How to Slash Your Taxes: Tax Liability Estimation

With tax day fast approaching, most of us are in crunch mode to get our taxes submitted by the deadline. It is now crunch time to finish before time runs out and penalties are assessed. Despite the desire to just finish our taxes, we should all take a step back and think about tax estimation.

Tax liability estimation is a very useful skill to have. Put to good use, it can slash your taxes and bring your freedom date closer. It allows you to leverage your knowledge of tax liability with your employer to lower your tax withholding from your paycheck and have a higher take-home pay each month.

Because estimating your taxes allows you to lower your tax withholding and not have a tax refund at the end of the year, you are able to put your money to work sooner gaining precious days and months on your freedom date.

As I worked with my tax preparation provider (paid for by work), I prepared a tax estimation spreadsheet. There are numerous calculators out there for estimating taxes, but none are as powerful and customizable as the simple spreadsheet. I developed it using the infamous Form 1040. Taxes always have a mystique of being complicated and impossible to do without help, but through my creation of this tool, I learned that it is not nearly as complicated as we are led to believe.

I went through the 1040 line-by-line and brought all applicable items over to the spreadsheet to be able to calculate my actual tax liability. Because I have the expat package now, this was a huge tool for me. I have $15,000+ per year that is un-taxed from my perspective because of gross-up taxes paid by the company. My tax preparers are doing my taxes based on not saving any money to tax-advantaged accounts and after I was able to estimate my tax liability for the next year, I was able to get them to lower my taxes over $300 per month. That is $3,600 for the year that I can invest up to a year earlier and get compound growth on.

Free TAX ESTIMATOR

If you are interested in seeing my tax estimation spreadsheet for yourself and playing with the numbers to optimize your situation, sign up below. Be prepared for extreme savings!

The 1040

The 1040 is broken up into sections to make it easier to understand. The sections are:

  • Filing Status (single, married filing joint, married filing separate, head of household, qualifying widow)
  • Exemptions (Used for the standard exemption calculation)
  • Income (All your various income streams are accounted here)
  • Adjusted Gross Income (allowed deductions to your taxable income)
  • Tax and Credits
  • Other Taxes (additional special taxes e.g. self-employment tax)
  • Payments (how much you paid through the year)
  • Refund (if overpaid on taxes throughout the year)
  • Amount You Owe (if underpaid on tax throughout the year)

There are a total of 79 line items to fill out on the 1040, but for most people, the majority of the items will be not applicable and the form quickly becomes very easy to fill out.

There are numerous software tools to help you fill out your taxes, but the tax forms are not complicated and can be filled out personally. Doing this will give you a more intimate knowledge of taxes and help you to slash through the waste.

How to Estimate Your Taxes

Everybody should track their income and expenses. Because you track your income and expenses, it is very easy estimate your tax liability for the year.

Income

First, you need to be able to project your income. This includes not only your salary, but dividends in your taxable investment accounts, business income, taxable refunds, capital gains from investment sales, taxable retirement income, rental income, farm income, unemployment compensation, and other miscellaneous income. Basically if you make money in any way, Uncle Sam wants a part of it.

From this list of taxable income, you should take notice of the dividends, capital gains, and retirement income. These are your personal levers to reduce taxes from your income. These may not seem like income during the year, but Uncle Sam sees it that way.

Adjusted Gross Income (AGI)

Second, you will estimate your deductions for the year. Your AGI is your income after allowed adjustments to income before the personal and standard deductions. AGI gives you an overview of your income that wasn't saved into tax-advantaged accounts or spent on tax-advantaged goods. Your main adjustments are:

  • Educator expenses
  • Health Savings Account (HSA) contributions
  • One half of Self-Employment Tax
  • Pre-tax retirement plan contributions (Traditional IRA, SEP, SIMPLE, Solo 401k, 401k)
  • Self-employed health insurance deduction
  • Student loan interest deduction
  • Tuition and fees to qualifying schools

This list is not comprehensive, but represents the most common deductions taken on your taxes. Normally the 401k deduction is accounted for on your W-2 and does not show up as income, however, when estimating your taxes, you should include it as a line item under AGI.

