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Whether you will owe the AMT in 2017 and why we should keep it

November 7, 2017

Will you owe the AMT in 2017?

 If you are reading this blog, probably not.  But maybe, especially in a higher tax state with a higher AGI.  I was pretty shocked when we owed a small increase in tax due to the AMT in year 2014 (one time significant income).  It is also something that we run into if we try to bunch our property taxes, so we are moderately close most years, it seems.

Here is an easy answer for a limited (but common) situation where your itemized deductions are limited to:

  • Mortgage Interest on your primary residence
  • Charity
  • Property Taxes
  • State and Local Taxes
  • Personal Exemptions (not technically a deduction, but you lose them under the AMT scenario)

Find your taxable income (AGI minus all colors of deductions listed above) on the x-axis. Add up the numbers in blue in my list above.  If your numbers in blue fall below the blue line, you probably don’t owe the AMT if you are married filing joint.  More likely, double check the math yourself to be sure.  I am not a tax professional! This works if you have other deductions, but you have to figure out how the AMT impacts each one.   You also have to add back in qualified incentive stock options and stock received under employee stock purchase plans, and some other things. This is a simplified view.

AMT Trigger All

My goal in creating this chart was to gain intuition on what drives the AMT.  If you have a lower taxable income, you are unlikely to have enough deductions to trigger it.   As your income increases, the value you can deduct before hitting the AMT shrinks.  If your are higher income but not astronomically rich, you just might be able to trigger it with enough kids/state/property taxes. Keep in mind that this chart includes the value of personal exemptions – $8,100 for a married couple and more for each kids.  Once you hit ~$500k, you are likely to do worse under the normal tax system unless you deduct very large amounts of money (more on that below). This is because the highest tax bracket under the AMT is 28%, while it is 39.5% for the normal tax system.

It is hard to compare apples to apples, but we can find the break even point for your taxable income under the regular system compared to your AMT taxable income for the same tax.  The chart below does that – at what taxable income in each system are your tax bills equivalent?  The chart above plots the difference so it is more readable.

BreakevenAMT

Why we should keep the AMT

With this insight, the proposal to eliminate the AMT doesn’t make sense.  After all, it seems reasonable that at high incomes, you maybe shouldn’t get to deduct quite so many things.  Further, while people like me may occasionally get hit with relatively small AMT bills, most of the AMT revenue comes from higher earners.  About 30% of households between $200-$500k will pay AMT, 63% of households between $500k and $1M, and 20% of those greater than $1M (because of the higher tax bracket under the normal tax system) [source].   This data may be true in 2017, but if the proposed tax plan goes through without the State and Local Tax deduction, I suspect fewer in the $200k – $1M would be impacted by the AMT.  We wouldn’t be.  Or, if they didn’t want that “feature”, the AMT could be adjusted to have less of an impact on those in the $100k-$500k range.

And what about the really rich?  If we don’t want to call those making under $1M super rich (which it is a stupidly high limit), consider those making beyond $1M.  The tax revenue from the AMT on the 20% of those earning over $1M can’t be a small thing to throw away.  Check this out.  The tipping point is around 295k taxable income.

superwealthyamt.png

If you have an taxable income of $2M, that means you that you could have had nearly $650k of the “add-that-back-in” deductions before triggering the AMT…. yet ~20% of the people in these high income ranges are still running into the AMT!

Eliminating the AMT (while simultaneously getting rid of the deductions likely to trigger it for people in the <$1M range) has no benefit beyond serving the interest of the very wealthy.  The goal is to leave itemizing to the wealthy with their sophisticated tax situations, while giving  most of the middle class a ~$1-$2k tax cut, and give upper class property owners in high tax states a modest tax hike to help cover it.

There are other ways to achieve a goal of making sure people pay their fair share, but I’m quite sure the tax proposal has none of them.

Bonus Charts for Californians:

Considering an $8,100 personal exemption, it seems you are certain to owe the AMT if your taxable income is greater than about $245k but less than about $600k.

AMTTriggerCA

Taking it one step further, here’s how much Californians can deduct in property taxes for a given taxable income (assumes $8,100 Personal Exemption).  Note this assumes you have withheld exactly what you owed in CA state taxes, so your result will vary.  We overwitheld this year, which makes it worse.  (The lines starts to go up again around $600k.)

maxdeductble property.png

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October Update

November 5, 2017

Net Worth / Money:

Our net worth climbed 1.7% this month, with the gains in retirement and a small gain in home equity due to our regular payment.

