Tax Return Mini Topic – Estimated Income Tax

Las Vegas, Nevada, 2009

We have already gotten our federal tax refund back due to ease of filing online (woohoo!). For details on how to prepare for annual tax filings, see my post here.

One item that people can miss when they file their annual tax return is the estimated tax they owe to the Uncle Sam, which must be paid every quarter throughout the year. Salaried employees typically get taxes deducted from their paychecks based on their filing status, number of dependents, and a few other factors. If you have significant income (whether from salary or other sources), it is possible you are underpaying your tax from these deductions from your paychecks. The IRS requires you to make up for the difference via estimated taxes.

For the 2016 tax year, we have paid approximately $32,000 in estimated taxes and for 2017 tax year, we will be paying close to $40,000.

When you file your tax return, pay special attention to 1040-ES vouchers if you are using tax filing software such as TurboTax (or a tax accountant for that matter). There are four of these vouchers and you need to send IRS additional checks of equal amounts on 4/18/17, 6/16/17, 9/15/17, and 1/16/18. If you don’t pay these estimated tax amounts, you may be incurring an underpayment penalty on your tax return the next time you file tax (by April 2018). I would recommend putting in calendar reminders a few weeks prior to the four deadlines to make sure you are sending your checks in. If you filing using TurboTax, the estimated tax amounts and deadline are also on the cover page with the instructions. The penalty amount is significantly higher than any interest you might get from delaying a payment to the IRS, so it would make economic sense to pay for this early rather than incurring the penalty.

Another TurboTax Filing Tip

Recall from my last tax post (link) that we used TurboTax to file our return. We are also helping one of our relatives with their tax filing and were using the same CD. Although the CD can be shared, each installation only comes with a single state return. As our relatives live in another state, TurboTax wanted to charge us $60 for the second state. A workaround would be to install the CD on another computer; this way, we were able to get the reduced price of $20 for E-filing the state return (or $0 for paper filing).

Getting Organized for Tax Season

Lima, Peru, 2011

The deadline to file for individual income tax returns is less than one month away. The annual tax filing season is exciting for those who are expecting a big refund check and dreadful for those who are sending a sizable check to Uncle Sam. For everyone, filing the annual tax return is a time-consuming process. According to the IRS, the average American spends 13 hours on filing taxes; those who are filing the full 1040 form spend 16 hours on average.

Not only is tax filing time-consuming, income tax is also the single highest annual expense for most of us. To illustrate, based on our 2015 family tax return as a married couple, we paid 26.5% of our income in federal taxes, 2.0% in Medicare taxes, 2.3% in Social Security taxes, and 5.0% in state taxes (two states combined), for a hefty 35.8% in total taxes. For 2016, we paid 24.7% of our income in federal taxes, 2.0% in Medicare taxes, and 2.5% in Social Security taxes, and 4.8% in state taxes (one state), for a total of 34.0%. Optimally filing your return can have a meaningful impact on your tax refund and personal financial position. In order to maximize your wealth, it is crucial to minimize your taxes through all legal means.

In this post, I will help you organize your tax documents. Even if you are using a professional tax preparer, it is important to understand the tax return components. Don’t expect tax preparer to cover all the basis. They ask you the typical questions but don’t know all the details of your life. You should be the one that covers everything and pass on all relevant information to your tax preparer. A tax preparation software such as TurboTax typically walks you through the steps, but I always use my own Excel spreadsheet as a check and guide.

Form 1040

There are different versions of form 1040, the IRS form used to file individual taxes. Form 1040 is the most comprehensive form, whereas forms1040EZ, 1040A, and other variations are shorter forms that can save you some time but you will likely miss some meaningful deductions. I recommend using the full 1040 form to make sure all components are captured to minimize your taxes due and maximize your refund.

Machu Picchu, Peru, 2011

Tax Return Components

When I think of my tax return, I put all my documents and calculations into the following categories.

1. Employment & Unemployment Income – My Excel file outlines both my spouse’s and my income & tax components:

  • Gross income
  • Federal tax
  • State tax
  • Medicare and social security tax

Employment income

If you are a salaried employee, your W-2 will show your total and taxable income. Note that your income contributed to your employer-sponsored pre-tax 401k retirement plan is not taxable in the tax year (but taxable upon withdrawal). If financially possible, I recommend maxing out your contribution at the $18,000 per year limit.