Tax and Credits

Tax and Credits is home to your personal and standard or itemized deductions. After subtracting these from your AGI, you get your taxable income. From your taxable income, you can determine which tax bracket you fit in and determine your taxes.

The US uses a progressive income tax. In other words, being in the 25% tax bracket does not mean you pay 25% of your income to Uncle Sam, it means you pay 25% of the amount above the 15% tax bracket and 15% of the amount between 10 and 15% brackets, and 10% of the amount below the 10% bracket.

tax ~= taxable income * 25%
tax = 10% * 10% tax bracket + 15% * (15% - 10% tax brackets) + 25% * (25% - 15% tax brackets) + ...

You pay less than your tax bracket sounds like.

You have your tax liability calculated and now it is time to take your tax credits. Credits are much more powerful than deductions because they directly effect the tax liability. They are directly subtracted from the tax liability. Credits available include:

  • Foreign tax credit
  • Dependent care credit
  • Education credit
  • Retirement savings contributions credit
  • Child tax credit
  • Residential energy credits
  • Other credits


Bringing it all together

Now we have enough information to estimate our tax liability. When we know our salary, contributions to tax-advantaged accounts, deductions, and credits, we can accurately estimate our tax liability for the year. Even if you get a bonus or some other windfall, your estimation is accurate and the bonus is just added in on top of what you already predicted.

The true power of the estimation is the chance for optimization. With a plan for the year and a model you can manipulate, you can see how different scenarios can effect your bottom line. The goal here is to minimize your tax liability and the only way to do that is to know how it works. By playing with the numbers you can watch the tax liability vary and determine the best way to plan out your taxes.

Spending your time on optimizing your taxes and determining how to qualify for the various tax credits will give you a huge return on investment. Not only can you minimize your tax liability today and get your money invested sooner (no tax refund), but you can also have more money overall by minimizing and planning your tax approach.

Free TAX ESTIMATOR

If you are interested in seeing my tax estimation spreadsheet for yourself and playing with the numbers to optimize your situation, sign up below. Be prepared for extreme savings!

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Is College the Only Path?

Why does society push us towards pursuing college?

Is college really the only path to freedom out there?

Society pushes college as the answer to everything. Yes, I went to college and got an engineering degree. After college, I got this big fancy engineering job with an international manufacturing company before moving to China on the expat package with the same company.

As an engineer, the skills I use most from day-to-day are those skills learned in the first year of engineering courses if not in high school. Were all 4 years really necessary to get to where I am today.

A degree is really nothing, but proof to employers that you can commit to something for four years. ~Anonymous

Mrs. Atypical came across this quote yesterday, and I immediately loved it!

It seems most employers don’t really care about what you learned in college. They are just looking for a check mark on your resume to say, yes, you went to college. The job requirement says BS degree in something. You are qualified!

Since I learned all of the essentials to my degree in one class, the introductory class, did I really need 4 years? I could have started working 4 years earlier (I went to college for 5 years because of a co-op job for one year), had way less student loan debt and already been retired at 28. Because society and employers value that piece of paper so much, I had to remain in school for the 4 years of classes, not to learn about engineering, but to demonstrate my persistence.

So after 4 years or more at an influential college, you now have a pretty piece of paper that you can show prospective employers. That pretty piece of paper proves nothing other than your ability to persist through 4 years of classes. It is the same paper regardless of your grades and regardless of your knowledge.

diploma

Hiring Young

Employers are scared to hire someone young. I hear the young bias on almost a daily basis. We are bringing in a 3rd party contractor to evaluate some equipment at work. He is my age, 28. My co-workers are scared. Since he isn’t 40+, he must be an inexperienced idiot. Being young must mean that you don’t know anything! I was ecstatic that our hired help is young because he has less of a chance of bias from too much experience.

