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Wiser in 21 Ways

Matt C. White

WHEN I MET ARON FOR dinner, the occasion marked a milestone for both of us. Aron had earned his bachelor’s degree in audio production in 2020—during the thick of the pandemic—and finding his place in the industry had been more difficult than he’d hoped.

Now that things were finally falling into place, Aron approached me for help with his finances. In particular, he wanted to understand his tax situation, which had grown into a mixture of self-employed contract work and part-time employment.

I’ve known Aron since my wife Sarah began babysitting for the family when she and I were dating in college. Aron’s parents took in Sarah and me as part of the family. They’re our treasured friends and mentors.

We’ve watched Aron and his two siblings grow up. To have him ask for financial advice meant a lot. I felt thankful for our enduring friendship—and a little bit old—but mostly thankful.

In the few hours we spent together, I covered as much ground as possible—in between bites and catching up, of course. Later, I asked Aron if he would mind if I summarized our discussion for HumbleDollar readers. He gave me the green light. Here are the 21 items we discussed—10 about taxes and 11 about investing. We started with taxes:

1. Big Picture. Both your self-employment income and your wages end up in the same place on your tax return—the taxable income line. Know the No. 1 tax return equation: taxable income x tax rate = total tax. Then No. 2: total tax – tax credits and previous payments = taxes owed or refunded.

2. One Schedule C. Even if you’re doing projects for several clients, think of your consulting work as one business. When you file your tax return, total up all of your business income and deductions on a single Schedule C.

3. Business deductions. These aren’t about being clever. Rather, you just have to keep organized records. Does the purchase have a business purpose? If so, you can probably deduct it.

4. Writeoffs. If you can deduct a business expense, it’s effectively a discount. That doesn’t mean it’s free. The discount percentage typically equals your marginal tax rate—anywhere from 10% to 37%, depending on your taxable income. Don’t spend money just because you get a discount. Instead, spend if it helps your business.

5. Tax brackets. This is how you know the tax rate that applies to your next dollar of income. You can look up your tax bracket here if you know your filing status—such as single or married filing jointly—and your amount of taxable income. The higher your income, the greater your tax rate.

6. Self-employment tax. This is the Social Security and Medicare tax. When you’re an employee, your employer foots half the bill and your half is withheld from your paycheck before you ever see it. But if you’re your own employer, it’s your responsibility to set aside the cash to pay both halves. At least the 15.3% tax is assessed not on every dollar you earn but on your net self-employment income after deductions. And you do get to deduct the employer half of the self-employment taxes that you pay.

7. Extra payments. When you earn wages as an employee, you make tax payments through withholding from every paycheck. When you’re self-employed, you make quarterly payments to cover both income tax and self-employment tax. The due dates are April 15, June 15, Sept. 15, and Jan. 15 of the next year. My suggestion: Go old school and mail a check along with an estimated tax voucher. Be sure to use certified mail so you can prove you sent it on time. The IRS’s website offers electronic payment options, but you might incur extra fees or frustrating issues—like a planned outage on a payment due date.

8. Underpayment penalty. You’ll avoid this unnecessary cost if you send timely payments covering at least 90% of what your total tax turns out to be—or 100% of the prior year’s total tax figure. Make that 110% if you’re a high-income earner. The penalty is a 6% annual rate of the amount you owe, compounded daily until you pay the shortfall. If you find yourself behind, increase the withholding on your paycheck from fulltime or part-time employment. It’s a magic way to make a fourth-quarter payment count as if it had been paid one-fourth in each quarter.

9. IRS tax calculator. If you think you need to make estimated tax payments, how do you know how much to pay? Hiring a tax professional would help, but otherwise try the IRS’s Tax Withholding Estimator. Answer its detailed questions and it’ll do the calculation for you. Just remember, the output’s accuracy depends on the input’s accuracy. The calculator is designed to tell you how much tax to have withheld from your pay by an employer, but the results are detailed enough to use to determine your estimated tax payments, too.