After realizing we can access 457b money at any age without a 10% penalty (if you’ve left the job), I decided to switch T from a 403b to a 457b. The change can’t go into effect until the December paycheck. Since I wanted to get as much as possible in for the 2017 calendar year,  I put in the maximum amount allowed on single paycheck.  The result is that we are saving ~$8k more in pre-tax retirement savings than I originally planned for the year.  Some of this will show up as a tax refund, and some of it will just be reduced cash flow – ultimately resulting in reduced mortgage prepayments for 2018 (probably).  I think this is the right call overall, and lines up with my latest thinking on how to target our savings.  In other words, the mortgage is becoming less of a concern, although still plan to make prepayments.

I considered paying the rest of my property taxes (not due until ~April or something) out of fears of tax code changes, but it does look like this will trigger the AMT for us.  I also think people had made the AMT to be this big scary and complicated thing, but it turned out to be just a few equations (for my situation) once I read this post.  Basically, you just calculate the AMT tax with only mortgage interest as deduction (no personal exemptions).  If the tax code does not change, this will be something for us to keep an eye on each year.

Spending:

The best purchase of the month was a ~$200 portable air filter (Sweet Home recommended). T is skeptical that it is doing more than just being an expensive fan, but as the one with allergies, I’m really happy with it. It also helped out when the smoke from relatively nearby fires was polluting the air.

I paid our 1st installment of property taxes in October, a bit earlier than usual for no really good reason other than to have it done.

House costs were high this month (see below) since we purchased our shower plumbing fixtures and some other stuff for the bathroom remodel.  I also bought a few things to add to our emergency kit, paid our yearly car registration fee, and sent another chunk to the student loan.  For chartity, I donated to the Redwood Credit Union North Bay Fire Relief.

House:

The bathroom remodel is progressing!  We’re ready to bring in the pros for plumbing and tiling! Things should speed up considerably now that the harder DIY stuff is over.  The bulk of it should be complete by the end of November.

Finishing the patio is stalled, but I’m hopeful we can get some work in on it during November when the bathroom project has been handed over to pros.  We’ve also been trying to prepare for “winter” / rainy season: cleaning gutters, repairing old caulking, changing the furnace filter, moving patio furniture to the garage, and considering covering some of our single pane windows with plastic. I also learned you are supposed to drain your hot water heater yearly, but if you’ve never done it, you are probably best off leaving it alone.  Do you drain yours? My parents certainly never did this and I’d never heard of it.

Work:

Work is a little weird right now. It isn’t bad, but it isn’t as good as it was. Some things that I was hoping would develop have not developed.  :/

I did talk with my manager in October (finally), and we discussed how things were going and how things might look in the long run. He asked if I was generally happy with how things were. I was honest. I am happy about a lot of things, but I like to have more firm longer term plans, and the long term uncertainty makes me bit unhappy. I also shared that there is nothing I could do about it, so learning to live with it was a far better option for me than any other ideas I had come up with.

Oh, I also got a small raise, retroactive a few months.  Yay!  When I took this job, I knew the days of significant raises were largely over, but I still am happy when my raise beats out inflation!

 

How Trump’s Tax Proposal Impacts Californians Who Itemize

November 3, 2017

(Quick Note:  My plots are referring to taxable income when I really mean “Adjusted Gross Income”, or your taxable income after all deductions.  Updates pending!)

I’ll start by saying that I disagree with the principles behind this tax plan, regardless how it impacts my personal taxes. Not every single idea in it is terrible, but as a whole, it benefits the wealthy while throwing a few crumbs to middle class families with children.

Politics aside, I took a look at how it would affect me, and other people like me. That is, people who own a home in an high cost area with high state taxes (blue states). If you want a more broad and detailed explanation, try this article.  For relatively simple tax scenarios, there are two main factors to consider:

  • Deductions you take that reduce your gross income to your taxable income.   Taxable Income = Income – Deductions.
  • The tax you pay on your taxable income, calculated with the tax brackets

The proposed tax plan reduces the number of itemized deductions available while simultaneously reducing taxes paid for any given taxable income. If your taxable income stays the same, you’ll pay less tax.  (My chart is less pretty than this one that I’ve seen on several media outlets, but it more clearly depicts the situation.)