Employers are scared to hire someone out of high school because there is no proof that they can stick with something. Just finishing high school is not proof because it is nearly required these days. By spending 4 years grinding your gears away, paying a college so that you can study and work for them, “proves” that you have what it takes to make it in the real world.

When we take a job in the real world, we are making the 2nd biggest commitment of our lives. Second only to marriage. As the employee, we know that we are going to help out our employer the best that we can, but employers don’t seem to believe it without proof from that piece of paper called a diploma. It shows that we can persist, and perhaps, that we have matured from our naive high school days.

What else is out there?

Despite society’s leaning towards college, there are other options out there for moving though life without a college degree. Sure a college degree, in an employable field, makes it easy to get a “good” job and make the big bucks, but it is not the end all.

Remember,

In the pursuit of freedom, less is more.

In this spirit, how can we get by without college?

The trades offer an excellent bypass of college and also a ticket to freedom. Going into the trades takes less time from your life to get certified and the pay is excellent. It also is applicable to almost anywhere you want to go because everyone needs an electrician, a plumber, a carpenter, etc. Learning to work with your hands and build practical things is a surefire way to bypass college and start pursuing your freedom earlier.

Starting your own business is another way to bypass the HR requirement of needing college. For those of us that are pursuing freedom, there is no better way than self-employment. It allows us to set our own schedule and live our own life instead of being beholden to our employer. There are a near infinite set of possibilities for self-employment that I will not list here. Suffice it to say, if you have the passion and the patience, self-employment can be the answer to bypassing college.

Can we change corporate requirements for college?

At this point in 2017, probably not. College has been driven home for too long and promoted too well, to be able to convince corporations that we are qualified despite no college degree.

Even though the probability is low, we should still do our part to convince corporations that college is not necessary to prove our worth. We go to college for 4 years, yet our future employers still require nearly 6 months of training and possibly 2 years of working experience before they find you beneficial to the company. If it takes 2 years of training after you just completed 4 years of training (college), why do we need the initial 4 years? Bringing this kind of solid argument to the table can help to influence change.

The transition to more reasonable requirements at work and better work-life balance has already started. The millennial generation has been hard at work getting flex-time schedules, more flexible vacation, remote working, and many other amenities. If we keep pushing our employers to focus on our potential and not on our qualifications, then we will be able to move towards a society where capability is king, not education.

Conclusion

College will always have its place in society, especially for knowledge for the sake of knowledge. However, we should not believe that it is the only path in life after high school. There are other ways to progress towards freedom.

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Atypical Life 2016 Investments

2016 was a good year for the investments of Atypical Life. We were able to set ourselves up for future success through investing all of our savings throughout the year. 2016 was a breakout year for us because our priorities changed from savings for debt payoff to savings for investing. 2016 also saw huge growth in the stock market worldwide allowing us to get 20% growth in one year. We lucked out that the year with 20% growth finally had money in the market.

With all of the advice out there for where to put your money and when to put it where, it is hard to filter through it and decide on a plan of action for yourself. After deliberating on it, I was able to come up with a plan for the year, even though it changed throughout the year.

Initial Plan

  1. Max out Roth 401k
  2. Max out Roth IRAs via backdoor contributions
  3. Invest all other savings in brokerage account

With a clear plan in mind, we were able to save and invest for the year with a purpose. Each month, I was going to get my paycheck and put it towards these different areas.

Roth 401k

The plan for the Roth 401k was to spread the contributions out throughout the year and reach the 2016 max contribution in December of $18,000. The Roth 401k seemed like the best choice at the time because we could save after-tax money and never have to pay tax on it again in retirement. I had lots of feedback from financial advisors that the Roth IRA and 401k is the best way to go because of the tax advantages in retirement. It surely makes it easier when withdrawing money because you know exactly how much you have, but we shall see in a future post which way is truly better.

