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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.

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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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SanLouisKid
SanLouisKid
2 months ago

This is an excellent list to work from. I could have used this, but I probably couldn’t have absorbed it all at once. Like golf, you can take a lesson with a lot of good pointers, but it takes a while (at least for me) to coordinate and put everything in practice. Hopefully Aron will visit again, several times, with his “coach” for a little reinforcement.

Matt White
Matt White
2 months ago
Reply to  SanLouisKid

You’re right—too much to process all at once. I tend to think in frameworks and wanted to try to put one together for Aron. I hope the article will serve as a good reference and spark many more conversations.

wtfwjtd
wtfwjtd
2 months ago

Great list Matt! I would also recommend for #10, to have a separate credit card that is set aside for the mostly exclusive use of business expenses. I know the Dave Ramsey types will hate me for saying this, but a separate credit card used for business expenses can really streamline the record-keeping process, and as a small business owner (especially a sole proprietor!) you need any edge you can get. Use it responsibly, and it will become one of your best friends when it comes to tax time.

Matt White
Matt White
2 months ago
Reply to  wtfwjtd

Thank you! Yes, I have personally found a business credit card to be a record-keeping help as well. Just have to condition yourself to think of it same as a cash expenditure.

Harry Crawford
Harry Crawford
2 months ago

In response to DrLefty’s comment, I also use EFTPS to make the estimated tax payments electronically. The only difference is I set up all 4 estimated payments at once. I calculate my total estimated tax, divide by 4 and set all 4 payments up at the same time. You can always go in and amend any or all of them if they haven’t been taken out of your bank account yet. I love EFTPS for its convenience and simplicity. It’s one of the best government websites for ease of use.

Matt White
Matt White
2 months ago
Reply to  Harry Crawford

Thanks for reading, Harry. I can see why a lot of people like the EFTPS. I left some additional thoughts in response to DrLefty’s comment.

Michael1
Michael1
2 months ago

This is a great article Matt.

Perhaps you can clarify something for me. From item 8:

“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.”

Is it not correct that if you have any regular withholding, then all payments made to the IRS, regardless of when they’re made, are considered to have been made throughout the year?

Matt White
Matt White
2 months ago
Reply to  Michael1

Thank you, Michael! And thanks for following up, Jonathan.

Last edited 2 months ago by Matt White
Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  Michael1

That’s correct. If you’re behind on your annual tax payments, you could still face penalties if you make a large fourth-quarter estimated tax payment. But if you have the option to increase your withholding on a paycheck received from an employer, you may be able to avoid a tax penalty for underpayment.

https://humbledollar.com/2018/02/rendering-unto-caesar/

Last edited 2 months ago by Jonathan Clements
Michael1
Michael1
2 months ago

Thanks Jonathan. Actually I think my understanding was wrong.

To illustrate, let’s say I have a small part time or pension that has regular withholding. Let’s also say I have a larger pension, and also receive dividends, realize capital gains and make Roth conversions every quarter with no withholding, and I only make one large estimated payment at the end of the year.

I said that because of ANY withholding throughout the year, ALL payments (whether through withholding or a check(s), whenever written) would be considered to have been made throughout the year.

The article and your response suggest this isn’t correct. I understand the point about increasing withholding, but assume the income/potential withholding from the job is too small to cover the required payments. The additional payment would have to be by writing a check.

If I now understand fully, it seems it would be accurate to say that if you have any regular withholding, then any WITHHOLDING (but not any PAYMENT) is considered to have been made through the year. But small regular withholding plus one big check in 4Q isn’t going to cut it.

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  Michael1

Exactly!

Humble Reader
Humble Reader
2 months ago

As someone who has moved between full-time employment, full-time self-employment, and most often a mixture, I would add to #20 the opening of and funding multiple types of retirement and investment accounts. If mostly self-employed the miserly contribution limit allowed for a standard IRA or Roth IRA will adversely impact tax-advantaged retirement savings rates. Having a SEP-IRA or one of the other individual plans allows savings at a rate comparable to what is possible with a 401(k). We currently fund a 401(k) from my employment income, a SEP-IRA from my self-employment side-gigs, an IRA for myself, and a spousal-IRA, as well as a normal brokerage account.

An additional point I would add for someone who does some or all self-employment is to understand how to accurately compare compensation rates between normal-employment and self-employment. Even HR professionals often do not understand how to do this comparison. And there is a difference between what a benefit costs an employer and what value it may have to you. After working on contract for more than 10 years for the same company, and twice turning down employment offers, a third notably generous offer from my current employer finally brought me in from the wild, as least until I retire.

Matt White
Matt White
2 months ago
Reply to  Humble Reader

Appreciate your comments and helpful thoughts! A solo 401(k) can be another good one for a sole proprietor in the right situation.

True, the benefits are a key component—as well as the fact that employers pay half of their employees’ Social Security and Medicare tax. I’m glad to hear you found a good situation that was worth making the change!

DrLefty
DrLefty
2 months ago

This is a great article, but I’ll quibble a bit with the advice to send estimated tax payments via snail mail. I’ve been paying them every quarter for some years and have always done them online.I set them up for every quarter at least 7-10 days before the deadline. The interface is easy to use, it’s automated for me so I won’t forget, and I’ve never had a problem, not once. I always save the online receipts as PDFs in my taxes file, and I get an annual paper statement from the IRS.

Matt White
Matt White
2 months ago
Reply to  DrLefty

I am glad the EFTPS works well for you. I can see the appeal. For quarterly estimated tax payments, there is just something I like about being the one that gets to control pushing the money out rather than attaching my bank account. The date of the postmark is considered the date of the payment, so there is no worry about being late if the check gets lost in the mail or at the IRS.

wtfwjtd
wtfwjtd
2 months ago
Reply to  DrLefty

Yes! I would never advise sending a check to the IRS; use the IRS’s EFTPS instead. It’s rock-solid reliable, and you can even schedule a few quarterly payments in advance if you like. It’s much easier and faster, and no worries about lost-in-the-mail checks, or the IRS “misplacing” your payment.

Last edited 2 months ago by wtfwjtd
Rick Connor
Rick Connor
2 months ago

Great article, Matt. Aron is lucky to have you as a friend. It sounds like he is off to a great start.

Your list for self-employed individuals is a great primer. I came to self-employment late in my career and wish I’d had it to guide me.

I’d be interested to know if you discussed budgeting, or how to automate savings. Automating savings and living with the remainder (The Dick Quinn rule!) is one of my first pieces of advice to younger friends.

I also want to say it’s great to read articles targeted for younger people. I wish I had learned a lot more about finances in my twenties.

Matt White
Matt White
2 months ago
Reply to  Rick Connor

I really appreciate that, Rick! Aron and his family have been a great blessing to me. It’s fun to see him take off professionally and care enough to ask me for help with his finances.

Yes, I’m right with you on that. It’s critical to start an early habit of automating savings—and giving—and spending what’s left. It’s so hard to change habits that are entrenched deeply. Starting out on the right track can prevent so much strife.

Edmund Marsh
Edmund Marsh
2 months ago

Great list, Matt. I’m sure you also included #22–make HumbleDollar a part of his regular reading.

Matt White
Matt White
2 months ago
Reply to  Edmund Marsh

Put that one at the top of the list!

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