Monday, February 17, 2014

Filing Small Biz Taxes Early? 5 Things to Know

Deborah Sweeney for Fox Business writes: Filing season is officially upon us. Yes, April 15th is still months away, but the IRS has begun accepting 2013’s returns, and millions of Americans are getting ready to file their taxes. However, tax law can still be extremely complicated, especially for small business owners. I typically recommend that business owners meet with an accountant to maximize their deduction, but if that isn’t fiscally possible, the next best tax strategy is to research as much as you can before preparing your returns. For small business owners taking a crack at filing on their own, keep the following tax tips in mind.
1. Remember Your Home Office Deduction
Calculating your home office deduction used to leave your brain feeling like cold mush – this one deduction actually required an entirely separate form! While you can still technically use Form 8829 to calculate your home office deduction, the IRS has kindly introduced another option. This much simpler rule allots $5 per square foot of your office, up to 300 square feet. If your office is bigger than that, you can claim a flat $1,500 deduction. Now, this rule doesn’t help businesses that take up a large part of the owner’s home, but it will help save plenty of tax preparation time for the small businesses that are effectively confined to a home office.
2. Standard Mileage Rates Have Changed
The standard mileage rate for 2013 was 56.5 cents per mile, which was one-cent more than the rate for 2012. While that doesn’t sound like much, every penny counts and, if you drive around a lot for work, that one-cent increase could be a real boon. Also, anyone claiming standard mileage should note that the mileage rate is going to drop down to 56 cents in 2014. Be sure to check in with the IRS’s site to make sure you have the latest up-to-date information on deduction limits.
MORE ALLBUSINESS: 
3. Section 179’s Limit Is Getting Slashed
Section 179 is a provision in the tax code that allows businesses to write off certain types of major purchases. For the past few years, the government has extended a $500,000 deduction limit for Section 179 purchases as a way to spur business investment and growth. Unfortunately, this limit has not been extended through 2014. While you can still claim up to $500,000 in your 2013 returns, that limit is going to fall back to $25,000 for this upcoming fiscal year. The most common purchases covered by Section 179 are business vehicles, office furniture, off-the-shelf software, and improvements to retail or restaurant property. If you made any major purchases within those categories in 2013 make sure you take advantage of the higher deduction limit while you can.
4. Self-Employment Tax Deductions
As you are calculating your adjusted gross income for 2013, don’t forget that you can deduct half of the amount you paid in self-employment taxes. If you were self-employed and paid for medical and dental insurance in 2013, the Small Business Jobs Act allows you to deduct those expenses as well.
5. Don’t Forget Next Quarter’s Estimated Tax Payments!
Estimated taxes cover what used to be taken out of your paycheck by your old employer; Medicare, social security, and basic income tax are all covered by your estimated tax payments. Most small business owners are also required to file quarterly estimated tax payments – the only exceptions are those who expect to owe less than $1,000 in taxes, and those who did not have to pay any taxes during the previous fiscal year. If you still feel lost here, IRS Form 1040ES has been made available to help calculate what you owe, and the deadline for 2014’s first quarter is the same filing deadline for your returns – April 15th.
Tax season is never fun, and the complex tax code in the United States, despite all the ease of filing faster online, can still leave plenty of people scratching their heads. If you need help with filing, I really do recommend hiring an accountant or other tax specialist. But if money is tight, you can go it alone. Just make sure to take your time, be honest, and don’t do it all in one sitting. Tackling your return bit by bit, section by section, minimizes the chance of making mistakes, and makes it easier to stay patient while filling out all of those forms.
Deborah Sweeney is the CEO of MyCorporation.com. MyCorporation is a leader in online legal filing services for entrepreneurs and businesses, providing start-up bundles that include corporation and LLC formation, registered agent, DBA, and trademark & copyright filing services. 
Posted on 1:42 PM | Categories:

Bitcoin: too big not to tax / Bitcoin’s popularity is reaching fever pitch with the taxman equally excited over the potential for new revenue

