Part 2 Module 1 Chapters 1-3

Today’s focus will be the first three chapters, a discussion on taxes

Tax Basics

 In addition to debt problems or cash flow issues that the member may ask about, think about how tax issues could add to the burden they are currently feeling.  A brief discussion on taxes is very common with clients struggling with cash flow. o How often do people wish they had more money on a monthly basis? o How much is being withheld from their paycheck for taxes? o What did they get back on their tax return last year? . If it was a large amount, could the money be re-distributed throughout the year? o If they end up owing each year, how can they plan each month to avoid this problem?  Members often don’t know what to expect. Because they are unsure, they often wait until the last minute to file their taxes. o I usually recommend doing taxes as soon as possible to receive a refund and apply it to financial goals sooner rather than later. If they owe money, they will have more time to plan for an take care of needed $ to pay the bill  The old saying is: “ Only two things in life are certain, death and taxes.” I usually add Student Loans to that.  What percentage of a members income actually goes to taxes? What is your guess, what percentage of your gross income do you thing goes to taxes? o Federal, State, Social Security, Medicare, Real Estate, Sales Tax… o Also, gasoline taxes, Utility taxes, travel taxes, Licenses… o The amount of money you pay on taxes is likely much higher than you think  Many of the clients I work with use their tax return in ways that are contrary to their financial goals, or plan that I would recommend.  This could be the largest “paycheck” that someone receives during the year, what will they do with the money they receive?  Many people simply fail to file a return. o They could be leaving money on the table, they could be missing out on funds that are owed back to them. In fact, many laborers who fail to file a tax return are lower moderate income households who often qualify for a good amount of money back on the return. o They might be afraid they owe on taxes, and don’t feel they have the money to pay o Ignorance is not bliss – the IRS may take serious actions against them o It is better to contact the IRS on your own and make arrangements with them to repay the debt o If you wait for the IRS to contact you, they are often much less willing to negotiate. o If they owe the IRS, they should not panic. They should get on the phone to discuss their options. o Do not promise to make payments you cannot afford. Using your budget, negotiate an affordable payment that is realistic. If you don’t know what to say, tell them you must speak with your financial counselor before making a decision or commitment.  Remember, you are not a licensed tax professional. You can provide general advice and recommendations to secure their finances. But you should refer in depth tax questions to a professional.  If someone has not filed taxes in many years, they should look at the possibility of getting a return for the last few years. You can actually file for past years (not all, just a few years into the past). This could be a large payment if the member has money owed to them.

Sources for Tax Filing Assistance

 VITA – Volunteer Income Tax Assistance o There are volunteer centers across the state of Utah o Individuals and Families can have their taxes prepared for free o The income limit for this service for 2010 will be somewhere in the neighborhood of 50k o Call 211 for site location and appointments o AAA Fair Credit Foundation hosts the scheduling system for the VITA program in Utah o We also host a tax site in our office o Some sites are walk in sites, but many are appointment sites o If you would like to volunteer, or if your Credit Union would like to host a site, let me know o In Utah, we offer free electronic filing . We want them to get the refund quickly . They are screened for all applicable credits/deductions/programs  Many members are unlikely to qualify for free tax programs. Make sure you are aware of reputable tax preparers, CPA’s, Tax accountants in your community that you can refer the member to. What to do with the Refund…What are the members financial goals? 1. Pay off Debt 2. Establish Emergency Savings 3. Create “set aside” savings for periodic expenses (taxes, holidays, vacations, car registration) 4. Accomplish long term financial goals Tax Anticipation Loan Avoidance o Some preparers will offer tax anticipation loans o They pay a “small fee” to receive their refund on the day the tax documents are done, instead of actually waiting for the refund o When you do the math, the actual interest rate is very large o They have waited an entire year for the return, convince them that they can wait just a few more days o The VITA sites file the taxes electronically for free, and allow for the payment to be submitted directly to a bank account (about 2 weeks)

