Announcer:
It’s time now on KROS for Financial Focus, brought to you by NelsonCorp Wealth Management. The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representative securities offered through Cambridge Investment Research Incorporated, a broker dealer, member FINRA, SIPC. Investment advisor representative, Cambridge Investment Research Advisors Incorporated. A registered investment advisor, Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. Now here’s today’s Financial Focus Program.
Nate Kreinbrink:
Good morning and welcome to this week’s Financial Focus brought to you each and every Wednesday morning right here on KROS. Well, this is Nate Kreinbrink. I have Andy Ferguson joining me today. I was just telling you there has been five Wednesdays in July and this is the last one.
Andy Fergurson:
Yeah, but if you’re going to have a month that has five Wednesdays, might as well be July, right?
Nate Kreinbrink:
Might as well be July.
Andy Fergurson:
We don’t want those five Wednesdays in March.
Nate Kreinbrink:
No.
Andy Fergurson:
That’s no good.
Nate Kreinbrink:
No, because then you’re busy.
Andy Fergurson:
You got to do five Wednesdays by yourself.
Nate Kreinbrink:
No, but it is hard to say that it is the last Wednesday in July. We will flip that calendar over to August and …
Andy Fergurson:
That seems really fast.
Nate Kreinbrink:
It does seem really fast. And I say it every year, years go by faster. You hit that 4th of July weekend and next thing you know, you’re here.
Andy Fergurson:
Yeah. You hit the nitrous on summer and it’s gone. Yeah, that means three weeks till school starts.
Nate Kreinbrink:
I’ve been seeing school supply lists really pop up a lot.
Andy Fergurson:
Well, they come out in May now anymore. I mean …
Nate Kreinbrink:
Yeah.
Andy Fergurson:
It’s the next holiday for Walmart so you got to get the school supply list out.
Nate Kreinbrink:
Yes, it is. It is flying by. I know Iowa at least, I think, this week for a lot of the schools is kind of that rest week, I guess you would say, where really no activities planned. So enjoy it. Take it all in. It’s kind of pleasant out there. It’s not 136 outside there.
Andy Fergurson:
Yeah, it’s not super hot. Yeah, it’s been good. And we talk about rest week. I feel like I got a lot of stuff to do during rest week, but at least it’s not football or baseball or cross country or any of those things happening.
Nate Kreinbrink:
Those Will be kicking off. I think a lot of area schools have football camps, I think, next week ….
Andy Fergurson:
Yeah, I think we start running …
Nate Kreinbrink:
Starting that first week of August or whatever, volleyball, fall sports with everything. Fall golf for I think bigger schools, I think, do.
Andy Fergurson:
We got tennis, I think, too this year. Yeah.
Nate Kreinbrink:
It’s coming. It’s going to get hot and heavy switching to that next season. Enjoy it. Enjoy what’s left of the summer.
Andy Fergurson:
Yeah, but I love the fall sports. I feel like it’s a great time in high school, the fall season, all that stuff happening at the same time. It’s a good time. It’s exciting and fun to get everybody back to school, get a new season started.
Nate Kreinbrink:
And it is. It’s kind of like we say that with opening day with baseball, right? Everyone’s excited. It’s a new season. Everyone’s in first place, whatever. It’s a new school year. You’re a grade older. It’s that anticipation for that first day, I guess is …
Andy Fergurson:
Well, and when you’re young, it’s how you measure your life, right? I’m old now and I measure my life in tax seasons, but my kids measure their lives in school years. And so they get a new opportunity to go out and excel and it’s an exciting time for everybody.
Nate Kreinbrink:
Well, and again, we talked a little bit about this last week and with Andy here I definitely want to utilize that time and talk a little tax topics. And one thing that you had that came up was, again, something we’ve talked about in other weeks and that’s letters coming out.
Andy Fergurson:
Yep.
Nate Kreinbrink:
But most notably, there’s a new one for those residents of Illinois with this letter that they’ve been receiving.