Richard Asquith & AccountancyLive write: There is nothing quite like 5,600% growth in an industry within one year. At least that is what the UK’s HMRC believes as it starts to ponder whether it is missing a taxing opportunity with Bitcoins, the largest of the world’s digital currencies. HMRC is currently re-thinking its tax treatment of digital currencies, and is expected to announce a fresh approach this month. Other tax authorities around the world are doing this same. 
So what are virtual currencies, and what is there to tax and when?
Digital currencies like Bitcoin exist virtually on shared networks of computers. Bitcoin uses open-source computer code to create, ‘store’ and record currency trades on electronic ledgers held on the network’s computers. A new Bitcoin is created or ‘mined’ by having your computer solve an algorithm puzzle which can take several hours of processing. The owner can then sell this Bitcoin through the ledger for cash or goods. It’s an ingenious system which prevents the forging or simultaneous trading of the same unit of currency – a flaw which has undermined similar attempts at virtual payment currencies in the past.
The big advantage to Bitcoin is that it cuts out the need for clearing banks and expensive regulation which can add up to 6% costs to any transaction
The big advantage to Bitcoin is that it cuts out the need for clearing banks and expensive regulation which can add up to 6% costs to any transaction. The worry for governments is that fraudsters and terrorists can use the system to launder money. This concern however, is somewhat overblown as any Bitcoin transaction’s provenance can be traced by anyone through the electronic ledger. For example, the US Federal Bureau of Investigation (FBI) recently closed down Silk Road, a website caught selling drugs, by examining its Bitcoin ledger deals.

Make or break
HMRC first started taking Bitcoin seriously as a payment system last autumn as its price rocketed from $200 (£121) to over $1,000. Its first conclusion was that it was a single-payment voucher. Following the Finance Act 2012, which introduced new rules on the back of the Lebara phonecard VAT case (Lebara Ltd v HMRC C-520/10), this meant that 20% VAT must be charged on the entire value of each Bitcoin transaction. For Bitcoin traders, this threatened a massive compounding of VAT costs as the currency was traded many times a week, or even per day.
By the end of 2013, this approach had effectively shut down the UK Bitcoin industry. There followed an intensive round of lobbying, including lengthy explanations of the applications of Bitcoins and how they are actually closer to those of a currency than a voucher. This has paid off, with HMRC agreeing that their initial voucher interpretation was wrong. It is now taking legal opinion on a more suitable classification, and should publish its conclusions in the next month or so.
What is certain is that HMRC will not give Bitcoin a full currency status, in competition with fiat (national) currencies. This would have made its use and holding exempt from VAT, capital gains tax (CGT) or corporation tax. One option HMRC may consider, is classifying Bitcoins as a ‘private currency’, used for barter for goods and services. This would exempt the sale of Bitcoins from VAT (although traders’ commissions would be liable). It would also potentially mean CGT would be charged on any holding gains by small traders. They would though benefit from their normal annual CGT allowance, and HMRC may follow the German lead of giving holdings of Bitcoins a CGT exemption after one year.
If the UK does go this route, then it has a real opportunity to create one of the more favourable tax regimes in Europe for Bitcoin traders. Singapore has possibly captured the AsiaPacific trading hub title as it recently exempted Bitcoins from VAT and CGT. The US is on pause as its Internal Revenue Service (IRS) is reluctant to give any tax guidance.
There is little doubt that 2014 will be the make or break year for Bitcoin as it nears critical mass as a global currency, but is attracting the nervous attention of governments, regulators and the law enforcement authorities. But whatever happens, HMRC will be there ready to tax it.
Posted on 9:52 AM | Categories:

Double Down this Tax Season {No Casino Necessary}

amandagrossman for the Houston Chron writes:  Isn’t it human nature to want just a little more?
This time of year can feel like winning the jackpot for some, and a time to pay the piper for others. I’m talking about taxes. You can bet that if you are anticipating a tax refund, you are much more likely to file your taxes as soon as you’ve collected all the forms.
Who wouldn’t be in a hurry to receive a big, fat check or deposit? (Note: whether or not it’s a sound financial decision to get a refund each year is an entirely different discussion).
So before you figure out how you want to spend those crisp twenties, I want to show you how to insteadincrease your holdings without gambling at a casino, under-reporting income earned, or taking on any risk at all. Intrigued?
Double Down Strategy #1: Double Your Tax Benefits
If you are a taxpayer who is eligible for the Saver’s Tax Credit, then I’ve got an exciting way to double your tax benefits (and yes, it is double the fun).
First, use your IRS refund to contribute to a retirement account.
Next, claim the Saver’s Tax Credit on next years’ return in order to receive up to $1,000 for Single households (IRS code for just you living in a household), or up to $2,000 for households of Married, Filing Jointly just for contributing to your retirement (IRA, 401(K), etc.).
Ready to add some icing to that pretty cupcake? If you contribute your refund money towards a traditionalretirement account, then you will also receive the Traditional IRA tax deduction!
Let’s recap:
  • Get a tax refund
  • Fund a traditional retirement account (such as a traditional IRA)
  • Next year, get a tax deduction for the traditional retirement contribution, and a tax credit from the Saver’s Tax Credit…all funded by your tax refund to begin with
  • Did I mention you should roll this as long as you can? Take that money you gained from the Saver’s Tax Credit and Tax Deduction, and use it to fund next year’s retirement account contributions…get tax credit and tax deduction…rinse and repeat {suddenly retirement’s not looking so bleak}

Pretty cool, huh?
And you can get the party started early by setting up a traditional IRA right now and contributing an amount into it that you anticipate you will get back in a refund. The IRS allows you to fund last year’s retirement contributions until you file your return (or else you will need to amend it), or by April 15th, whichever comes first. That way you can claim your Saver’s Tax Credit and Traditional IRA deduction on this year’s tax return, starting the cycle early.
Double Down Strategy #2: Stuff an Interest-Bearing Account with It
Savings accounts aren’t earning that much interest at the moment (oh, for the days of 5% interest!). But you still earn something, and money earning its own money is pretty exciting anyway you cut it. This one tip alone can earn you thousands; since opening my savings account in December 2005 I have “earned” our household $2,204.83.
Did I mention that this extra two grand accrued while I was showering, eating, and watching Meet the Fockers for the millionth time?
Double Down Strategy #3: Put it Towards Your Mortgage
It’s not sexy-sounding to take your new check and put a chunk of it onto your mortgage. But let’s see if we can add to the allure. What if I said you can:
  • Turn $1,000 into $4,121.67*
  • Turn $2,000 into $8,140.94*
  • Turn $3,000 into $12,059.96*
Much sexier, right?
(*examples assume you make this payment at the beginning of a 30-year, 5.5% interest, $200,000 mortgage). To easily calculate your own interest saved check this out.
Double Down Strategy #4: Use it to Pay Down Debt
It may not feel like you are “doubling down” when you choose to take your tax refund and pay down part of your debt. But you must remember that you are most likely paying interest on top of your loan. In other words, any deduction in your balance now is a deduction in the amount of future money leaving your pocket.
Take our situation for an example of how much money you can earn back by paying down your debt: we paid our debt off ten years before the last creditor wanted to be through with us. So far (as in, more savings are to come), we’ve added an estimated $2,700 of not-paid interest to our pockets since the fall of 2010. Now that’s what I call doubling down!
P.S. pink editedInterested in doubling down on the backs of your own creditors? Subscribe to be the first to know when my new course, The Debt Manipulator 3.0, is released. You wallet will thank you!
Posted on 9:44 AM | Categories:

