The SoapBoxers

Mitt Romney made the news when video from a private fundraiser surfaced this week.  In the video, he is having a candid chat with donors, telling him that 47% of Americans will never vote for him because they are dependent on the government – asserting that these people don’t pay income taxes and feel entitled to health care, food, and housing provided by government handouts.

The 47% number gets bandied about a lot.  You should ask yourself two main questions:

Is it true that 47% of people don’t pay income tax?

I addressed the topic of how many people don’t pay income taxes in greater detail in an earlier article.  A big problem is that people use the terms people, households, and filers interchangeably.  This is a mistake.  I’ll create an example household consist of a mom and dad (married filing jointly, with tax liability), elderly grandparent living with them (minimal taxable income, no tax liability), teenage son with a part time job (minimal taxable income, no tax liability), and a ten year old and four year old.  That’s one household, six people, three tax returns – only one of which has tax liability.  

If you’re using statistics about filers (such as IRS data), it is very inaccurate to substitute the word “people” or “households” for “filers”.  Yet, politicians and the mainstream media often do this, because it’s easier than trying to explain the nuances, even though there is a significant statistical difference.  When you see these quotes, go back to the source they used and verify that they are using the correct term.

Should “the 47%ers” pay taxes?

This is a more complex question.  Who are the 47% who don’t pay taxes, and why don’t they pax taxes?

The stereotype that some people are trying to construct is a family where nobody works, the kids run wild, and the parent use the welfare checks to buy Cheetos and Xbox games.  Certainly this sort of abuse of the system does exist, but let’s look at other examples of people who don’t pay taxes.  All of these fictional scenarios are using a very simplified tax situation of the standard deduction and exemptions, before taking any credits into account.

• The elderly – Abigail is 70 and a retired high school principal.  She works ten hours each week at the local library, earning $10 per hour.  She also spends twenty hours each week volunteering at various organization within her town.  Other than the $5200 per year she earns at the library, the rest of her income consists of a Roth IRA (taxes paid up front), her husband’s life insurance benefits (non-taxable) and Social Security.  Abigail currently doesn’t pay taxes … but she paid her fair share of taxes for decades when she was working full time.
• The young – Becky works with Abigail at the library.  Becky is sixteen years old and works ten hours per week.  Becky helps her parents with some of the bills and puts the rest toward college.  Becky doesn’t currently pay any taxes – but she expects to pay a lot of taxes when she graduates from law school.
• The working poor – Charles and Debra, age 24, have two year old twins.  Prior to the birth of the twins, both of them worked at the local grocery store.  Due to high costs of day care in the community, Charles quit to stay at home with the kids until they are in school.  Debra earns $12.50 per hour and is being groomed for a management position.  While Charles and Debra don’t currently pay taxes, their household income will jump when Charles returns to the workforce and will continue to grow as they move up in the organization.  In a few years, they’ll resume paying income tax and will do so until retirement.
• The unemployed – The factory where Edward worked shut down, resulting in hundreds of people losing their jobs.  The resulting glut of a particular skill set on the market has made it very difficult to find a job, and Edward has been unable to find work.  At this point, it would be difficult for Edward to move.  He has strong tied to the community and he’d take a financial loss if he sold his house at the moment.  Edward is no longer collecting unemployment and is burning through his nest egg and he attempts to find work.  Edward is not currently paying taxes – but he’d absolutely love to return to the ranks of the tax payers.

This is not a comprehensive list. 

As you can see, not everyone in the 47%ers is a “lifer”.  Depending on age and/or circumstance, you may end up paying no taxes some years and paying taxes in others.  Assuming that the 47%ers is a non-changing block of people is a dangerous fallacy for politicians. 

Jimmy Buffett, thinking about taxes.

Back in February, my friend Lazy Man discussed the different tax rates paid by the Brothers Buffett. The gist is that Jimmy gets hammered with a 35% tax rate on his earnings, while Warren wheels and deals his way to a rate near 15%, due to the majority of his income coming from capital gains. There was some lively discussion on the matter. One assertion was that Warren was actually paying a higher tax rate than Jimmy, as the companies owned by Warren had already paid corporate income taxes, essentially paying taxes on behalf of owners like Warren Buffett. Add this rate to the individual tax rate of Warren, and he pays a higher rate than Jimmy.

Sometimes capital gains results in double taxation

I’ll concede the point that sometimes a capital gain does result in double taxation. If the capital gain results from the corporate earnings that have accrued over time, then the capital gain would indeed be double taxation.