Andy Fergurson:
Yeah. It’s not necessarily a new letter, but yeah, this week or maybe the last couple of weeks, we’ve seen Illinois send out their penalty letters. And so what a lot of the penalties are that people are experiencing is the failure to prepay tax penalty. And that’s an interesting concept to them because people don’t understand how the law works there. If you have more than $1,000 due to the state of Illinois, and it might be $500, but if you have a balance due to the state of Illinois and you haven’t prepaid that balance … So the way you prepay is withholding or estimates. If you haven’t prepaid that balance and it exceeds the threshold, the state of Illinois, under the Illinois Constitution, has the right to charge you a failure to prepay penalty. It’s not interest. You’re not in trouble because you paid your tax late. You are getting a penalty because you didn’t pay it early, which is an interesting concept. And people are like, “How is that fair? That doesn’t work.” Well, the federal government does it too. The federal government will charge you a penalty if you don’t pay your taxes early.
Nate Kreinbrink:
If you owe above a certain amount.
Andy Fergurson:
If you owe above a certain amount. If you have a refund, there’s no concern about it. Or if you are close, meaning you don’t owe them more than $1,000 at the end of the year, they don’t care when you pay them. But they don’t want people to hold their money until tax day because the government needs money all year round. And so to keep people, especially large earners, you think about if you were somebody who paid $100,000 in tax, if you held that money for the whole year, you could make $5,000, $6,000, $7,000 on that money sometimes. Well, they don’t want you holding that money. They want you paying that money as you go so that they can fund the government, things that need to be funded. And so the law is written in a way that you can be charged a failure to prepay penalty.
We talk about it every year with people who owe money and we talk about making estimates and the common statement from people is, “I don’t want to pay any earlier than I have to.” And we try to explain to them, “Okay. Well, you may incur a small penalty for not doing that,” but then they forget about that conversation. And then when they get their letter in July and they’re like, “What is happening? Why do I owe 43 more dollars? I already paid them $3,600. Why do I owe more money?” And the answer is because you didn’t pay early. You’re not in trouble. You didn’t pay late. You didn’t pay early and that’s the problem. You have to pay early and on time.
Nate Kreinbrink:
And I think that all comes back to, again, how do you know that? Well, it’s planning. It’s understanding kind of where you were at last year, what income looks like for this current year, and what you are withholding.
Andy Fergurson:
Yeah. It is. It’s planning and strategy. Of course, sometimes it’s worth it to pay the penalty. And if you know the way the penalty is calculated, the penalty is calculated based on the previous year’s tax and this year’s tax. And you’re required to pay either 100% or 110% of the previous year’s tax or 90% of the current year tax. Well, you never really know what your current year tax is going to be because if you have investments or if you have income, overtime, things like that, you don’t really know where your tax is going to be, but it’s based on the previous year as well. And so estimates then basically don’t estimate your tax for the current year.
Nate Kreinbrink:
Right.
Andy Fergurson:
What they do is they pay enough of the tax to cover that requirement that the previous year is based on so that you don’t get the penalty. And so I have people all the time who will make estimated payments and will come back and they still owe $3,000 or $4,000 and they’re like, “Well, what did the estimates do?” Well, the estimates eliminated the penalty that would’ve existed on that $3,000 or $5,000. And so yeah, there’s some strategy behind when you do it. And the other thing is because it’s based on the previous year, if you didn’t have tax the previous year, well, 110% of zero is zero. So there is no requirement for you to prepay. It’s when you had a tax the previous year and then you didn’t prepay or cover that tax.
And so people don’t really experience it until they get into the point where the majority or a lot of their income is coming from investment income or things that don’t normally have withholding on it, maybe business income. Because when you’re an employee, you have withholding. That withholding is usually keeping pace enough to keep you from paying the penalty. And so people don’t experience it until they start to have, like I said, business income, rent income, investment income, things like that that nobody’s withholding on because withholding counts as that prepayment.
Nate Kreinbrink:
Well, and I think, too, when you start thinking about that, when you start understanding and kind of breaking down a tax return, it’s understanding the type of tax too that you are paying.
Andy Fergurson:
Sure.
Nate Kreinbrink:
And when you think about that, people are like, “Well, different types of taxes, what is that?”
Andy Fergurson:
Yeah.
Nate Kreinbrink:
And again, when we do it, we’re looking at is this a ordinary income, which people are most familiar with and then what you see …
Andy Fergurson:
Right.