10 IRS Audit Red Flags / Do you ever wonder how the IRS chooses which taxpayers it wants to audit?

Fool.com writes: Do you ever wonder how the IRS chooses which taxpayers it wants to audit?While the IRS audits only about 1 percent of all individual tax returns annually, you don't want to be one of the unlucky few to get audited.
The IRS says being selected for an audit does not always suggest that an error has been made. Returns are selected using a variety of methods, including:
  • Random selection and computer screening — sometimes returns are selected based solely on a statistical formula.
  • Document matching — when pay records, such as Forms W-2 or Form 1099, don't match the information reported.
  • Related examinations — returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.
Avoid getting audited. Here are a few red flags you should watch out for:
1. Making mistakesEven if you do so by accident, errors on your tax return will give the IRS pause.Putting down the wrong Social Security Number and calculating something incorrectly are common mistakes that might cause the IRS to take a second look.Be sure that you enter the correct information and double check everything.
2. Incomplete informationIt's easy to make mistakes on your return if you're filling it out yourself. And one mistake that will raise a red flag for the IRS is if your return is missing information. The IRS might wonder what other information is missing and audit you.
3. High incomeIf you make more than $200,000 your chances of being audited increase, a recent report on the IRS' enforcement activity said. People with incomes of $200,000 or more had an audit rate of 3.7 percent. That's about one out of every 27 returns. And the more you earn, the more likely you will be audited.
4. Being too charitable
Giving or donating to charity is commendable, but don't over-exaggerate how much you give. The IRS is aware of how much people around your income level donate, so if you report giving away much more you're going to raise some eyebrows.
5. Not reporting all taxable incomeYou must report all 1099 and W-2 forms. Remember, the IRS gets copies of everything you receive. Failure to report all your taxable income may cause red flags.
6. Excessive deductions
By all means, deduct everything you're allowed to. But don't overstate your deductions or lie about them. The IRS is well aware of what is outside the norm for people at your income level.
7. Home office deductionsBe careful about deducting for having a home office. As we mentioned, deductions raise eyebrows. To qualify for this deduction, your home office space must be used exclusively as your place of business. If you're entitled to the deduction, take it — but be prepared to prove that you regularly use the space for your business. And be sure to only deduct items that were used for your business.
8. Owning a small businessIf your business runs mostly on cash or cash incentives — you're a taxi driver, car washer, work in a hair salon or bar — you're more likely to get audited.Workers in these professions tend to not accurately report all of their taxable income, like the amount of tips earned. If you are the owner a small business, be sure to report all the income you've received to avoid getting audited. Don't push the envelope. Also, don't try to pass off a hobby as a business just to try to get a deduction.
9. Not reporting a foreign bank accountForeign bank accounts have come under increasing scrutiny in the last few years. The IRS has actively tried to get foreign banks to disclose account information and launched initiatives encouraging tax evaders to come clean. If you've got a foreign bank account and fail to report it, you could face severe penalties if the IRS finds out.
10. Not filingClearly you're asking to be audited if you've filed returns in the past, but stop doing so. Maybe you are unsure of how you will pay your tax bill, but you'll be charged with late payment penalties if you miss the filing deadline. And you could get into even more financial trouble if you're identified as a non-filer.
If you do pull a fast one of the IRS, think twice before you brag about it. Many cases start out with a whistleblower reporting how you failed to pay the taxes you owed. Why? Because the IRS offers a reward of up to 30 percent on the additional tax, penalty and other amounts it collects from the tax evader.
If you are audited, you'll be notified by mail or telephone — not email. The length of the audit will depend on its type, the complexity of items being reviewed, the availability of information being requested, the availability of both parties for scheduling of meetings and your agreement or disagreement with the findings. If you are audited, know that you do have rights:
  • A right to professional and courteous treatment by IRS employees.
  • A right to privacy and confidentiality about tax matters.
  • A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
  • A right to representation, by oneself or an authorized representative.
  • A right to appeal disagreements, both within the IRS and before the courts.
For more information on what to expect if you're audited, visit the IRS website .
Posted on 8:18 AM | Categories:

Tax Deduction Guide: Contractors Vs. Employees

Katherine Muniz for Investopedia writes: Tax season can either be a blessing or a curse. Some will see their money go, while others will get a well-deserved windfall back from the government. In the case of independent contractors, who are different than employees, there are several built-in setbacks that come with the territory, including:

  • No sick days
  • No vacation hours
  • No health insurance
  • No worker's compensation
  • No retirement, pension, and unemployment benefits
  • No eligibility for overtime pay
However, there are deductions that contractors can write off, decreasing their taxable income and by extension, how much they will be taxed. The following are deductions independent contractors can write off, employees can write off, and a few that overlap.

