory, or improvements that would not be possible if they did not incur debts. To emphasize, it should be used wisely and sparingly.

Expenses, income and savings: Most likely your expenses are way too high. If you are able to save 15- 20% of your income and have no debts then spend whatever you want. Otherwise, set aside money towards savings to steadily increase the percentage that you save each time you get paid. This way you will spend whatever is left over. If you are not able to do this then you need to take a serious look at decreasing your expenses and increasing your income. The truth is that it is really not that hard, but most people have a hard time doing this. As Yogi Berra said, “Baseball is ninety percent mental. The other half is physical.”

Home and health = wealth: In the quest for success, don’t ignore your most valued relationships or your health. Nothing can cripple your finances as quickly as health or family issues, such as divorce. With either of these issues your expenses increase exponentially while your income suffers at the same time. Make sure to prioritize.

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Don’t Make These Easily Avoided Financial Mistakes

We are all not perfect and everyone makes mistakes. However, the key is to avoid these financial mistakes as much as possible:

Penny wise and dollar dumb: The actual expression is penny wise and pound foolish, but I still remember a partner from my first job saying this to a client (maybe it’s the American version). I guess it doesn’t matter how you say it as long as you make your point. The message is to not be cheap so that you save a few dollars, but it ends up costing you a lot more down the road. This can happen with almost any financial transaction so always be aware of what you are trying to accomplish.

Ignoring tax notices: Don’t be surprised to find out that your bank account has been levied or there are liens against your assets if you don’t address tax notices. Surprisingly, the notice may actually be wrong, but the IRS or states do not know this. If you do not resolve the notice timely, then penalties, interest, and collection costs may be added to your balance or you may not receive your refund.

Not filing your returns: Sometimes taxpayers hesitate to file their tax returns when they know that they owe money, but do not have the ability to pay their balance. Fortunately, there are usually payment arrangements that can be made in these cases. Also, every now and then I come across a situation where there is actually a refund due to a client, but they took too long to file their returns so they are not longer eligible to receive it. Now that’s painful!

Not saving anything: Just about everyone can save at least 1% of their income to make this a habit, and then can increase their savings rate over time. The earlier you start, the better and don’t convince yourself otherwise.

Too much long-term savings/illiquid assets: Sometimes the opposite is true when people tie up all of their money in their retirement plans or real estate, but do not accumulate short-term savings. What tends to happen is that retirement savings are tapped if there is a financial emergency or long-term financial set-back, which in turns ends up creating a tax issue.

Do You Have Too Many Financial Accounts?

How many financial accounts should you have both personally and for your business? These days it is so easy to open up accounts, but if there is no strategy for having a lot of accounts, then it can create unnecessary chaos and even increase your accounting and tax preparation costs. Let’s look at the pros and cons:

Multiple investment accounts: You may have a traditional brokerage account with one firm, your IRA’s somewhere else, and your old 401k’s still at your employer. The problem with this approach is that it may be hard to coordinate your asset allocation and investment strategies if you are not looking at them as a whole. This is especially true if you have a financial advisor because he or she most likely does not have visibility to your other accounts and cannot advise you properly.

Multiple bank and credit card accounts for your business: There are strategies that can be implemented whereas you transfer money between bank accounts as sort of a shelter as a way of budgeting for your expenses. This strategy is outlined in a book called “Profit First,” which is a very good read, and if you are able to implement this strategy then that is excellent. Aside from the business owners that use this strategy, anecdotally, there seems to be a very high correlation between poor financial performance and multiple bank and credit card accounts.

Multiple bank and credit card accounts personally: The most common issue is when husbands and wives have separate bank accounts. Aside from this being a smart move if there are legal issues, addictions, or tax issues, it makes sense to have one joint checking account for a married couple. Money issues are at the forefront of arguments so why not coordinate your finances as one unit so that you make better decisions jointly and without conflict?

