April Fool

PlainDonut

This plain, simple donut looks a lot like a zero. Don’t add zeroes to your tax bill. Don’t pay $10,000 instead of $1,000.
April 15th is coming. Tax Day is coming. Don’t be an April Fool with your taxes.


 

Testing Before Teaching

Most teachers teach before they test. I prefer to test before I teach. My way is more fun and informative because it may show you what you don’t know and need to learn.


Consider carefully the following two hypothetical tax returns:

 

 

  Case 1 Case 2
YOUR TAX BILL
(Your money which the IRS gets to keep)
$10,000 $1,000
TAXES PAID IN DURING THE YEAR
(Through withholding from your
paychecks)
$15,000 -0-
Your Tax Refund or Balance You
Owe to IRS
$5000 Refund $1000 Owed to IRS

 

WHICH CASE IS BETTER AND WHY?

 

Don’t Confuse the Bill With the Payment

This is one of the most frequent errors I’ve seen people make with their taxes. Every tax return consists of two major sections. The first section, which is the most important, determines what your tax bill is. This tax determination section lists out all your income, deductions and most credits and arrives at a bottom line figure which represents the cost of your taxes for that year. For a year 2011 long form 1040 this bottom line amount is shown on Line 61.


The second, less important section of your tax return lists out prepayments, some credits and estimated payments you made towards your tax bill. PAYMENTS HAVE NOTHING TO DO WITH THE TAX BILL. They are merely what you have paid in during the year. If your tax bill is zero then you will get a refund of all the payments you made. If your tax bill is larger than the total payments made then you will owe more to the IRS.


Many people simplistically believe the size of their IRS refund is all that counts. If they get a big refund they are happy. If they owe the IRS they are unhappy. While I completely understand why people feel this way, the truth is that what really counts is the size of the tax bill itself. The size of your refund merely tells you the extent to which you overpaid the bill. If you owe the IRS that merely means you underpaid the bill.


What matters most is the tax bill, not how well (or poorly) you financed the bill during the year. Payments made to the IRS during the year include withholding from your paycheck, quarterly estimated tax payments, and certain refundable credits.


Focus on the bill itself and not whether it was overpaid or underpaid. Your tax bill represents the true cost of taxes for the year ignoring the separate and unrelated issue of payment. Don’t let refunds or balance dues distract you.


One reason why some people ignore their tax bill and obsess over their refund is that they use the IRS as a savings bank. They know (or hope) they are overpaying the IRS during the year in order to obtain a refund early the following year. What these people are doing is making an interest free loan to the government.

 
But what if an emergency arises in October and they need the money then? The IRS won’t give it to them. It is indeed foolish to use the IRS to save money. Banks and other institutions will serve you far better. Talk with a financial advisor and find a smarter, better way to save money.
Why entrust your savings with the IRS?

 


The Answer: Case 2 is Better

Case 2 is much better because the tax bill is $1,000 while the tax bill in case 1 is $10,000. If these cases applied to you, you would save $9,000 by choosing case 2.

The separate and unrelated matter of how the tax bill was financed has NOTHING TO DO with how to determine which case is better. Case 1 does indeed result in a wonderful $5,000 refund from the IRS. But look at the costs that were incurred in order to get this refund:

 

(1) The tax bill is $9,000 higher than Case 2 meaning the IRS keeps $9,000 more of your money;

 

(2) You gave an interest free loan of $15,000 to the IRS during the year. Of course you might say to me that interest rates today are pathetically low so this doesn’t matter. But what if you have credit card bills with 21% interest rates? What rate are you paying on your car loan? Your mortgage? Your student loan? All these rates represent the cost of money for you.


 
Instead of loaning $15,000 for free to the government you might have been better off using this money to pay down your own debt and save money that way.

It is always foolish to loan money for free to the government. You may love your big refund check from the IRS, but the IRS loves you even more. The IRS loves April Fools.

 


Invisible Income

One of the greatest frustrations I face is the fact that some people are simply unable to benefit from tax planning and good advice. This is tragic but true. The inability to benefit from good tax advice is in many ways a form of blindness: an inability of some people to see money that does indeed exist and has already been or could be put into their pockets. But various combinations of impatience, stubbornness, unwillingness to learn and other factors prevent some people from saving substantial amounts of money on their tax bill or seeing what they have already saved. I wish I could help these people, but they just won’t let me.


One particular way this situation arises is with invisible income. Assume there is a decent, hard-working individual named Joe Simple who has a very hard time managing his money wisely. Joe Simple lives paycheck to paycheck.


One day a miracle happens and Joe Simple’s income is doubled. Instead of making $400 a week he now makes $800. But Joe Simple doesn’t change how he handles money. He continues to spend every dollar as fast as it comes in. At the end of the year Joe Simple has no savings at all and still lives paycheck to paycheck.