Contractors

Independent contractors are defined by the IRS as self-employed individuals providing services to businesses, who have the right to "control or direct only the result of the work and not what will be done and how will it be done."

Contractors are subject to different tax rules than regular employees in a number of ways. For instance, employees split the cost of payroll taxes for Social Security and Medicare with their employer, each paying 7.65 percent of the employee's eligible wages. However, a contractor is technically considered both the employer and employee, and must pay both halves, 15.3 percent in total. The silver lining is that there are several tax deductions they can claim to minimize how big a chunk the government takes back in taxes.

Home office: As a contractor, you most likely use a portion of your home or a separate structure to conduct your business or meet with clients. This space must solely be used for business purposes, as the IRS has become very strict with what counts as an office. You are entitled to claim deductions for this space and expenses that may include real estate taxes, mortgage interest, utilities, insurance, painting, rent, repairs and depreciation, and this write-off can be claimed on Form 8829 and deducted on Schedule C.

Moving expenses: You can deduct a portion of your moving expenses from your taxable income if you move your work space at least 50 miles farther away than your old space. As a contractor, you must be employed full-time for at least 78 weeks for the next 24 months after the move to deduct these expenses. Moving expenses include packing and shipping costs, travel to your new space, hotel rooms, disconnecting and reconnecting utilities, and up to 30 days of storage.

Meals and Entertaining expenses: This is another categorization of costs the IRS is stringent about. Uncle Sam stipulates that the setting must be conducive to conducting business, and it has to show. For instance, an individual who tried to write off tickets to a baseball game was rejected because the IRS states that the volume levels of a baseball stadium don't allow for "comprehensive business discussion."

Interestingly, if you throw a business party with a mix of employees and spouses, you can deduct 100 percent of the cost. However, if it is only for clients, potential clients, and other contractors, you can only deduct 50 percent of the cost.

Commuting expenses: Self-employed individuals working from home can deduct the cost of driving to see a client or go to a work location. Keep a record of this driving or else the IRS can deny you the deduction.

Medical insurance expenses: Contractors can deduct 100 percent of the health insurance premiums paid for themselves, their spouse, and dependents, which will reduce their income tax.

Retirement plans: Contractors are able to establish IRAs such as an SEP (Simplified Employee Pension Plan) or a Keogh plan, through which you can deposit 20 percent of your net earnings, your net profit minus the deduction for one of the halves of your self-employment tax.

Overlapping Deductions

Travel expenses: If you're scheduled to take a business trip to another U.S. city, by spending a few more days there as vacation, you can deduct 100 percent of your airfare expenses! Just make sure the days for business take up more of your trip than your vacation. Also, lodging, hotel tips and 50 percent of meals are eligible to deducted only for the business days.

Hobby/business: For employees that aren't really independent contractors but have a hobby such as growing vegetables that you sell to others, you can report your business income and expenses on your normal 1040 tax return (Schedule C) and deduct the expenses related to your business. However, if your business is not profitable, the IRS will investigate your losses as a tax shelter. If your business is profitable for three out of five years however, consider yourself in the clear.

Education expenses: The IRS college tax credit comes in two ways: the American Opportunity Tax Credit and the Lifetime Learning tax credit. The IRS will credit your tax bill and fund up to 40 percent of your college tax credit in the first, with the latter being more flexible for any professional taking college courses to better their employment opportunities.