Needless to say, I switched from the Roth to Traditional (pre-tax) 401k for the tax savings now. By the end of the year, I had saved the maximum $18,000 between the 2 and had only lost out on the tax savings of $2,380 contributed to the Roth 401k which amounted to $595.

Company 401k Match

My company has recently become generous to the 401k match and gives us 9%, so long as we contribute 6%. This is a very high percentage of salary when compared with other company match programs, and is a big boost to the 4% we used to receive. 2016 was the first year for our new matching contributions and it was well received by all employees. It is free money, and we made the most of it amassing $6,825 in matching contributions throughout the year. Anytime we can get free money, we are all over it.

Roth IRAs

The trendy suggestion of the day is the Roth IRAs, so that is what we have been focusing on getting our money into. In the end, the difference may not be that big between the 2, but Roth IRAs are much easier while in retirement.

Moving abroad and accepting the expat package, our W-2 salary sky rocketed because of all the costs the company incurs that make it there. Because our salary might be above the limit for contributions to the Roth IRA ($181,000 for married filing jointly), we decided to exercise the backdoor Roth.

The backdoor Roth consisted of contributions after-tax to our Traditional IRAs and then after a few days/weeks, rolling the money over to our Roth IRAs. This was very easy inside of Vanguard because it was just treated as exchanging money between mutual funds. In this way, we were able to protect our Roth contributions from the possibility of our “salary” being too high. The only downside of this was losing out on pre-tax contributions to the Traditional IRA, but our salary was definitely too high to qualify.

Brokerage

We managed to get our brokerage account funded starting in December 2015, but we started to amass funds here during 2016 with a final account value at EOY 2016 of $98,000. We owned various mutual funds from Vanguard throughout the year, but eventually landed on the Vanguard Total US Stock Market Index Fund Admiral Shares (VTSAX) by the end. Because of our trading and strategy changes throughout the year, we incurred taxable short-term capital gains. This was an unfortunate part of the learning curve of investing for the Atypical Life family, but we will likely never incur these short-term gains again.

Changes to the Plan

After the year got rolling and I started doing more research, I came upon different strategies to save more money. When you are pursuing financial freedom, the recommendations for the masses may not apply.

During my research, I came across explanations of why to contribute to the after-tax 401k. The after-tax 401k is a Roth IRA in disguise. Because we can contribute a huge amount of money here ($53,000 total including pre-tax, Roth, and after-tax), it is a great way to get money to the Roth IRA. We want to get the most amount of money after retirement into Roth IRA for ease of withdrawal and tax advantages. After-tax 401k contributions can be withdrawn and rolled over separately from pre-tax 401k contributions. This allows you to rollover the after-tax contributions to a Roth IRA and only pay tax on the earnings while it was in the 401k.

When we learned the advantages here, it was a no-brainer to start contributing to the after-tax 401k. By EOY 2016 we had contributed $3,800 to the after-tax 401k with plan contributions much higher for 2017. These contributions lowered the amount in our brokerage account, but is money not needed until “retirement” so it can be placed in tax advantaged locations for the time being.

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In Conclusion

2016 saw our net worth and investment accounts sky rocket. We managed 20% gains during the year, but then again everybody did. Because we finally had a good amount of money in the market (>$100,000) gains moved the value up a lot.

I was happy to have a plan for the beginning of the year and know what my path forward was. However, refining and adjusting the plan as the year goes by can lead to future gains. Our adjustments to the plan are positioning us to reach financial and personal freedom sooner.

All of our talk and worry about finances mean nothing if you don’t have the chance to enjoy your money. So get out there, do your investing, and enjoy life.

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The Power of Tracking – Track and Improve with Ease

How do we know we have reached financial independence?
How much money do we have?
How much money did we spend widgets this month?
Where did all of our money go?
Why do we live paycheck to paycheck?
Why can’t I lose weight?
How much do I actually go to the gym?
etc. etc. etc.
All of these questions and many, many more can be answered by tracking. Just the act of tracking  will make you more aware of your habits, and you habits will invariably improve without any effort beyond tracking.