You should always strive to simplify your finances, but as Albert Einstein said, “Everything should be made as simple as possible, but not simpler.”

Deadline Approaching: Should You Make a Retirement Plan Contribution?

The due date for your tax return is fast approaching and so is the deadline to make a contribution to your IRA or a SEP-IRA if you own a business. Should you make the contribution, save the cash, or pay off some debt?

Reasons to Make the Contribution: Let’s assume that you have the extra cash. If you are looking for an extra deduction and you are able to make a deductible contribution then this is a great last minute strategy. You may have also maxed out your retirement plans at work and are looking for additional retirement savings. A non-deductible IRA contribution can also be advantageous too and may be able to be converted to a Roth IRA with no tax consequence, depending upon your situation.

Save the Cash: You may need the cash to start a business or expand your business. Start-ups need every bit of cash so saving for retirement may need to be put on hold for now. Additionally, the returns of starting or expanding a business can be many times greater than a retirement plan contribution.

Pay Off Debt: If you have very high interest rate debt, then paying down your debt will help you to pay off the debt faster and decrease your liabilities, which will in turn strengthen your finances. However, I do not recommend not contributing to a retirement plan to make extra payments towards your mortgage.

Other factors to consider are: large expenses that you may need to fund in the near future, your health, job and business stability, emergency fund balances, and your overall financial goals.

Did Your Tax Balance Catch You by Surprise?

What should you do if you file your tax return and then realize that you now have a large liability that can’t pay? First, don’t panic as there are several options for you:

Installment Agreement: An installment agreement can be a good option for you, which can sometimes be requested when you file your tax return. Interest and penalties will still accrue, but now you do not have to worry about levies. You may also request an extension of time to pay for several months if you expect to be able to pay off your balance quickly.

Offer in Compromise: Pennies on the dollar! We’ve all heard this advertisement from tax resolution companies. There is some truth to this, but it is greatly overstated. The way it works is that the IRS will accept an amount that is less than the amount of your tax liability. However, a majority of the offers are not accepted by the IRS.

Currently Not Collectible: This option allows you to postpone making any payments towards your tax balance and essentially places all collection activities on hold. However, the IRS may reassess your situation in the future to determine your ability to pay. Penalties and interest will still accrue.

No matter which payment arrangement you make, the caveat is that going forward you must always file your returns timely and full pay your balances. If not, then any arrangement that you have in place can default. Additionally, you generally need to submit financial information to the IRS for them to determine eligibility of an arrangement.

Prevention: How can this be prevented going forward? The first way is to make sure that you are properly planning how to minimize your tax liabilities before the year is over with proactive tax planning. The second way is to project your tax liabilities during the fall to estimate what your tax liability will be, which will make you aware of how much you will owe and give more time to figure out a good solution.

If You Want More Success Then Know the Difference Between Important vs Urgent

Important vs. urgent. Many people confuse the two, but if you want to be more successful, then you need to be able to discern between them. Important items have great significance or value while urgent items require our attention immediately. Here are some examples:

Important:  These are items that you need to do, but do not have to be done today, such as projects and assignments, planning, exercising, learning/training, saving for the future, etc.

Urgent: These usually have to do with grabbing your attention immediately, such as text messages, social media, doing dishes (our spouses may disagree with this one), interruptions, emails, most telephone calls, etc.

The problem arises when the urgent items seem to be important because they are pulling at us, and then we ignore all of the important items that we should have done. This is probably why many people say that they didn’t get anything done because their attention was diverted to urgent items. Even worse is when we procrastinate and make the important items both important and urgent.

What are some solutions? If an item is important, then you should set aside time either daily, weekly, or monthly to take care of it and actually put it on your calendar. Once an important item is scheduled there is a high probability it will get done. As for the urgent items, you can schedule these as well to take care of them at specified times or on a specific day. If you want to be bold then try this experiment for one week or even one month: shut off all of your alerts, emails, etc. while you are working, and designate a time to check them, say twice a day. Then, see if your productivity improves, and let me know what happens.