Health insurance premiums: Starting in 2014, those who get their health insurance coverage through the Health Insurance Marketplace are eligible for the premium tax credit, which you can have some or all of the estimated credit paid in advance to your insurance company to lower your out-of-pocket expenses during 2014, or get it later and wait to get all of the credit when you file your 2014 tax return in 2015.

Business-related goods: Clothing and equipment like scrubs, lap coats, and tools can be deducted, as well as laundering and cleaning these items. Additionally, professional journals, subscriptions, and reference books are deductible as well as the business-use percentage of Internet expenses and the cost of online research.

Employees

Commuting expenses: A loophole has made it possible to deduct the cost of commuting to your place of employment. Some employers in America have begun participating in commute benefit programs, such as TransitChek. Due to this, employees can make pre-tax deductions from monthly paychecks to cover your expenses, which functions as a deduction from your overall taxable income (since the money is deducted from your paycheck before taxes). However, only 6 percent of American employees participate in these commuter benefit programs.

Work expenses not covered by employers: You can deduct items such as uniforms you are required to buy and wear, dues if you belong to a union and other professional organizations, and business-related vehicle expenses like gas and repairs.

Travel and auto expenses: Travel expenses are deductible as long as you incurred the costs for traveling between workplaces (not a home office like the ones contractors work out of) and you can even deduct the cost of laundry, baggage, telephone bills, tips, and meals when traveling. You can deduct parking to attend a business meeting, and if your car is used for business purposes, you can deduct either your car expenses for the year or the standard mileage rate, which was 56.5 cents per mile in 2013.

Job search expenses: During your current occupation, you can deduct anything from the cost of producing and printing your resumes to travel expenses you accumulate while interviewing for a job.

Passport: This is only if you need to buy one for a business trip. All in all, though contract workers are known to get slammed during tax season, there are plenty of ways for these individuals to minimize their taxable income and get quite a few breaks, and, employees who have the fortune of having their tax burden shared with their employers, also have a few significant ways to save.
Posted on 8:16 AM | Categories:

Traditional 401k vs. Roth 401k

Over at Bogleheads we came across the following discussion: Traditional 401k vs. Roth 401k

Traditional 401k vs. Roth 401kby bigez17 » Sun Feb 16, 2014 11:44 am

I am interested in perspective regarding the pros and cons of whether to invest in traditional or Roth 401k.


If we start with the fact that we do not know what the tax rates will be when the money is taken out (no one has crystal ball) then we cannot compare to current rates, expelling the rate argument. It matters, but is all speculation.
I would also dismiss the argument of whether or not the Roth will continue to receive favorable congressional treatment, again speculation.
That brings me to the only differences I conclude we can compare:
1) with a Roth 401k we can escape any tax on principal and earnings withdrawn
2) we can pass on to heirs a more valuable inheritance
3) we can roll over to Roth IRA and avoid 70 1/2 required minimum distribution
4) by putting max amount in ($17,500 or $23,000) Roth, the whole amount is available vs. the ultimately taxable same amount which means less overall dollars to be available after taxes
5) we will spend more to fund Roth given the need to pay taxes now and not receive a tax break now
It is #4 that puts the decision over the top and thinking the Roth is the way to go.
I would appreciate your insights.
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Re: Traditional 401k vs. Roth 401kby freebeer » Sun Feb 16, 2014 11:46 am

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Location: Seattle area USA

Re: Traditional 401k vs. Roth 401kby livesoft » Sun Feb 16, 2014 11:51 am

I guess I will try to throw a wrench into this.
It is not a "traditional 401(k) vs Roth 401(k)" decision. It is a "Traditional 401(k) + taxable investments vs Roth 401(k)" decision.
Does a traditional 401(k) give you tax breaks that will make your taxable investments tax-free?
Can you withdraw your taxable investments tax-free and that way make your traditional 401(k) withdrawals tax-free as well?
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Traditional 401k vs. Roth 401kby DSInvestor » Sun Feb 16, 2014 12:00 pm