Reducing the Income Tax Burden

 There are companies out there that offer to settle your debts with the IRS for less than the full balance. Consumers should be cautious with these companies just as they are with the other settlement companies. They often charge heavy front loaded fees before doing anything to help the consumer.  Many people who have a difficult time saving prefer to have a more than enough set aside to pay taxes each month. This essentially forces them to pay their taxes each paycheck, and they are okay with having a large return o But if they need more cash-flow, this should be evaluated. o These same people, when receiving a large return, have failed to develop good savings habits. They are likely to spend the money quickly on big ticket items rather than paying debt or establishing savings  Some spouses prefer to file individually, they keep their money/debt/taxes completely separate.  But most file jointly. If one spouse works as a W2 employee, and the other is self employed, the W2 employee can elect to have a higher amount of money allocated to taxes to even things out.  NOT MENTIONED IN THE MANUAL: o If one spouse has past tax problems, or even garnishments, it may be wise to file separately so that the other spouses funds are not seized as part of the garnishment or tax lien.  Finding a qualified Tax Professional o I recommend finding someone that understands deductions and doesn’t miss them. If you have to ask if you qualify for a deduction or benefit that they fail to ask about, they might not be the most knowledgeable tax professional. o A tax pro will/should actually discuss with the individual how they can adjust spending or other allocations in the upcoming year to maximize tax benefits. o It is November, we should be thinking about arranging our finances and preparing for taxation as the year comes to a close.

Using Tax Free savings/investing to lower your taxes  Does anyone use a Flex spending account? The two most common types of flexible spending accounts are for 1-Medical Expenses and 2-Child Care expenses o The member can allocate money to come out of their paycheck to pay for these expenses BEFORE TAXES. This essentially lowers your taxable income. o These programs are use it or lose it though…If the member sets aside $1500 for medical and health expenses, they must use that full amount by years end in order to not loose the money . But if someone’s tax bracket was 25%, they could leave $375 in the account and not use it and still break even because of the tax benefit. So if they use all the money for health or childcare, they are saving themselves money. o That isn’t a problem though…because at years end they can always stock up on things they need, then reduce the amount they set aside for the upcoming year . This splurge spending is normally contrary to what we promote. But as we are buying things that we will use next year, and we reduce our taxable income, it is still beneficial. You can adjust the withholdings each year. o I use flex for contacts, contact solution, dr visits, co-pays, prescriptions, etc. I think I have a little left this year, I will go and buy some OTC stuff before the years end as the recent healthcare legislation has changed what you can buy. o Here is what I look for . A client that has monthly medical and health expenses . A client that has childcare expenses . I tell them to consult their HR department to see if they have the option of using a Flex account to lower their taxes.  HSA or Health Savings accounts are similar to Flex accounts, except they are not “use it or lose it” accounts. You can carry over the saved amount from year to year.

Another way to reduce your taxable income is to save in Retirement Accounts.  We will touch on the details next time, but we will mention tax benefits today.  If a member makes $40k, and sets aside $1k for Flex Accounts, and contributes $2k to a retirement account, they would only pay income tax on $37k worth of income… minus any other deductions.  Many members have the option of placing money in a 401k through the employer and receiving a match. If their employer provides a match, they should at least contribute the matched amount. If they do not, they are essentially saying no to money. It is like not taking advantage of a raise. o In many cases, members may consider reducing or stopping contributions to a retirement account while they address financial problems o While this may be necessary, we want to prevent them from breaking this good habit that they have. Be careful with this type of recommendation if you give it. Taxes will also go up. o They should learn to treat retirement accounts as items they do not touch right now, only at retirement age. o Those electing to use a 401k loan should proceed carefully to ensure that they alter their spending habits to ensure they can repay the loan. If they don’t, there can be severe penalties.  Should the member save in a traditional account, or a ROTH account? That depends: o A 401k or IRA account will lower their taxes now, and they will pay taxes when they pull money out at retirement o A Roth 401k or Roth IRA will have taxes paid on it now, and it will be pulled out at retirement tax free (I like Roth) o Even if the member knows how much they make now, and how much they will make at retirement, tax %’s can and will likely change between now and retirement. Any further advice should be given to the member by a licensed professional. You may have one on staff.

Today’s Overview  Members may need to re-adjust their withholdings  If they receive large tax returns, they can redistribute the Money throughout the year  If they always owe, they can pay a little more each month to avoid large tax bills  Look for Tax Resources: VITA provides Free Tax Assistance (Dial 211). Find other reputable tax organizations in your community where you can refer members.  Using Flex or HAS accounts will lower your taxable income  Saving for Retirement can lower your taxable income (today or in the future depending on how you allocate the money in different accounts). o Retirement savings should be part of a healthy financial plan.