Should we feel sorry for people who find themselves doubly taxed as a result? I don’t. Why not? Because there are several ownership types other than a C-Corporation (the “normal” type of corporation). Partnerships and even S-Corporations (small corporations) only file informational tax returns, with each owner being personally responsible for taxes on their share of earnings. If two people each have 50% ownership in a partnership that has a profit of $100,000, then each partner has $50,000 in income as a result. The earnings are taxed only at the individual level, resulting in single taxation. Companies that form C-Corporations volunteer for double taxation as a result of opting for that form of ownership – they aren’t forced into it.

Why, you ask, would anyone form a C-Corp, then? Because there are a lot of other advantages, such as the ability to easily buy and sell an ownership stake. Sometimes factors other than taxes can form the foundation for a sound business decision.

Sometimes capital gains aren’t double taxation

Amazon.com was incorporated in 1994 but did not make a profit until 2001. During this time, the company was growing and increasing market share – but losing money. Effectively, taxpayers were subsidizing the growth through tax refunds and net operating loss carryforwards. If you combine capital gains taxes with a shareholder’s proportional share of corporate taxes – exactly what is being proposed by others as the “correct” way to calculate an individual’s tax rate – the rate is effectively LOWER than the capital gains rate.

Amazon’s seven year odyssey to profitability is a somewhat extreme example, but it’s not uncommon for companies to lose money during the first few years.

Even for companies that are profitable, the gain on a sale will often exceed what you’d expect based on the accumulated profits of the company. Why? Because people are buying the promise of future earnings. Obviously, these earnings haven’t been taxed at the corporate level (they haven’t even been earned yet), so there’s clearly no double taxation for the portion of capital gains that relates to expected future earnings.

It’s not all about stock

While people tend to get locked into the mindset that all capital gains are related to the sales of stock, this isn’t the case. There are a variety of assets that can generate capital gains. Some are income-producing assets (farmland), but some are not. That gold nugget or T-206 Honus Wagner card don’t generate any income, but they do generate a capital gain when sold. There’s definitely no double taxation when you sell non-income generating assets.

I have already finished and filed my taxes for the year…which is an achievement for me. 2011 was different than past years. I had 1099’s this year from my writing, had started my writing gig, we moved….it was a busy year. I was learning what I could and couldn’t deduct (business cards and office supplies are deductible; a “family size” bag of circus peanuts not so much), what I did right and what I did wrong last year. But I got it done, the tax software checked for errors and it sent it on its way.

And then H&R Block sent me an email from the IRS (panic!!). The headline read “Refund funding issues” (what?). Yes, apparently the IRS has “funding issues” and it would take over a month to get my return sent back to me.

Really, IRS. Really. I wonder, if I ever have to pay in the future, if the IRS would just accept my delay in payment to them, if I sent them an email and said I was having “Payment Funding Issues”. Somehow I don’t think their response would be so nice.

Pro Tip for the IRS: people who get refunds generally file pretty early, while the people who owe money usually file much later. You might want to plan for this cash flow discrepancy in your budget. I’m guessing this happens fairly frequently … like, say, every single year?

Oh, well. I guess I can at least track the status of my refund on the “Where’s my refund” site the IRS runs. What? That site’s having problems? Does the IRS have a “funding issue” with its IT department, too?

So I’ll just wait for my refund. With another baby on the way, we’ve already decided we’re going to use it as a down payment on a new (to us) vehicle. My 1993 Dodge Caravan just isn’t cutting it anymore. While I love my “broke-ass soccer mom van”, I would like a vehicle with a muffler…and a speedometer that works all of the time, not just when it wants to. I’m not picky.

Tax related articles from our other writers:

Starting a small business in 2012? The details can get a little tricky, especially if you’re forming a separate legal entity. Check out Kosmo’s guide to starting a small business so that you can get off on the right foot.

Sell a lot of items on eBay? You’ll want to be aware of the new 1099-K form. Johnny Goodman takes a break from sports writing to discuss the 1099-K and how it can even affect collectors.

As the stock market has meandered through peaks and valleys in recent years, gold has continued its rapid upward ascent. This has not gone unnoticed. On the one hand, we are bombarded by ads from companies urging you to invest in gold (by purchasing from them, of course). On the other side of the equation, everyone is offering to buy your gold jewelry – even the ugly and broken pieces. I must admit that I’m a bit confused at seeing both types of ads – is this a time to buy gold or sell gold?

So I have to ask myself – should I invest in gold?