Contributions to Traditional 401k give you a tax deduction at your marginal bracket. Taxation of withdrawals from Traditional 401k can vary greatly depending on the composition of your income in retirement. For example if you have a generous defined benefit pension that consumes your 0% and low tax brackets, your 401k withdrawals will be taxed at a higher rate than if you do not have pension. Without a pension, the 401k withdrawals are taxed at 0% first to consume deductions and exemptions and then creep up the tax brackets. As long as the tax code provides for deductions and exemptions, there will be a 0% tax bracket even if tax rates may be higher. Run some numbers with taxcaster to see what the tax cost for 20k, 40K, 60K, 80K of IRA/401k withdrawal would be with no other income.


I did not have a defined benefit pension. I maxed out Traditional 401k, Roth IRA, and also invested in taxable accounts. The Traditional IRA contributions gave me a tax break in 25-33% Fed tax bracket and 6-8% state. My tax savings allowed me to invest more in taxable accounts and have more take home pay to accelerate mortgage payments, student loans, house/car purchase etc. After I stopped working, I tapped assets in taxable accounts and that was so tax efficient that I was able to convert Traditional assets to Roth for little or no tax cost. Roth 401k contributions would not have been the way to go in my situation. I'm very happy to get a tax deduction at 40% and convert at 0-10%. YMMV.
Last edited by DSInvestor on Sun Feb 16, 2014 12:13 pm, edited 1 time in total.
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Re: Traditional 401k vs. Roth 401kby retiredjg » Sun Feb 16, 2014 12:13 pm

bigez17 wrote:If we start with the fact that we do not know what the tax rates will be when the money is taken out (no one has crystal ball) then we cannot compare to current rates, expelling the rate argument. It matters, but is all speculation.
I'd argue it is not all speculation. Yes, there is some speculation involved about what future taxes will look like, but I believe it is pretty clear that most people are in a lower bracket or the same bracket in retirement.



It is #4 that puts the decision over the top and thinking the Roth is the way to go.
It is #4 where you have made your error.



4) by putting max amount in ($17,500 or $23,000) Roth, the whole amount is available vs. the ultimately taxable same amount which means less overall dollars to be available after taxes
If the tax rate is the same going into Roth 401k as it would be coming out of traditional 401k, you end up with the same amount of money, to the penny.


If all your assets are in Roth status, you could actually end up with less money in the end because you need some income in retirement to fill up the lower tax brackets. If you don't fill the lower tax brackets with money that has not yet been taxed (SS, pension, withdrawals from traditional IRA/401k/403b), you will be taking it all from Roth which might have been taxed quite heavily on the front end.
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Re: Traditional 401k vs. Roth 401kby Calm Man » Sun Feb 16, 2014 3:20 pm

OP, without realizing it you have given responders no real choice except to disagree with your assumptions. Because you start out by throwing out 2 of the major arguments against this as speculation and therefore not worth considering. In fact, it is the unexpected or less expected events that can have the most profound influences on situations. So unless you come to terms with that, I do not think you will find any of the input useful.
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Joined: 19 Sep 2012

Re: Traditional 401k vs. Roth 401kby billfromct » Sun Feb 16, 2014 4:17 pm

I would use (for myself or if I was advising my kids) the following guide lines based on age & marginal tax rate
-under 30, Roth 401K (all tax brackets because you have 35-40 years of tax free compounding & ultimate tax free withdrawal)
-30 to 40, Roth 401K if 25% & lower tax bracket (you still have 25-35 years of tax free compounding & ultimate tax free withdrawal), Traditional 401K if 28% tax bracket & higher
-40 & older, Traditional 401K
bill
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Re: Traditional 401k vs. Roth 401kby fungus_amungus » Sun Feb 16, 2014 4:34 pm