Unemployment income 

If you are unemployed any part of the year and received income from the state (via unemployment insurance), you will receive a 1099-G, showing the amount of unemployment income received as well as the amount of federal and state taxes paid.

Self-employment (e.g. commission income) as independent contractors

Even though this is an income component, I typically address this separately due to the need to aggregate both income and expenses. I have a separate tab in my Excel tax file to organize business expenses. I will do another post just on self-employment tax deductions.

2. Other Income

  • Interest (e.g. interest earned from savings & checking accounts, checking account opening bonuses, etc.) – Most banks will mail out 1099-INT forms. Income from this category can be meaningful. Last year, we have received approximately $2,600 from bank interests and checking account opening bonuses.
  • Stock dividends and bond interests – brokerage firms typically provide 1099-DIV or 1099-Composite forms.
  • Stock and bonds gain or loss on sale (short term vs long term)

3. Income (or gain) from sale from real estate (e.g. sale of your primary residence) – I recommend keeping good documentation from your HUD closing statement during your initial purchase. In addition, I would recommend keeping track of all home improvements and respectively costs. If the gain on the sale of your primary residence is below $500,000 (per couple) and certain conditions are satisfied, the gain is tax free. If you have sold your investments properties, with the exception of 1031 exchanges, your gains are typically taxable in the tax year the transaction took place.

4. Deductions

Tax payers can choose from two types of deductions: standard deduction ($6,300 for single filer and $12,600 for married couple filer in 2016) and itemized deductions. If you own your own home (paying real estate tax and mortgage interest) and have other meaningful deductions (e.g. donation to charity), you will be better off with itemized deductions as the itemized deduction amount will meaningfully exceed the standard deduction amount. Common itemized deduction items include:

  • Mortgage interest – Interest is capped at interest on $1,000,000 loan. Any interest above loan amount of $1,000,000 is not tax deductible. If you bought your home during the year, your lender’s form 1098 may or may not include the interest you paid during closing.
  • Property taxes – If you have an escrow account with your lender, your lender may provide a form 1098. If you don’t have an escrow account, your town typically provides a bill you can keep as a record. Similar to mortgage interest, you may have paid additional property taxes during closing and may need to do additional calculation on your own to figure out the correct number. If you closed an escrow account during the year, remember to combine the 1098 from your lender and your tax bill from the town.
  • Traditional IRA contributions – you can contribute up to $5,500 per person or $6,500 if you are above age 50. One benefit of Traditional IRA is tax-deferred growth. In addition, for those with adjusted gross income below a certain threshold ($61,000 for single filers or $98,000 for married couple filers), the Traditional IRA contribution is fully tax-deductible.
  • Some states offer tax deduction on 529 plans – these are tax-advantaged savings plans sponsored by states to encourage the pursuit of higher education. Many states offer tax deductions for contribution to 529 plans of those particular states; Massachusetts will start offering tax deductions (of up to $1,000) in 2017.

5. Business income and expenses

The Schedule C is used to aggregate all your small business related income and expenses. The income components should be straight forward. Common expense components include:

  • Auto (choose from either mileage or actual expense incurred) including vehicle registration cost
  • Advertising
  • Supplies
  • Communication
  • Utilities
  • Food and entertainment
  • Insurances
  • Licenses
  • Home office expense – depreciation (building only; not land), mortgage interest, real estate tax, utilities, and other expenses for your home prorated based on the room you are using exclusively as office.

6. Rental income and expenses

The Schedule E is used to capture income and expenses from rental properties and several other sources. In addition to reporting the rental income received, it is important to report any and all expenses that could offset the rental income. Expenses may include:

  • Advertising
  • Maintenance and repairs
  • Insurance
  • Management fees
  • Mortgage and other interest
  • Supplies
  • Taxes
  • Utilities
  • Depreciation

Once the above key components are inputted into your tax software, the system will generate the total refund or tax due amounts. Easy enough?

Machu Picchu, Peru, 2011

Tax Preparation Software

Do not attempt to do the tax return without tax software as the amount of calculations and work is a lot vs the cost (discussed at the end of this post). For several of these items, I plan to do separate posts.