FedTaxesZoomed

But your taxable income won’t stay the same!  It is necessary to keep in mind that the plan removes personal exemptions, so it is highly misleading to state the standard deduction is nearly doubling.  For married couples without children who don’t itemize, the Personal Exemption + Standard Deduction would go from the current $20,800 ($12,700+$4,050*2) to $24,000.  It would increase, but not by all that much.  If you have a kid or more, it is actually going down a bit – but there are other child credit tax changes that might make up for it.  If you don’t itemize and you are single or married without kids, your tax bill will indeed go down.

As a Californian who saves a lot on taxes due to itemizing property taxes, state taxes, and mortgage interest, my taxable income is going to go up rather than down.  The red line below shows how much it could go up (how many deductions I could lose) before I would see an increased tax bill.  Considering our taxable income is automatically going up by $8,100 due to the loss of the personal exemption, how much MORE could our taxable income go up and leave us with the same tax bill?  That’s the purple line.  So, if we had a taxable income of $125k, we could lose about $5,000 more in deductions and still come out with a similar tax bill.  I’ve overlaid California state taxes, which could no longer be deducted under this plan. (Disclaimer: I haven’t double checked everything, so let me know if this seems off.)

TaxResult

If you are a California home owner who itemizes, and expects to continue to itemize, this chart says you are probably going to see a tax increase!   If you live in a different state with state income taxes, you can figure out if you are likely to have an increase under the proposed plan by comparing the purple line to your state tax bill.

But, if you make more than 320k for MFJ, then the Pease limitation jumps in and complicates things!  Maybe you won’t see a tax increase!

Personal tax situations aside, this tax bill gives massive tax breaks to the wealthy and repeals provisions that ensure they pay their fair share.  It eliminates the alternative minimum tax, and provides a 4.6% cut for marginal income between $470,700 and $1 million (for married couples), and eliminates the estate tax (which only impacts estates greater than ~$5M). It also increases the deficit and provides corporate tax cuts. Please call your representatives and take action against this tax bill.

 

 

Thoughts on financial independence

October 30, 2017

Despite the fact that early retirement isn’t our plan, I’ve been on a little bit of  an obsessive Financial Independence kick lately.  Early retirement and financial independence are two different goals, but the methods of getting there are both pretty similar.  I can tell you exactly why I’m getting fixated on this right now, but that is a post for another day.

First, I wondered what our life would look like without my salary. I knew we would be able to withstand it and live on one income, but didn’t know what that really would look like.  Would be be able to save?  Would we have to cut back on our few extravagances?    After running through the math, things are looking surprisingly good.  We could still max out T’s 403b or 457b, as well as bank some cash and/or do some mortgage prepayments each year.  This includes a generous 1% per year home maintenance budget, mostly because I project we’re likely to want to spend that in our first 10 years of ownership.  We won’t have the speedy savings growth we go at with two incomes, but it is perfectly adequate.

Once I’d determined we could indeed afford to add to tax-deferred accounts, I worried that we actually are going to end up with more money in tax advantaged accounts (that we can’t access until we are 60) than we could possibly spend from age 60.5 until end-of-life. This is actually quite likely even if we stop contributing entirely.  This concern sent me down a rabbit hole as I debated if we should be focusing more on taxable investments (even though we have tax deferred room available).  The short answer is we absolutely should not.

Here are a few things I learned:

  • Getting money out of retirement accounts: There are ways to access money in normal retirement accounts (401k, etc.) before you are 59.5 through Roth conversions, SEPP/Rule 72t, or even just paying the penalty.   This is important to know if you wonder if you are over-saving for retirement.
  • Tax impacts of required minimum distributions is something I have not yet considered.
  • 403b vs 457b #1: For those with access to both a 457b and a 403b, a 457b allows you to take out money at any age if you no longer work for a place providing a 457b. You have to pay taxes when you withdraw (of course), but there is no 10% penalty.
  • 403b vs 457b #2: Non-profit 457bs are generally owned by the employer and subject to creditors in case of bankruptcy.  Government 457bs are held in trust for the employee/participant. On the other hand, all 403bs are owned by the participant (not the employer). So, there is some risk in non-profit 457bs, and that is worth being aware of if you have this type of account.
  • 403b vs 457b #3: If you decide to work through your 60s/70s, you cannot access money in a 456b until you are 70.5.  This is only an issue if you don’t have other accounts that will be available around age 60. Plus, you are still working in this scenario, so you shouldn’t need the money yet!  The end result of this is that we should likely favor a 457b over a 403b, despite misleading information from T’s employer deeming the 403b to be the more flexible option.  Only true while you are still working for the employer!
  • Roth IRA/401k vs other options:  I’m still wrapping my head around this one.  This post from Mad Fientist indicates you should always fill up your tax-advangated accounts before investing in taxable accounts, and even before investing in a Roth. Paying the 10% penalty does better than a taxable account!  There are assumptions about tax rates and timelines here that are important to understand the nuances of.  I’m still puzzling this out, since most PF bloggers prefer a Roth.  Maybe a Roth is still more advantageous if you are not trying to retire early.  Early retirees generally have higher tax rates while working compared to while retired.
  • FAFSA/CSS considerations for college:  If you have kids, private colleges use something called a CSS and consider home equity in financial aid calculations.  If we are successful at having kids, this could affect long term plans.
  • Social security: I also learned how social security benefits are calculated, in case that might be around and available to us at some point in the distant future.
And a few things I learned about our own situation:
  • If I understand it correctly (which I probably don’t since I have done very little research and the plan is not detailed yet) Trump’s tax plan could cost us ~$9k in 2018 in an extreme scenario. This could change our strategy next year.  I am patriotic so I don’t mind paying taxes, but I don’t like for my taxes to be increased to give corporations and the wealthy a break.  I await the details of how the State and Local Taxes deduction will be changed, and might pay my February tax bill early if it changes unfavorably.  (I’d have to ensure we wouldn’t be subject to the AMT if we did that.)  By the way, California is already a donor state, so my high state taxes are not being subsidized by low tax states.
  • I can see an argument for a higher standard deduction and removing some deductions (or “loopholes” if someone else is taking them) to simplify the tax code.  I guess. I don’t understand the wisdom of collapsing the personal exemption into the standard deduction.  This will impact families with kids, and the only reason I see for doing this is so they can claim “we are raising the standard deduction from X to Y” and have the difference between X and Y be larger.
  • Living one income is totally doable without lifestyle sacrifices. This does assume our mortgage recast and tax laws roughly similar to current ones, but there are enough knobs to turn if any of these assumptions turn out to be false.

Historical Net Worth since 2007

October 27, 2017

I annotated our historical net worth plot with our major life events.  Inspiration from Revanche at AGL!

A few comments:

  • In the early years, this is my net worth only.  There is a bump about a year after we got married when I combined our net worth in my spreadsheet.
  • Real estate equity assumes the tax assessed value, since the market value is hard to get a good estimate for.  In California, the tax assessed value is limited to a small increase each year.  I’d estimate market value is at least $100k higher, some sites state it is $300k+ higher.
  • After 2014, the cash/investments line is just calculated as (Net Worth – Home Equity), so it captures everything that is not home equity.  There is a tiny bit of student loan debt and car equity in there. I haven’t historically broke those out in my long term spreadsheet (only yearly).  This is a simplification, but fixing it wouldn’t change the overall picture much and would take quite a bit of effort in digging through my historical spreadsheets. So, there it is.  In the early years, the difference between investments and net worth is student loans.

Historical NW

After making this chart, a few things jumped out at me:

  • We’ve lived in our house for longer than it feels like.  It takes up a good 1/3 of this chart, but I still feel like we are new home owners!  Time flies!
  • All of my hard work in the first few years of my working career didn’t make much immediate traction, but the compounding returns help in the long run.  We’d made some really great headway prior to T starting his first full time full salary job in 2014.
  • Both of us having high paying jobs has been crazy helpful in making headway the past few years.  The stock market helps too!  It could be interesting to break this out further, but would take a lot more time.  It probably won’t happen.

This is basically the only chart in our personal finances spreadsheet that T looks at on a regular basis, and it is the one I look at the least.  I liked the picture Revanche made that more clearly showed the mortgage debt, since it is often significant if you live in a high cost area.  I would have to play around to get this in my picture!

Do you track your net worth over time?  Was there a particular inflection point in your life where your finances improved significantly?  I would say ours improved a lot when we moved in together and cut housing, and then even more so when we moved to northern California and both had full salary jobs.

Our approach to married finances

October 24, 2017

When it comes to married finances, there are a variety of ways to handle things.  If someone asks me, I generally say that we subscribe to a “one pot” approach.  But, if you dig below the surface, we have a lot of pots.

Account structure – the nuts and bolts

You don’t have to dig far – we actually don’t even have a joint checking account, despite operating on a “my money is our money” basis.  Here’s how our accounts work.

JointMoney

We both get paid into our individual checking accounts.  The mortgage automatically comes out of T’s account, and I pay the credit card (almost always) from my checking account (T will pay it if I tell him to). When either checking account  accumulates a large buffer, I transfer to joint savings. It could go the other way if needed.  Nearly all of our spending is on the joint credit card, but random bills or cash might come out of either of our accounts.  I am generally in charge of bills, except for any bill we pay with a check.

