AAR44 - Taxes Nobody Warns You About

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3:15Good morning, everyone, and welcome back to At Any Rate. My name is Evan Rate, and we are here to help you make sustainable financial changes without breaking a sweat. And today I've got back my favorite co-host, Andrew Sather, the bullish investor, the bullishest, if that's a word, investor that I know. How are you doing this morning, Andrew? I haven't been running from the bulls. I haven't been chasing the bulls. That's not on my bucket list, so I don't know just how bullish I am. But would you? How much would you? No, no. How much would we pay you to... I would need to be paid an absolute ton of money to go through that.

3:50Some people just... Adrenaline junkies, adrenaline over anything. I don't... I don't know that. Is that... 10 million? Who would the money go to if I died? Nobody? Or what if I maimed severely? Does it go to anybody? Does it still go to me? No, no. That's the risky take. Oh, I have to get out injury-free. I can't even sprain an ankle running. does that seem realistic what if the bull spurns an ankle you're asking all the tough questions i uh i withdraw my offer okay well if you ever change your mind i'll read the terms and conditions and we can go from there but i'm not gonna i'm not gonna go off of anything else so today we want to cover a trap that i think is very easy to fall into and i think it's likely something we've all fallen into at some point which regarding tax is the sort of I did everything right trap.

4:43So say you listen to this podcast or you read content similar to this and maybe you started a side hustle, you have a high-old savings account, you're investing, you have a Roth IRA, and then April comes around and tax time comes around and there's a lot of confusion over how exactly you should be handling things. What is taxed versus what isn't? What kind of taxes are there out there that aren't usually talked about or you don't realize? and most personal advice personal finance advice out there just skips this topic overall and and that's definitely something that we've done in the past at times because frankly it's it there's not always time for it it's always kind of a separate conversation in and of itself but it's a very important part of the part of the conversation that if you don't have then you're just not getting the whole picture it's great to say okay something's gonna earn you four percent but by the way there's a form you're going to need to get from them you're going to need to submit that that four percent will actually turn into blank percent there's there's some back-end calculations that always happen the good news is that any of the tax conversations that we have today none of them are really going to change anything we've said before or any any other financial advice you've heard elsewhere it's really just it's another aspect to to kind of dial in your your your lens your financial lens for your financial situation to get a better grasp of where you're at and where you're going to be at, as opposed to really kind of flipping a whole conversation on its head.

6:10And I also want to kind of start at the top that, that I personally each year and same this year, I do actually use a tax advisor. I use a company where I can just basically give them all of my forms, you know, give them any, any life related updates. They have this, this very useful checklist that basically goes through my, my final, my personal finance situation. and I can just go through checkboxes, give them some more info when necessary, and then they just compile everything for me, give it to me to review, and if it all looks good to me, then they just submit it for me. And even though I do pay, I usually pay about$200 or so to do that, it's not the cheapest thing in the world, but they always find a lot more to deduct than I would have realized otherwise and usually easily save me more than that$200.

6:55And I get a ton of peace of mind that I'm not going to be missing basically anything in the conversation that we're going to be discussing today. I don't have to remember a lot of this, so to speak, because I have somebody out there who's looking out for me to take care of that. Is that something you've ever used yourself, Andrew, or considered using yourself? Yeah, I've used for years two separate firms just because, like you're saying, you don't know what you don't know. And being a small business owner, I don't want to mess that up. So I've definitely had mistakes in the past that we're going to dive into.

7:34So this will be a little personal for me. Hopefully not too traumatic. But yeah, I mean, it's one of those things that's not fun to talk about. Not a lot of the people talk about it. And the time of April being that time that you could have a nice surprise with a little bit of a tax refund. or you could have another headache on your hands. Just know we've been there and you can come out of it and learn the lesson and be ready next time. But we're hoping that this can alleviate that for somebody in the future so they don't have to deal with tax surprises because those can be quite unpleasant. Yep.

8:18As always, we want to reduce basically surprises as much as possible. The more you know and the more you understand up front, the better off you're going to be. And that applies to everything, including taxes. So to start that off, something that's pretty dang well related to you is side gig income. So if you're somebody who's self-employed, one of the first things that's very easy to miss or not realize if you're just say, okay, well, I'm just going to go work for myself and I'll be done. You have to pay basically both ends of taxes. So self-employment tax around 15 % or so, you pay both sides of that usually one side of that is is paid by an employer so you know me i work at a company and so i pay one end of the taxes but the employer pays the other end of the taxes of the employment tax if you're self-employed you have to cover both sides of that sandwich and that can be a big surprise for a lot of people also you have to pay out pay out your quarterly estimated taxes so you're not just paying you know once in april or whatever or filing and seeing if you get a refund or not, like you usually would if you're employed and not self-employed.

