Don’t Put Your Tax Return Away Yet! Look for a Few Bits to Improve Your Finances Going Forward

Welp, you’ve done your taxes. At least, I sure hope you have. 

In this here blog post, I wish not to look backwards and cast aspersions at the IRS or the Trump Administration or your company’s HR department (although lord knows, at times they’ve all deserved it…some more than others). Instead I want to show how you might use your 2018 tax return to make your ongoing finances better.

My firm doesn’t prepare taxes. But I have reviewed a lot of tax returns in the last two weeks (hats off to actual tax preparers…how do they do this?) I review them not to catch a mistake that the accountant made (although that’d be a bonus), but to get a better view into the state of my client’s total financial life…and to see how we can use that information to plan more effectively for them in 2019 and beyond.

I thought I’d share a bit of what I’ve been noticing in my clients’ tax returns. Almost all of my clients are in the tech industry, so to first order, their tax returns are kinda the same, for a few reasons:

1. They make high incomes.
2. Large dollar amounts of RSUs vested in 2018.
3. They live in high-income-tax states.
4. They give to charity.

See yourself in any part of that description? Maybe you’ll benefit from some of the advice I give to my clients in that situation, too. Read on, I implore you…

The Two Biggest Recurring “Gotchas”

Everyone’s tax situation is different, but I am seeing two big things over and over.

YOU DON’T HAVE A MORTGAGE. YOU DON’T ITEMIZE. YOU DON’T GET A TAX BREAK FOR CHARITABLE DONATIONS.

If you live in California or New York or Oregon or other high-income-tax states, you are likely accustomed to itemizing the hell out of your deductions. Now, however, you’re capped at a $10k deduction for state income tax+property tax combined, thanks to the 2017 tax law changes. For many people, that is a huuuuge haircut.

[For those of us in Washington state, we never had the state income tax to deduct in the first place, so the 2017 changes don’t affect us as much…in this way.]

At the same time as your itemized deductions have been constrained by that $10k, the standard deduction is much higher: now $12k for a single person, $24k for a couple. Your itemized deductions have to be higher than those numbers to make itemizing worthwhile. And without you owning a home (or, more specifically, paying a mortgage), I just haven’t seen anyone itemize.

Of course, it can happen. Most likely route: your charitable contributions are really high. But for most people, you itemize because of two things:

1. State and local income taxes (and property tax to a lesser extent)
2. Mortgage interest

#1 is now limited. And if you don’t have #2, well…standard deduction it is.

There’s no inherent problem with taking the standard over the itemized deduction. One place where it screws people up, though, is that they’re not getting a benefit for their cash donations to charity.

Going forward? There are a few things to consider here:

1. The point of charitable donations isn’t a tax benefit. It’s to help. So, even if my other suggestions aren’t reasonable for you, please, carry on.
2. If you have company stock that has grown in value (and if you’ve kept your vested RSUs, then it likely has because the last few years have been very kind to many tech stocks), donate stock instead of cash. Even if you don’t itemize, you still get a tax benefit of not having to pay the taxes when you sell that stock, at a gain.
3. “Bunch” your contributions into every 2 or 3 years. Donate 3 years’ worth of donations in 1 year, and then don’t donate again for another 3 years.  This makes you more likely to get into itemizing territory every 3rd year, getting the full tax benefit of a donation, and the other years you can take the standard deduction. Over the course of 3 years, this maximizes your total deductions.
4. Financially support causes that aren’t charities. If you don’t itemize, you don’t get a tax benefit from charitable donations anyways, so you might as well consider donating to causes that aren’t charities. My family hasn’t itemized in the last few years, because we live in Washington state (no income tax to deduct) and have a very low-interest-rate mortgage.

So we have shifted from giving money to 501(c)3 charities to other causes that aren’t charities. For example, you can give to the Sierra Club Foundation (a 501(c)3) and be eligible to itemize that donation. But if you give to the Sierra Club (a 501(c)4)), that donation isn’t eligible. But the Sierra Club uses that money to do lobbying and other political activities I’d like to support. Same thing with the ACLU. We very much support the ACLU’s mission, and we can support it with cash without giving up any tax benefits (because we wouldn’t have had them anyways).

TAXES FOR VESTED RSUS WERE WAY UNDER-WITHHELD SO YOU OWE A LOT.