Disclamer: I am an engineer by training

As an engineer, I enjoy tracking many different parameters which I later analyze. Just to list what I track:

  • Cycling: miles, speed, cadence, heart rate, power output, etc.
  • Health: pedometer (for work), sleep, illnesses, immunizations, doctor’s visits
  • Finances: All expenses and income, investment growth, estimated time to financial independence
  • Work: hours spent at work, excess days at work
  • Values of bikes and cameras, and when they were purchased
  • Lists of items wanted (wish list)
  • Destinations traveled to and ones remaining unseen
  • etc.

This above list does not include the numerous metrics I am required to track for work, since that list is not one anyone reading here (possibly while at work) cares much about.

What gets measured gets improved.  ~Peter Drucker

Peter hit the nail  squarely on the head with the above quote. What gets measured, gets improved with no effort, just from the exercise of measurement. From measuring, you become explicitly aware of effort applied and become more active in passive activities.

Tracking finances is a fine pursuit and one that can bring about financial independence much more quickly than without tracking. It truly is amazing to see how much money can be spent in a given time period and what all of this money is spent on.
This does not mean it is not possible to reach financial independence without tracking. My parents are a good example of this. Because they never connected their bank accounts to the internet, it is more difficult to passively track your finances. They never needed to track their finances, since they were by nature frugal people. Tracking brings frugality to the masses.

My financial tracking experience 

I started tracking my finances after finishing up college before starting my first real job. By tracking I was able to see where all my expenses were going to, though I could not control many of them, as I had to buy appliances and essentials for the house I was moving into after college. Even though these expenses were required, I was able to minimize them because I was tracking and spread them out over time instead of racking them all up at once on a credit card that would then charge outrageous interest rates. My eyes were opened from the beginning to the expenses of the “real world”.
I have been proud of saying that I managed my finances down to the razors edge. I was out of cash and had $13 in my bank accounts when I started work and my first pay check came. Looking back, I am no longer proud of that achievement, but see it as money wasted on frivolous consumerism leading up to working life. At this point, I start to save more money and dig out from the debt accumulated by going to college out-of-state. By tracking finances closely, I was able to pay off $30,000 of student loans in 2 years and another $20,000 of student loans from my wife, in an additional year. Tracking my finances enabled me to make the decisions to move money to the right places at the right times and pursue a life of freedom.

Tracking for the masses

For the vast majority of us, before we started tracking finances, we were following the typical life, just keeping up with the Jones’s. Tracking and measurement can make an atypical life achievable for more of the population. It allows the rest of us, who are not pre-wired for frugal living and non-commercial tendencies, to view the game that is playing out. To be able to see where money comes from and goes, all in one place gives us the power to change.
Once we start to track and the changes start as a result, then we can see the benefit of tracking. This then compounds, when we start to make conscious changes in our habits to reduce spending further.  This snowball effect can put us on the quick path to financial freedom and independence.
I think all would agree that to not have to worry about money is extremely liberating. Those with the highest net worth’s never have to worry since their money will not run out in their lifetimes, but for the rest of us, worrying about money seems, unfortunately so, natural. Tracking our money can liberate us from the uncertainty, since we do not have to wonder how much is spent when and if our balances are enough to support spending. Through tracking, we now know definitively, either yes we have enough, or no we do not.

Where to track

 There are many places to track your finances, and in future posts, I will highlight these. I have used many platforms over the years and they all have their pros and cons, with no one platform being right for everyone. Check out these platforms:
  • Personal Capital (personal favorite online and mobile platform)
  • Mint by Intuit (another very good online platform)
  • Credit Karma (continues to add functionality to be an all in one financial tracker)
  • Gnucash (open-source software for true double-entry accounting)

Final Thoughts

No amount of tracking, can force us to make the right decisions financially if we are too caught up in the consumerist mindset. However, tracking can put us on the path towards financial independence if we are willing. Let the power of tracking free you from the bindings of financial dependence.

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