9:24But if you're self-employed, you've got to be doing the income and revenue calculations along the way to calculate and estimate your taxes and pay them quarterly to make sure that you're up and ahead. And if you don't do this, then you're going to get pretty severely penalized. And so you can't fall into the trap of the, oh, I'll just pay it, you know, when tax time comes because you're already going to be way behind the eight ball if you try to just do it then. And another aspect that I've missed myself doing some side gigs is you can often deduct some side gig expenses, but it's often not as much as you think.

9:58At least from my point of view, there's a common belief in kind of social media content that if you have a side gig, then kind of whatever you earn, it's all tax exempt. That's kind of how the connotation they give to the conversation is, well, you get a ton of tax benefits from doing it, so it'll all be good and easy. but it's not that all-encompassing, the benefits you get from it. You might get an additional deduction for, say, you use a home office or something, but they're not going to deduct your entire rent or your entire mortgage or something. They're going to deduct a very small percentage of it based on the amount of time each week that you actually spend working on it, the amount of space in your home or apartment that you actually use towards that business or that side gig.

10:42so it it even though it is still useful and it is still a sum of money and some amount of deduction it's often not as much as you might go into it thinking thinking oh well you know i worked at home so bang my rent is you know deducted or something like that it's it's not that that big of a uh of a needle shifter but it's definitely still worthwhile but from your point of view andrew does this kind of change whether a side hustle is worth having um or is this just an aspect of the conversation for you yeah for me it's just an aspect i know that can be discouraging to think that it's in it's interesting that you say the the social media conversation right now can lead people astray because that's one of the things that's always grinded my gears a little bit is the whole mentality which i've heard for years and i remember when i first started that mentality was quite popular that, um, oh, I can deduct anything and everything because I have a, a small business or because I have a side gig and, you know, um, the way people get rich is by dodging their taxes because they have a side business or something.

11:50And it's like, no, not really. Um, uh, that is something that's, uh, kind of annoying that, that people believe. So if you're looking to just kind of sideswipe rules and you think that's how you're going to get rich and doing a side hustle is the way you're going to do that, then yeah, then don't go down the side gig route. but if you're finding something you're passionate about or pays good money and ideally has a higher ceiling for that income of how high it can go then side hustle and working towards it is absolutely worth it but just be careful you're not thinking of it in the wrong way that 15.3 % that self-employment tax that one rocked me I did it It did, yeah.

12:50So I've had two attempts at going full-time for what we know as IFB today and had to end up going back to a full-time job and then trying again. And the first time was because I didn't know about this two sides. And I would Google what's the federal tax rate and just think that that's what I would owe for taxes. And that was before having payroll kind of set up and all of that, which can alleviate a lot of this conversation. but before you get big enough to have a payroll company working on your behalf yeah i was um i was like driving uber and i was like okay the the money from this and the money from that and i'm good and then i i vividly remember sitting outside the starbucks i remember the street i was on i remember the almost down to the table i was sitting at and just that moment the realization, crap, I gotta go get a job.

13:56That is so difficult. I mean, that's part of the journey and that's kind of what you sign up for. So yeah, hopefully we're looking at FICA and self-employment tax and not just looking at federal only. There's downsides to trying to DIY everything and taxes can be one of those things. Yeah, agreed. I mean, some people out there would say that it was because you were going to Starbucks that you couldn't afford to go full time. That would have been, I mean, you would have been, I'm not one of those people. I'm just saying there's some people in social media that would say that. Um, but yeah, this is one of those kind of massive, massive needle movers for quote unquote, very little effort, obviously not to, you know, put you down for, for missing that in the first place.

14:40Cause I know a ton of people do, but it's just crazy how that one little tidbit of information to just shift, you know, your calculations of what's financial realistic or not. makes a life-changing amount of difference just for whether you know that or not. So I really hope there's somebody out there who is considering becoming self-employed or is seeing that on the horizon at some point in the future. And even just a little tidbit of information like that can be a night and day difference between whether that becomes feasible for them or not. So I really hope that's able to help some people out there.