It has often been said that gold tends to keep its value in a down economy. But why is this? As I see if, gold has two things going for it.

1. It’s pretty
2. It does a good job of conducting electricity

Obviously, the price of gold isn’t driven by its ability to conduct electricity. Certainly gold jewelry is pretty, but should this be the sole reason to pay more than $1300 per ounce?

There is another reason, of course. As gold enthusiasts will tell you, for thousands of years, people have used gold as currency – long before the advent of paper currency (this is the old argument of “this is how we’ve always done it in the past”). After all, you can always print more money, but you can’t make more gold. While that statement is literally true, it’s misleading. While the amount of gold existing in the world cannot be increased, the fact of the matter is that we don’t know how much exists. We know how much exists in the marketplace, but this can be increased by mining for gold. Is there a mother lode in the midst of the Amazon basin, just waiting to be extracted?

If the world economy was teetering on the brink of collapse, how valuable would gold really be? The basic necessities of life are food, water, and shelter. Gold provides none of these. Can you trade gold for these necessities? Sure – as long as your trading partner values gold more than food, water, or shelter.

Why, then, does gold continue to rise? I believe that it’s not because gold is intrinsically immune from economic downturns, but merely that a large number of people have convinced themselves that gold is immune from economic downturns. There’s a term for this – a self-fulfilling prophecy.

The “buy gold” advertisements tend to fan the flames a bit more. At some point, we’re going to reach a point where all of the believers have bought into the gold bull market. What will happen at that point? Will the bubble burst?
Invest in gold if you wish, but I urge you to keep an open mind and ask yourself what, exactly, is driving the demand. I can understand using gold as one aspect of your portfolio, but it might not be wise to put all your eggs in one basket.

Much attention has been given to Dave Ramsey’s method for reducing debt.  The gist is that you pay off the smallest debts first, then use this money toward the smallest remaining debt, until a snowball effect takes place, zooming you out of debt in no time.  This is a simplified version, but I’ll focus on this core idea today.

From a pure dollars and cents perspective, this doesn’t make logical sense.  You should instead pay off the debts that are at the highest interest rate – this will save you money in the long run.  If you have the discipline to pay off debts in this manner, it’s a no-brainer to do it this way.

So, then, why does Dave Ramsey have some many followers?  Because many people get frustrated with their inability to make a sizeable dent in their debt.  If they have $3500 car loan at 0.9% and a $15,000 credit card loan at 18.9%, they pay off the car loan because it’s a quick win.  For many people, emotion trumps logic.

Wouldn’t it be great if people were somehow able to inject emotion into the logical approach?  I’m going to introduce a method that I call The Ramsey Backflip.  The method attempts to take the strengths of the Ramsey approach (emotional victories) and inject it into the more financial advantageous method of paying off the high rate debts first.

The first step in the process is to name your debts.  Give the highest interest rate an unpleasant name (Merkleton McWarty, for example) and the lowest interest rate a more pleasant name (Princess).  Then, assign actual physical characteristics to the debts.  You might choose to personify the lowest interest rate debt after Scarlett Johansson (if you are a guy) or Tom Cruise (if you are female).  Likewise, choose negative characteristics for the highest interest rate debts – for example, you might pick Tom Cruise, if you are a guy.  (I’m kidding, Tom Cruise.  I’m sure you’re a great guy.  The rest of us are just jealous).

Now you should have a band of imaginary debt-friends.  OK, they aren’t real friends, because they are mooches.  It’s like the movie You, Me, and Dupree.  You invited the house guests, but you really need to show them the door – and fast.

If you have several house guests and need to kick one out, whom do you kick out?  The boring, ugly guy with bad breath.  Merkleton McWarty.  Find a nice big photo of Merkleton McWarty (or the person you use for the mental image of Merkleton) and waste some ink and paper by printing it out.  Every time you make a payment against Merkleton (that credit card debt of $15,000 at 18.9%), put a sticker on top of Merkleton’s ugly mug.  By the time you finish with Merkleton, he’s nothing but a page of stickers.

When the first debt is gone, repeat the process with the ugliest remaining houseguest.  As you work through the debts, the photos get progressively more attractive.  At the end, you’re left with Scarlett Johansson – the $3500 car loan at 0.9%.  When you get to that point in your debt repayment process, it might not even make sense to pay off the loan early – you may instead choose to invest in something that can beat the 0.9% rate.

Is this a bit immature?  Certainly.  However, I urge you to try to find your own path – a way that you can convince yourself, emotionally, that it is in your best interests to pay off those higher interest debts first.  Make it a game if you must.  Your wallet will thank you.