Nate Kreinbrink:
Or is it a capital gains tax? Or can we get this tax down into that capital gains line, preferably long-term capital gains, and seeing how that benefits you?
Andy Fergurson:
Yeah, capital gains is a hard concept for people to grasp because of the way we use it. There’s short-term capital gains and there’s long-term capital gains, but only long-term capital gains get treated with capital gain as capital gain income. Short-term capital gains are treated as ordinary income. And so the difference is the brackets. So ordinary income follows the same bracket that your wages do, right? The 10%, 12%, 22%, 24% bracket. Capital gains follow a different bracket structure and they’re always advantageous to ordinary income. So I have people all the time that are worried. They’re like, “Well, I don’t want to realize this capital gain,” and I have to remind them capital gains is better income. If you can get capital gains instead of ordinary income, you’re getting an advantage on your tax return. And the more money you make or the higher you are in the brackets in the ordinary income brackets, the more advantageous the capital gain is.
And so you think about what is the difference there. Well, the difference between $7,000 of interest from a CD versus $7,000 of long-term capital gain, depending on your other income levels, well, the capital gain may be at 0%. The interest may be at 22%.
Nate Kreinbrink:
Right.
Andy Fergurson:
Right? Or 19%. And so it definitely matters which way you go. And so that, again, comes into strategy. What kind of income do we want to realize? Do we want to realize some of this capital gain or do we want to realize ordinary income? And when you get to the point where your income isn’t all coming from your wages, it’s a good time to start strategizing that. And that’s what we do all the time when we’re looking at people who are on social security and pensions and retirement income, and then who also have investment income. What kind of income do we want to realize?
Nate Kreinbrink:
Right. And I think, too, people just understanding that. You mentioned banks or CDs or things like that. And that’s where a lot of that kind of common question comes in, where they’re comfortable with those CDs and the interest from those where they’re paying ordinary income on it, but when you look at what it would change by getting that to capital gains. And kind of the general rule of thumb is if you’re in the 12% bracket or lower, you’re probably playing a 0% long-term capital gains rate.
Andy Fergurson:
Right.
Nate Kreinbrink:
And again, that’s zero. You can’t get lower than zero. So again, if you have some of those, like you said, looking at it, realizing possibly some of those gains in a year where you don’t necessarily need to realize it, but filling up that 0% bracket and resetting that cost basis now for the future …
Andy Fergurson:
Right.
Nate Kreinbrink:
Puts you in a much better spot to move forward.
Andy Fergurson:
And it gives you an opportunity to compare them a little bit differently. When you have income from capital gains and you look at the rate of return that you get on an investment, you can’t compare that to a flat rate that you get on a return when that return is interest. Because of the cost of tax on that interest income versus the cost of capital gains on the other income, the rates aren’t exactly the same. Sometimes that rate that you’re getting from your bank interest may be effectively half of what it really is because of the tax you’re paying.
Nate Kreinbrink:
Right. And people don’t understand that because they don’t see the tax on those type of things. It just shows up …
Andy Fergurson:
Right.
Nate Kreinbrink:
On your tax return. So they don’t put that together to say, “Well, that tax is because of that.”
Andy Fergurson:
Yeah, and they think, “Well, I’m getting 5% at the bank and I’m getting 3% on my investments. I should take the 5%.” Well, depending on where their income is, that 5% that they’re getting on the bank may really be 2.5% because of the cost of the tax.
Nate Kreinbrink:
So it’s all stuff. Give us a call. We’d be happy to kind of walk through this individually with you, look over your tax return. Do want to mention real quick though that the charity for the month of July that we are featuring is the Big Brothers Big Sisters Over the Edge for Kids’ Sake Event. Again, this is Nate and Andy bringing you this week’s Financial Focus. Thanks for tuning in and have a great rest of your week.
Announcer:
Financial Focus is a production of NelsonCorp Wealth Management in Clinton and Davenport. The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representative securities offered through Cambridge Investment Research Incorporated, a broker dealer, member FINRA, SIPC. Investment advisor representative, Cambridge Investment Research Advisors Incorporated. A registered investment advisor, Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. For more information, visit our website at www.nelsoncorp.com.