For me the decision was mostly pension related. My wife will receive a pension that will fill the lower tax brackets by itself and push us into 15% without an extra dime. We will also likely receive a significant windfall at some point. We are currently in the 15% bracket so it makes sense for me to go ahead and pay the tax man and go Roth
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Re: Traditional 401k vs. Roth 401kby retiredjg » Sun Feb 16, 2014 4:48 pm

fungus_amungus wrote:For me the decision was mostly pension related. My wife will receive a pension that will fill the lower tax brackets by itself and push us into 15% without an extra dime. We will also likely receive a significant windfall at some point. We are currently in the 15% bracket so it makes sense for me to go ahead and pay the tax man and go Roth
You have 2 independent factors that argue FOR using Roth now.
  • First is the pension which will fill much of your lower brackets.
Second is getting money into Roth at only 15%.
Even if/when you move into the 25% bracket, you might want to continue to put some money into Roth 401k, in my opinion. But I would use some traditional as well so you'll have money in retirement to finish filling the 15% bracket. Yes, I know it won't be exactly the same then, but you get the idea.
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Joined: 10 Jan 2008

Re: Traditional 401k vs. Roth 401kby fungus_amungus » Sun Feb 16, 2014 5:45 pm

retiredjg wrote:
fungus_amungus wrote:For me the decision was mostly pension related. My wife will receive a pension that will fill the lower tax brackets by itself and push us into 15% without an extra dime. We will also likely receive a significant windfall at some point. We are currently in the 15% bracket so it makes sense for me to go ahead and pay the tax man and go Roth
You have 2 independent factors that argue FOR using Roth now.
  • First is the pension which will fill much of your lower brackets.
Second is getting money into Roth at only 15%.
Even if/when you move into the 25% bracket, you might want to continue to put some money into Roth 401k, in my opinion. But I would use some traditional as well so you'll have money in retirement to finish filling the 15% bracket. Yes, I know it won't be exactly the same then, but you get the idea.



I don't want to hijack the topic but I did have a question here.


Because I have a taxable account and plan to take advantage of tax gain harvesting given my 15% tax bracket and thus no federal capital gains tax, I'm guessing it would benefit me to scale my Roth contributions to traditional to stay in the 15% bracket given increases in income over time right?
For instance in 2013 numbers, I would start going traditional when our combined gross income exceeds 72500 + 12200 standard deduction + 3900 exemption (me) + 3900 exemption (wife) + 3900 exemption (daughter) + 1000 child tax credit = $97400 in order to maintain this capital gains federal exemption right? Or have I missed something with regards to how the federal brackets are calculated?
Edit: By the way, thanks to livesoft for making me aware of tax gain harvesting yesterday. It's going to be tricky because I live in Tennessee have to keep capital gains and dividends under $2500 before getting taxed, but I do have a bit of wiggle room anyway.
Last edited by fungus_amungus on Sun Feb 16, 2014 6:01 pm, edited 1 time in total.
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Re: Traditional 401k vs. Roth 401kby grabiner » Sun Feb 16, 2014 5:51 pm

livesoft wrote:I guess I will try to throw a wrench into this.
It is not a "traditional 401(k) vs Roth 401(k)" decision. It is a "Traditional 401(k) + taxable investments vs Roth 401(k)" decision.



And with that situation, the Roth 401(k) is better if your marginal tax rate is the same as it will be in retirement, but still worse if your marginal tax rate is significantly higher. (Note "marginal tax rate", not "tax bracket"; if you are in the phase-out of the child tax credit, your tax bracket is 25% but the child tax credit phases out at 5%, giving you a total marginal rate of 30%.)

If your marginal rate is only 25%, the Roth is likely to be better, as you will likely either retire in the 25% bracket, or in the 15% bracket with the phase-in of taxable Social Security giving you a 27.75% marginal tax rate. (Still better would be to convert to a traditional 401(k) at 25% deduction, and then convert some of it to a Roth at 15% before you start taking Social Security; this would apply if you expect to retire before taking Social Security and won't be filling up the 15% bracket with 401(k) withdrawals in those years.) David Grabiner
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