Joe Simple would deny that his income has doubled and might even get angry if I told him this even though it’s a provable mathematical fact that he is making twice what he used to. I see these situations frequently. It is wise to trust facts instead of your memory.


The lesson is clear: Saving money on taxes is useless if you don’t see the savings. Invisibility confers non-existence on money in connection with people’s feelings and motivations. If you can’t see the money it will be hard to believe it exists, and it will be even harder to feel you are ahead of the game.


 

You Don’t Need to be a Genius to Save on Taxes

I believe anyone who really wants to can find ways to save on taxes, and can benefit from good tax advice. You don’t need to be a genius. But it’s true that when it comes to teaching people something new there are five groups:

 

 

JOE SIMPLE This is a small minority of people who, for whatever reason, can’t learn no matter how many times a lesson is repeated.
AVERAGE JOE The majority of people need to hear something three times in order to digest and understand it. There is nothing wrong or bad about this. It’s just a fact of life.
SMART JOE A minority of people will absorb new learning after hearing it only twice.
VERY SMART JOE A very small minority will learn something new after hearing it just once.
JOE GENIUS One person in a million won’t need to hear it at all because they already know it and are ten steps ahead of you besides.

 

Which group a person fits into depends on the subject: Physics, cooking, taxes, carpentry, fishing, or caring for children. (Most mothers seem to be geniuses in this subject.)


All that really matters is that you don’t fall into the first group. If you want to save money on taxes please don’t be Joe Simple. I won’t be able to help you at all. No one will. All you have to do is be motivated and commit to spending the effort required. I believe everyone who wants to can benefit from tax planning and good advice.


Read, be patient, and talk to your accountant. Ask questions until you understand. Demand to be treated with respect and courtesy. After all, it’s your money at stake. You worked for it. You deserve to find all legitimate ways to pay the legal minimum tax and not one penny more.

 


If Money Is Invisible Does It Still Exist?

I’ve heard many of my fellow accountants complain about their clients. Some accountants whine. Some cry. Some punch their computer screens and smash to pieces their adding machines. Some steal cash from their clients while armed with a hammer and go to jail. (Bucksport Accountant Goes Berserk). Some go insane. And some accountants give up completely and seek a far easier and more comfortable life in Siberia, North Korea or the South Pole.

I prefer to teach.

Here is my final lesson for today:

Imagine I stand in front of a large crowd of people and have them watch me stuff a suitcase with $50,000 in cash and place it on the roof of a tall building. I then announce to the entire neighborhood what I’ve just done and say that whoever gets to the cash first can keep it. What will happen?


You can be sure many people will risk severe injury, even death, to grab the cash. One day soon there may even be a reality TV show (with 911 on speed-dial) based on this concept.
People will pursue money when it’s obvious, when they can clearly see it, when they can smell it.


But explain to a business owner that several complicated steps and transactions will be required to obtain exactly the same amount of money and all of a sudden interest will fade. Motivation will decline. Very few people will risk injury (beyond paper cuts) while studying budgets, analyzing tax returns and financial statements, and overusing calculators to find ways to save exactly the same amount of money.

Physical money is highly visible and motivates people to the maximum extent.

Abstract money (like saving money on your taxes) appears less real to people because it is physically invisible. But this is a costly mistake. Money is money, and continues to exist even if you can’t touch it. The money you can’t see still counts, and is countable. The wisest investors know this. People who can’t see abstract money need glasses. Accountants, not eye doctors, can help with this.


Two qualities make money invisible and impair or even destroy the motivation of people to achieve savings and efficiencies:

 

1) Smaller amounts of money received over a long period of time will be far less visible than a larger amount of money received as a single lump sum. Saving $100 a week for a year on your taxes will become boring and taken for granted after only a few weeks while getting a $5,200 refund check one day out of the year will be remembered for a long time. Mathematically, these two situations are precisely equivalent. Emotionally and psychologically, they are opposites.

 

2) Abstractions and mental effort make money less visible. Sweat makes money less visible. The more work that must be performed to obtain a given sum of money the less value and visibility the money will possess.

 


Your money should be managed by reason, not emotions. Facts and logic, not fantasies and impulses, should guide your financial thinking. All of us need to fight and subdue our inner dummy. Better thinking will produce better results with your money, taxes, and retirement planning. Emotional thinking will produce (literally) poorer results.  


You will now be tested on all of these lessons. But it won’t be me giving you the test. Instead, you will be tested by the world you live in. Unlike my tests the world will be tough and unforgiving. You may not get a second chance. So do your very best and manage your taxes and finances as well as you can. And if you see Joe Simple remind him that a fool and his money are soon parted.

AprilFoolGraphic-900

 

AVOID THIS COSTLY MISTAKE: THE MONEY YOU DON'T SEE STILL EXISTS AND IS YOURS TO LOSE.

 

 

 

 

LEGAL DISCLAIMER

George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339

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