15:13State tax too. So consider your federal, consider your state tax, and then consider your FICA or self-employment tax. And state tax applies for both employer and employees on both sides. Yeah, it all adds up. All right, so to move on to the next one, this one's kind of near and dear to my heart because I'm definitely a massive advocate of high-yield savings accounts. I think they're a huge, huge, powerful, easy-to-use tool for the average person for emergency funds or kind of medium-term savings, that sort of stuff, where your money can still grow. But one kind of dirty aspect of it, quote unquote, is that whatever interest you gain from a high-old savings account is taxed as ordinary income.

15:57It's not taxed as capital gains. And so basically it's going to be taxed at your worst rate. So it would be the same as if you got a$1 ,000 raise. If you were in$1 ,000 in high-old savings interest, you would be taxed exactly the same at your normal income rate depending on your tax bracket. So this can definitely knock things down a bit when you see, you know, we talk about a three and a half, four or five percent yield that you can get from your high-end savings account. It's definitely going to be subtracted down from there based on your tax bracket. And as always, state taxes apply too, so that can take off another chunk of it as well.

16:34And a headache of it is just that it's not automatically withheld. And that applies to other accounts here as well. but I think it's just easy to forget that when you get paid at work, you know, you're getting taxed from it, but your taxes are withheld. So the, the, your side of the equation is very easy to handle because you're not really having to, to do any extra work. But when you earn income, quote unquote, from a high yield savings account, you, if you earn a thousand dollars, like we talked about, you need to be ready to fork over$200 when tax time comes to cover your side of the taxes.

17:06So it's not an easy, okay, well I got my thousand. and I'm sure everything's handled on the back end, you need to make sure that whatever you're earning from a high-old savings account through interest, you need to have in savings, basically, when tax time comes around ready to pay out, it'd be a good thing to keep that in a high-old savings account, keep that$200 around ready to pay when tax time comes because that was not withheld prior to that. My caveat here is that it's still far and above exceeds a normal savings account, if we're talking 0.3 % or some crappy return, and that's going to be taxed as well because that's still going to be income as well.

17:38but a hailed savings account still is going to easily surpass your other options, but it's not just going to be, you know, a perfect, easy equation of a four or 5%. You're done. There's a little bit more math you would have to do if you want to really dial that in. Now that springtime is here, it is time to update and reset my wardrobe. Last month, I talked to you guys about how I was getting my shipment from Quince in the mail. I got myself a three pack of Lima cotton shirts, and they are quite easily my favorite shirts to wear right now. The material is soft but still airy, so I feel cool while I'm wearing it, but comfy at the same time.

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20:41Does this change, because it's taxed as ordinary income, does this change how much you put in a high-yield savings account and maybe tax defer more things? It's like, I got an extra$10 ,000. I could put in a high-yield savings account. would I rather put in a 401k because the high yield savings account will be taxed? Is it enough to do that or does it still kind of not affect how you look at the overall priority of extra income? For me, it still doesn't affect where I would put the money only because the only money that I want to be putting in a high yield savings account is money I'm going to need soon.

21:26And if it's money I'm going to need soon, then there's no real tax deferred way for me to grow that money somewhere to pull it out quickly. I mean, something like health savings account, you could some very specific uses you could, but for a general savings account, there's just no way to go about that. I will say that it is, it's further affirmation that if there's any money that you want to just grow as much as possible and you're not going to need it for 10, 20, 30 plus years, then it's definitely further affirmation to go put that somewhere else where you can get those tax benefits and not pay any taxes on the gains um but it doesn't change the equation if i have an emergency fund or we're going to be buying a house sooner you're looking getting a new car you need to get the ac replaced whatever it is it doesn't change those kinds of equations because there's no real way you could get that taxed or for growth and then pull that money out for free penalty free blah blah in a year to go you know replace your hvac system or something yeah makes sense beautiful all right on to the next one another kind of tricky one and this one also has a little bit more you're going to need to look up a table likely for this one so this is going to require definitely at least one extra step which is a taxable investing account the big the big kind of trick here is that there's short-term versus long-term capital gains so there's there's sort of a cliff you drop off in terms of tax rates after one year of holding a given asset so say you're investing in coca-cola as just a random stock if you hold coca-cola and then sell it for whether it's for profit or loss after after 11 months your tax rate is going to be significantly higher than if you would held on to that for you know another month or month and a half and sold it after 12 and a half months since you've hit that year your capital gains tax basically shifts to another table like i mentioned before there's one table for less than a year your capital gains taxes based on your income level.