I’m deviating from the politics just for today. There is plenty to write about, but I’ve been pondering refinancing our home mortgage a lot and maybe someone can counsel me.

First of all, we refinanced our home in December 2009 and have an incredible rate of 4.75% for a 30 year fixed mortgage. I was happy with that and never intended to touch our mortgage again. However, that changed last week when I received a call on my cell phone.

A representative from Amerisave.com called and began talking to me about refinancing. Apparently, they still had my information from two or three years ago when I was interested in a refinancing our mortgage. Todd (the rep) told me that rates were even lower now and sent me a “personalized quote”. I looked at my Droid and found it in my Gmail spam folder. I clicked on the link and I am able to obtain a 30 year fixed mortgage with around $1800 in credits. If I were willing to pay for closing costs, I could have an even lower rate.

The questions that I continue to run through my head are: How much will the closing really cost? Will that $1800 in credits cover it? How much deviation could there be from those estimated costs that they provide on the website? I understand that escrows are in addition to the closing costs, but those should pretty well wash when we get our escrow back from our current mortgage company.

Does anyone have any feedback of suggestions? Are the specific questions that I need to ask that will help me catch any shell games that may be happening? I know this is a high pressure industry and they’re pushed to sell. However, if I can get a “no cost” refi am I truly getting a no cost refi?

From time to time, when reading the advice columns, I read articles about parents who are concerned that they are spending too freely in retirement and will have little money to leave to their children when they die.  Sometimes, there are even letters from grown children who are concerned that their inheritance is being spent.

My personal thought on this is that children are not entitled to an inheritance.  I’ll make an exception for young children left under the guardianship of others when you die.  In this case, it would definitely be good if you were able to leave some money (such as life insurance proceeds) to cover the cost of raising the children.  But if your children are grown, married, and established in their careers, should they really be leaning on you for financial support?  Probably not.  They should really be flying under their own power at that point.

Some people seem to be under the impression that financial assets are the most important thing parents can leave to children.  I sincerely hope that I am remembered for more than a financial bequest after I die.  I’m hoping my children will be able to look back at life skills they have learned from me and memories of times we spent together.  If money overshadows the non-financial gifts, I’d consider that a colossal failure.

For those of you who are worried about spending yours kids’ inheritance – don’t worry about it.  It’s your money, earned by decades of hard work.  You’re certainly entitled to spend it to enjoy your retirement years.  Take that trip to Europe you’ve always dreamed of (or whatever it is you’ve always dreamed of).  You may be pleasantly surprised to find out that your children actually prefer that you spend the money on yourself.

If you’re one of the kids who worry that your parents are spending money that is “rightfully yours” – I’d recommend spending 99 cents to buy the song The Will by Mark Chestnut.  Listen to it a few times and maybe your perspective will change.

In the midwest, ethanol is often a key discussion point regarding alternative energy. I am not going to try to touch on the many political, environmental, and social issues regarding ethanol. Instead, I will touch base on a rather simply mathematical point.

It is often said that ethanol provides 70% of the energy of gasoline. Does this mean that your 30 mpg car will drop to 21 MPH (30mpg X 70%) when you use the ethanol pump?

No.

The 70% figure is the energy of straight ethanol (100% ethanol). What you see at gas stations is most commonly a 90/10 blend (90% gasoline, 10% ethanol) or E-85 (85% ethanol, 15% gasoline).

Let’s quickly run the math of the mileage for these two types of fuel.

• For the 90/10 blend (by far the most common type of ethanol based fuel), 90% of the fuel (the gasoline) will provide 30 mpg while 10% of the fuel (the ethanol) will provide 21 mpg (30 X .70). When we use weighted averages (.9 X 30) + (.1 X 21) = 29.1 mpg. This is 97% of the fuel economy of gasoline.
• For the E-85 blend (used in FlexFuel vehicles), 15% of the fuel (the gasoline) will provide 30 mpg while 85% of the fuel (the ethanol) will provide 21 mpg (30 X .70). When we use weighted averages (.15 X 30) + (.85 X 21) = 22.35 mpg. This is 74.5% of the fuel mileage of gasoline.

If you are trying to simply buy the most economical fuel, this should allow you to determine which fuel will provide the most miles per dollar.

Note: in some states, only 90/10 ethanol and E-85 is available – straight gasoline is not available. For this situation, bear in mind that E-85 provides 76.5% of the fuel mileage of the 90/10 blend.