All of our savings accounts are joint, and that is the heart of our system. The most active account is the slush fund, which I occasionally pay our join credit card from.  Property taxes (paid twice yearly) hang out in “planned spending” until needed.  Our home maintenance fund and emergency fund are there, as well as any targeted savings. Retirement accounts have individual names on them, but legally and mentally, they are shared.

The main reason it is set up with separate checking accounts is simply inertia. We had these accounts when we married and saw no reason to change it.  Maybe there is some advantages to redundancy (like when T’s checking account number was stolen), but our system would work just fine with a single joint checking account.

Mini socialism for budgeting

We don’t really have “individual” expenses or a budget.  We each buy what we need and what we want. We don’t have a threshold where we must check in, but neither of us would want to make an expensive purchase without hemming and hawing over it first. In the rare cases when T wants to buy something that I think is not a good value, I tell him my opinion, but leave the final decision to him.  In the less-rare case where I want to buy something that he doesn’t think is a great value, I take his opinion into consideration. We both trust each other’s judgement.  This system works best if you are both frugal by nature and are not on a super tight budget.  If we had a tight budget, we might try adult allowances, but then you have to start figuring out exactly what should be an individual expense.

Money management

As the resident PF blogger who has an interest in this stuff, I handle nearly all of the planning and make most of the decisions. T is very much in the loop and understands what is going on with our money, but doesn’t specific actions himself.  We talk about money whenever I want to make a big transaction (a mortgage pre-payment) or approximately monthly when I update our net worth. We talk about it more when I come up with some “interesting” fact I want to share with him, like our progress towards Financial Independence, the percentage of our assets in our home, or what our net worth would do in a big stock drop.

We arrived at this system pretty naturally, and it works really well for us.  We both understand what is going on, but we spend only as much time on it as we want to (i.e. I spend time on it, he doesn’t).  We never fight about money, and we regularly talk about shared goals.  We aren’t afraid to share opinions with each other, and we listen to each other – but we ultimately trust each other to make our own decisions.

What system do you use?  Does it work well for you? Have you tried alternate systems?

September Update

October 4, 2017

Money:  

Let’s start here, since this is a personal finance blog!

Spending – The bathroom project has started, so spending was a bit higher in September – but planned.  I started a blog page for this and will convert it a summary post when we are done.  You can see we have a long to do list before we are done!  We have spent ~$600 so far on tools and supplies for the demolition and framing portion of the project, and I sent another $9,000 to “planned spending” for some of the next steps.  (This is one of my accounting quirks – money in the planned spending account is allocated towards something specific and not counted in net worth  – but it is not spent yet. I use this most often for property taxes, but also for other larger expenses that are imminent.)  My total estimate is a bit over $15k.

I also finally got two rugs and a rug gripper/pad.  We have a really long hallway and I was tired of my dog skidding down it like the road runner (meep meep!).  I also replaced our area rug with something softer and more attractive (but a bit harder to clean).

Net Worth / Financial Independence – Net worth is up about a percent this month.  I made a small mortgage prepayment and I sent a bunch of extra cash to my student loan (as discussed here).  We’re about halfway to a 4% SWR, and 30% there for mortgage payoff – and those numbers don’t move much month-to-month.  It also isn’t a singular goal and we are not willing to move or make drastic lifestyle changes to accelerate the timeline, so it is just a metric rather than a plan.

Work: Because this brings in the money!

I don’t feel like saying much this month. Things are busy and good, although I feel a little burnt out at the moment. Some longer term stuff is in worrisome, but there is time before it will be an issue, and there is nothing I can do now that I’m not already doing.

Life:

We had a fun wedding in Tahoe – beautiful venue and a nice intimate crowed.  It was so much fun, and we got to see some old acquaintances from our LA days.

My parents visited!  It was short, but good.  We spent one day up the coast eating fresh oysters and checking out the beach.  The other day we hosted my uncle and cousin and her husband and  cute little girls – so much fun to see family nearby.

Other than that, there was some work travel (good but draining) and some dog training, and the aforementioned house project.  Life is good and busy, but not so exciting to write about.

Looking ahead…

October will be more of the same – work, work travel, house projects, dog, celebrating some birthdays in our usual low key way (dinner out).  We spent so many weekends out-of-town for the summer that I’m having trouble justifying any fun day trips when we have so much to do at home.