23:18And then there's a separate table for if you held it for longer than the year. So you have long-term capital gains. And those are significantly lower, so much lower to the point that you can pay 0 % depending on what your tax bracket is. So you could earn a healthy amount of money from an investment. But if you're retired or you're not earning much, or you're filing separately and you don't have an income yourself, whatever it is, then you can actually pay 0 % on that, or at least pay 10, 12 % less than you would have otherwise. So that is a massive, massive change. Then also dividend taxes. There can be different forms of taxes, qualified versus ordinary.

23:54All this kind of conversation around taxable investing and individual investing, I think Andrew definitely knows a ton more about. So Andrew, do you want to kind of cover the different aspects that can affect somebody's taxable investing account and things they need to keep in mind when they're trading in that account that can actually affect their end tax rate and amount they pay? Yeah, a couple things that might not be obvious. One is a wash-sell rule. This is a weird one. You might know this around December. The market can sometimes take a little bit of a dump every December, almost like clockwork.

24:35What's happening for some of these investors is they are tax loss harvesting. So the idea being when you sell a stock for a loss, you can either offset some of those capital gains you were mentioning. And so if I have$1 ,000 in gains at Coca-Cola and I have$1 ,000 loss in Palantir, you sell both of those at the same time. Now you're paying zero capital gains because they offset. You can also write off some of the capital loss if it's more than your capital gains and you can push some of that to a further year if you go over the limit. But the limit is different every year, so I'm not going to go over what that is.

25:22But it's like a few thousand dollars. I think it's like 3 ,000. Don't quote me on that. So one way somebody, some genius tried to figure out how to beat the system of doing a wash sale where if I'm down$1 ,000 on my Palantir stock, I'm going to sell it on December 30th and then I'm going to buy it January 1st. And now I have a different cost basis or I'm taking that deduction and then continuing to... You're taking the deduction and then still owning the stock. so it's like you're having your cake and you're eating it too and that's actually against the rules so the rule is you can't there's a 61 day window according to Gemini so 30 days before the sale, the day of the sale and 30 days after the sale so you cannot sell a stock and then buy the same stock and then write that off as as a deduction.

26:37And you can't sell a security and buy a similar security and think you're getting off too. You can't sell VTI and buy another index that covers the same thing and think you're okay. So you just don't try to finagle the rules too much. A good tax advisor should tell you what deductions you are allowed to take, what deductions you are not allowed to take. The wash sale rule is one to be cognizant of. Don't be trying to take deductions you're not supposed to. And if you're being advised to, then I would maybe get a second opinion. Yeah, definitely. Definitely agreed there. And to that, there's never a problem with asking your tax advisor any of these kinds of questions, really at any point in the year, because it's their job to help you and frankly to get your business and keep you around.

27:34And so the more they can educate you on this kind of stuff so you can make the best financial decisions, the more likely you are to stick with them and the more likely they are to get your business. So there's no downside to just asking an expert if you're in, because there's a lot of niche situations out there, very niche accounts, niche financial situations, niche things around wills and trusts. they can get very, very complicated in terms of taxes as well. So there's never, never a downside to just asking an expert for help. But one last question around taxable investing, Andrew, how do you kind of plan to be tax efficient when you're selling a position?

28:13Because obviously when you sell a position is really when you trigger the, the, the tax aspect of it all. Prior to that, nothing is really happening. But when, when you finally sell a position is, is when taxes really have to be taken into account. So how do you try to be tax efficient when you're selling a position? It's one of those things. I think you have to set up the system to give you the best advantages, just like inherently the system you're following inherently gives you more tax advantages. But on a stock by stock basis, you should not be making decisions based on how am I going to optimize my taxes?

28:55A lot of the really good investors that we've followed over the years we talk about on the show, they say don't try to be too cute. You should be buying stocks and selling stocks based on how you think those businesses will perform over the long term and not based on what is my individual tax situation. Having a strategy like I'm going to buy businesses for the long-term means that fundamentally you are taking advantage of having long-term capital gains tax because that's your goal is to own for five years or longer. But sometimes you buy a stock, you make a mistake, you have to sell six months later.

29:43And if you pay taxes on it, you pay taxes on it. This is not financial or tax advice, But one idea you could try, if you are interested in playing with the numbers a little bit, you could buy your dividend stocks in a Roth and buy your non-dividend paying stocks in a taxable brokerage account, as an example. So you don't pay dividend tax. That all assumes that you're buying a mix of both, but that's one idea. but I would say in general if you are stock picking do not try to mix the two objectives because you could you could end up really sabotaging yourself and selling things you shouldn't and hurting what would have been great results over the long term that's really good info it makes it a lot easier frankly to deal with taxes are just an outcome, a byproduct of decisions you make but just make the same decisions you would otherwise.