10. Separate business bank account. Open one and run all business-related deposits, withdrawals, income and expenses through it. For the sake of record keeping and good business governance, don’t mix personal and business transactions.

At this point, our conversation turned to investing.

11. Red flags. When you come across someone who claims to have exclusive insights that’ll bring investing windfalls, don’t listen. Take your money lessons from a teacher who’s thoughtful, objective, thorough and humble.

12. Risk. It’s impossible to avoid risk when investing. Instead of always seeking to minimize risk, aim to manage it wisely.

13. Volatility. Markets will go up and down—sometimes sharply. Don’t let that surprise or discourage you. When markets are down, you get to invest at clearance sale prices. Keep investing when markets are up, too—because you won’t know when “up” and “down” happened except in hindsight.

14. Types of assets. There are essentially three: cash, bonds and stocks. Yes, there are alternatives, but you should keep most of your money in these three, and perhaps all of it. Cash—think checking and savings accounts, savings bonds and certificates of deposit—is most likely to preserve value but won’t earn much return. Stocks pose the greatest risk of quickly losing value but also have the best potential for high long-run performance. Bonds are in the middle.

15. Diversification. Manage market volatility by spreading your investments among both stocks and bonds, and by owning large numbers of securities within these two categories. When one asset class goes down, the other should be going up—or at least going down less.

16. Funds. Rather than buying individual stocks and bonds, buy shares of a mutual fund or exchange-traded fund that holds a portfolio of them. This is the simplest and most effective way to eliminate the risk that a single bad stock or bond could cause you big losses.

17. Investment philosophies. There are essentially two: active and passive. You could buy an actively managed fund that attempts to use knowledge and intuition to outdo the market’s average return. You’ll win some, you’ll lose some, but this way will always be more expensive. Alternatively, you could buy a passively managed index fund that aims to earn the market average while incurring lower costs.

18. Time horizon. Ask yourself this question before every investment decision: How long will it be until I withdraw my money? If you’ll need part of your money within five years, keep it in cash.

19. Long-term investing. A long time horizon is an investor’s best friend. When you have it, you don’t need to care about the market’s short-term volatility, so give your money its best chance to grow by favoring stocks. Remember, if you don’t at least outpace inflation, you’re losing ground. Long-term investors can also earn compounded returns. Check out the math; it’ll inspire you.

20. Types of accounts. Before you choose what investment fund to buy, you’ll need to choose which type of account to use. At the highest level, there are two choices: a regular investment account which is taxed every year, or a retirement account—like a 401(k) or IRA—which gives you tax benefits but where you typically need to keep the money invested until age 59½.

21. Long-term investment tax rates. Even if you hold investments in a regular taxable account, you’ll get a special low tax rate not only on qualified dividend income, but also on long-term capital gains—provided you own the investments for at least a year and a day. This tax rate can even be 0% if your taxable income is low enough. It’s another reward for taking a long-term approach to investing.

After sharing so much with Aron, I wanted to recommend one action that he could take as soon as we parted ways. My suggestion: Open a Roth IRA and start investing regularly. Getting started by making investing a habit and giving your money time to compound—those are slam dunks.

I later visited Aron, and he gave me a tour of his audio production studio. He’d assembled an impressive collection of cool equipment. Even cooler: He told me about how he had documented his spending to take business tax deductions—and about his new Roth IRA.

Matt Christopher White is a CPA and CFP® who writes about money and apprenticeship to Jesus. He’s the author of “How to Love Money: Four Paradoxes that Breathe Life into Your Finances,” available at MattChristopherWhite.com. Matt is equally comfortable talking about Luke 6:43, Section 643 of the Internal Revenue Code and the 6-4-3 double play. There’s no place he’d rather be than with Sarah and their two girls, Lydia and Eliza, at their home in the foothills of the Smoky Mountains. Follow Matt on Twitter @WriteMattWhite and check out his earlier articles.

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