Is it Better if I File Separately from My Spouse and Other Common Tax Questions Answered

We receive a lot of questions pertaining to tax and financial matters. Here is a sample of commonly asked questions:

Q: Is it better if I file separately from my spouse?

A: Usually the answer is no, and the only way to know for certain is to perform an analysis when preparing the tax return to split income and deductions between spouses to see if there is a benefit. However, you may want to file separately from your spouse if there are tax or legal issues.

Q: Is social security taxable?

A: That depends. If you are only receiving social security and do not have other income, then the answer will probably be no. A quick way of checking is to add one half of your social security plus your other income to see if it is greater than your base amount, which varies based upon your filing status (currently it is $32,000 for married filers).

Q: Does my son or daughter need to file a tax return?

A: Generally, if your dependent child has more than $6,300 of earned income or $1,050 of unearned income, such as from dividends, then they need to file a return.

Q: If I file an extension, will it extend the amount of time that I have to pay my taxes.

A: No, the extension only grants you additional time to file your return and all payments must be made by the original due date, otherwise additional interest and penalties may be incurred.

Q: Can the IRS levy my IRA?

A: Yes, the IRS has the power to levy almost all of your income and assets, with few exceptions, such as workers’ compensation.

Q: Are legal fees for a divorce deductible?

A: Many of the legal fees for a divorce are not tax-deductible, except for the portion relating to taxable income.

Muni Bonds or Taxable Bonds?

Investing in municipal bonds can be a benefit due to the fact that the interest income they provide is generally tax-exempt. In order to realize the full tax benefits of municipal bonds, you have to be careful not to make the following mistakes.

Low Interest Rates: Interest income from municipal bonds is usually much lower than corporate bonds, but since municipal bond interest is generally tax-exempt, your tax adjusted returns may be higher. The problem arises when you would have received a greater return by investing in corporate bonds than municipal bonds when adjusting your return for taxes. Generally, if you are in a low tax bracket, then municipal bonds may not make sense.

Purchasing Out of State Bonds: Municipal bonds are not subject to either Federal or state taxes if you purchase bonds from your home state. If you live in a high income tax state, such as California, New York, or New Jersey, then you should consider purchasing a bond from your state to reduce the overall tax exemption.

Alternative Minimum Tax: This dreaded tax, also known as the AMT, may make your tax-exempt municipal bonds taxable. If a bond is considered a private activity bond, then you may end up paying taxes on the bond interest.

You must be careful when selecting municipal bonds by doing your research. Otherwise, in the quest for tax-exempt income, you may end up overpaying taxes or unnecessarily receive a low interest rate.

Municipal Bond Investing Mistakes

Investing in municipal bonds can be a benefit due to the fact that the interest income they provide is generally tax-exempt. In order to realize the full tax benefits of municipal bonds, you have to be careful not to make the following mistakes.

Low Interest Rates: Interest income from municipal bonds is usually much lower than corporate bonds, but since municipal bond interest is generally tax-exempt, your returns may be higher when factoring in taxes. The problem arises when you would have received a greater return by investing in corporate bonds than municipal bonds when factoring in taxes. Generally, if you are in a low tax bracket, then municipal bonds may not make sense.

Purchasing Out of State Bonds: Municipal bonds are not subject to either Federal or state taxes if you purchase bonds from your home state. If you live in a high income tax state, such as California, New York, or New Jersey, then you should consider purchasing a bond from your state to reduce the overall tax exemption.

Alternative Minimum Tax: This dreaded tax, also known as the AMT, may make your tax-exempt municipal bonds taxable. If a bond is considered a private activity bond, then you may end up paying taxes on the bond interest.

You must be careful when selecting municipal bonds by doing your research. Otherwise, in your quest for tax-exempt income, you may end up overpaying taxes or unnecessarily receive a low interest rate.