This is the biggest thing that’s kicking my clients in the gut this tax season. They paid way too little in taxes on their vesting Restricted Stock Units. This happened for a couple of reasons:

1. When your RSUs vest, companies are required only to withhold the statutory 22% taxes on the RSU income. But if your top/marginal tax rate is higher (which it often is for my clients and maybe you, too), then you still owe more tax.
2. 2018 saw a lot of tech stocks go up up up. (Hello, Twillio and Etsy and Atlassian and Tableau!) So, maybe your RSU income was a lot higher than you thought it was going to be, early in 2018. [Of course, many tech stocks were middling (Adobe, Amazon) and some just straight up lost value over 2018 (sorry, Facebook and Google).]

So, you’ve got more RSU income than expected, on which taxes are being under-withheld. You now owe a lot of tax, and possibly a penalty, too. Ouch.

Going forward? Start paying estimated taxes. You can do it online! It’s easy to pay! (Don’t forget your state income taxes, too.) Harder part is figuring out how much to pay. I don’t have shortcuts for that. Best advice is to work with a CPA who understands RSUs.

You can’t easily handle these extra taxes by increasing your normal paycheck tax withholding because these RSUs vest in “lumps” (technical term, I assure you). The money doesn’t come every paycheck. It comes every month, or every quarter. And those paycheck settings are, well, per paycheck.

Two More Things

Aaaand, a couple more things I find myself pointing out to clients that I bet apply to a lot of you, too, if not now, then soon, as you keep cultivating your career.

THE NET INVESTMENT INCOME TAX. LEARN IT. LIVE IT. LOVING OPTIONAL.

Do you have investment income (interest, dividends, gains from the sale of company stock, and so on)? I’m assuming you have at least interest income.  

If you have investment income, and your total income is over $200k (single) or $250k (couple), then that investment income gets an extra tax added on top of its “normal tax” (my words). Without NII, investment income is taxed thusly:

1. Interest and non-qualified dividends and short-term capital gains are taxed at the same rate as your ordinary income (like your salary)
2. Qualified dividends and long-term capital gains are taxed at the long-term capital gains rate (usually 15%).

But if any of this income exceeds that threshold, you will also pay the Net Investment Income Tax (which you can find on Form 8960), another 3.8% on top, for a total of 18.8%.

And remember, it’s not just your salary that counts towards that threshold. If you have RSUs, sometimes when those vest, it pushes your total income over that NII threshold.

Going forward? So, if you’re subject to the NII, you want to be extra attentive when you sell investments. This includes your regular ol’ investments (in Vanguard or Robinhood or Betterment), but also, notably, your company stock.

Of course, don’t let the tax tail wag the investment dog. I encourage people all the time to sell company stock, taxes be damned! (kinda sorta), because the investment risk of keeping it is too high. But it’s something to be aware of:

• you’re paying not 15%, but 18.8% on the gains in your company stock, or
• that wicked good 2.5% interest rate on that high yield online bank is more like 1.5% after you take taxes into consideration.

HIGH MARGINAL TAX RATE? LOOK AROUND FOR SOME MORE PRE-TAX OPPORTUNITIES FOR YOUR INCOME

What is your marginal tax rate? I mean your specific number, not the definition. The definition is, more or less, the tax rate you’ll pay on your very next dollar of income. And, I already know that. What we’re concerned with here is, what’s the number for you?

For example, if you’re single, and your income is:

• $150k, your marginal tax rate is 24%
• $200k, your marginal tax rate is 32%
• $300k, your marginal tax rate is 35%

You should ideally be able to find this number on your tax return paperwork, either through software like TurboTax or from your tax preparer. The higher the marginal rate, the more you’ll benefit from getting any sort of pre-tax benefit:

• Putting money into your 401(k) pre-tax (not Roth)
• HSA
• FSA (dependent care of health care)
• Transit/commuter benefits
• Deferred compensation plans

Going forward? So, hunt around in your employee benefits program for ways you can pay for things with pre-tax dollars.

(I feel compelled to down a rat hole here and carve out an exception for paying for long-term disability insurance. If you have the opportunity at your company to pay for this insurance with after-tax dollars please do it. Because that means, if you ever claim benefits, all the benefits will be tax-free. That could be huge.)

Here’s hoping you can find one way to improve your finances based on what you find in your 2018 tax returns.