Let me just state for the record, “I hate taxes.” I hate federal income tax, sales tax, property taxes, state taxes, local taxes, school taxes…. Well, I think you get the picture. It’s not so much that I hate the services provided by paying taxes, I just hate thinking about all the things I may want to save for or buy instead.
As much as I despise taxes, I really hate to hear people make the same stupid tax reduction mistakes over and over. I want to expose the five that I come across most often, and give an explanation why these stink.
Stupid Idea #1: Getting a mortgage for the tax deduction
It is true that most home owners can deduct the mortgage interest on their homes. This is one of the biggest and best tax deductions, and also helps reduce your taxable income too. Going into debt for a home just for the tax deduction is equivalent to paying the bank a dollar to get a quarter back.
So if you are close to retirement and have 10 years left on a 30 year mortgage, it makes more sense to pay off this debt. The deduction you are getting is relatively small in todays low interest rate environment. Provided you have the liquidity.
Don’t get a mortgage just for the tax deduction, it’s stupid.
Stupid Idea #2: Not Selling a Stock because of capital gains
Unfortunately, I hear this one all the time. To begin with, you should have a predetermined buy and sell strategy with every single individual stock you purchase. Otherwise, you will allow emotion to decide when to pull the trigger.
Even worse than emotion, is allowing your tax hit to deter you from moving on. So often, investors will not sell because of capital gains, only to see those gains evaporate! The whole point of investing is to make money-not to avoid taxes.
Don’t hold an investment just to avoid the taxes, it’s really stupid.
Stupid Idea #3: Buying an investment to lower your taxes
Back in the 80s the hottest tax reduction investment was the limited partnership. Thousands of investors bought these so they could get a tax loss and a deduction, and somehow they still managed to make some money. Well the tax code changed and people lost lots of money.
Today annuities and municipal bonds are sold with the intent to reduce your taxable income. I think any investment has it’s rightful place in a portfolio. Both annuities and muni bonds will be suitable for high income earners in the upper tax brackets. My point here is:
Never buy an investment with the sole intent to lower your taxes, it’s really, really stupid.
Stupid Idea #4: Getting a large tax refund
I know that getting that large refund at tax time is exciting. You get to decide what you want to buy with the new windfall! However, it shouldn’t be used as a forced savings vehicle. The point is not to give Uncle Sam an interest free loan for the windfall at tax time.
In addition, you should not judge your accountant’s performance by the size of the refund he got you. That could be a recipe for disaster. So even if you have a mistake on the return, guess what? You are still responsible for the mistakes and the penalties.
Adjust your withholdings so you don’t write or receive a big check at tax time, it’s moderately stupid.
Stupid Idea #5: Filing your own taxes
I’m a financial advisor. I believe in the value of advice. So I’m going to be a little biased here. As complicated as the tax code is, fancy software or low-cost tax preparation services probably won’t cut it. However, if your tax situation is fairly simple you may want to consider one of these options.
In my personal situation, I can tell you my accountant is worth his weight in gold. He has helped me better understand not only my own situation, but the tax code itself. So it might be a good idea to consider a professional for something this important.
Don’t prepare your own taxes, it’s stupid, and could be costly.
If you would like help with tax reduction strategies, write me at firstname.lastname@example.org, or call me at (859) 225-2596.