My favorite tax software is TurboTax. I found it generally easy to use. If you plan to file on your own online, expect to spend $90 for an online file. Alternatively, you can purchase a TurboTax CD. The CD will allow you to file up to five federal and state returns. To minimize your tax prep fee, consider sharing a CD with family or friends. The cost if you share a CD with others is a nominal $13 per year. Filing the federal return online is included and state return is included if you file by mail. Therefore, you can get a net saving of $77 per year. If you prefer to file the state tax return electronically, the cost is an additional $20.

Machu Picchu, Peru, 2011
Machu Picchu, Peru, 2011

Importing Prior Year’s Tax Returns

If you file online with TurboTax, your prior year’s return will be automatically loaded into the current year’s return. If you file using a CD, you can import your prior year’s return if you have a pdf copy (easily done as well).

I hope the above gives you a general structure for filing your taxes. I hope to have more blog topics on tax filing strategies.

Dear readers, how do you get organized for tax season? How many hours do you spend on filing for taxes? Do you have the system in place to maximize your tax refund?

Credit Traps and No Free Lunch Theory

My first post in my credit score blog series focused on monitoring and tracking credit score, and my second post focused on tips for improving your credit score. This third post in the series walks you through the common traps that you may encounter. If you are not careful, you could inadvertently hurt your credit score – which detracts from your financial goals. After this post, I will move on to other interesting personal finance topics.

Acropolis of Athens, Greece, 2012

Trap 1: The Enticing “0% Financing” and “0% Balance Transfer” Credit Card Promotions

I just got another “0% financing” advertisement from Home Depot today. These promotions sound so attractive! As a cardholder, you get to make any purchase without paying interest for the next 24 months. There are no shortage of 0% financing and 0% balance transfer credit card promotions out there. Frequently furniture retailers offer this to consumers who just paid the majority of their cash into their home and don’t have much cash left to purchase furniture. In order to take advantage of the 0% financing, you only need to pay the minimum balance due in order to avoid the finance charges (could be as low as $25 per month). This means you can effectively borrow for free and invest at a higher rate of return, right?

My “No Free Lunch Theory”

If something sounds too good to be true, it probably is. There must be a string attached to this seemingly great deal, right? Yes and No.

Why there isn’t a string attached? As long as you keep paying the minimum amount due and abide by the lenders’ requirements, you can avoid any interest and late payment charges. As long as you follow the rules, your lender should too.

Why there is a string attached? Taking advantage of this seemingly attractive offer could hurt your credit score. To illustrate, if you decide to take advantage of this promo and borrow $5,000 and pay $25 each month and pay off the remaining balance at the end of 24-month term, your average balance for the next 24 months will be $4,524. This will meaningfully increase your credit utilization ratio. Recall from my prior post, credit utilization rate accounts for 30% of the credit score – the higher the ratio, the lower your score! Therefore, if you have the cash for the purchase, I would pass on this type of promotion.

Franklin Zoo, Boston, MA 2015

Trap 2: Purchasing A Car with Auto Loan Instead of Cash

When you purchase a new or used vehicle, car dealers often will offer you an attractive financing option (e.g. 0%, 0.9%, 1.9%, etc.). These rates are typically lower than your mortgage rates. Wouldn’t it be great get an auto loan and pay down your other debt (e.g. mortgage, credit card) at higher rates first?

One way to evaluate whether you should pay cash or borrow, think about the follow aspects:

  • Alternative use for your cash: what can you do with the cash to invest?
  • How does the loan affect your credit score?
  • Are you willing to monitor the payment and balances and even take the risk of missing on a payment?

I recommend paying for your car with cash. Because if you start an auto loan, it will increase the “amount you owe”, the factor that accounts for 30% of your credit score. In addition, running a credit inquiry could (temporarily) hurt your credit score as well.

If you do decide to get an auto loan, always make sure you are paying on time. If you prefer to use autopay, be careful when the first payment is set (I would also call the lender to confirm). If autopay is set incorrectly, it is possible to get off cycle and unintentionally miss a payment. I would avoid the hassle of auto loans altogether if you have the cash.

Trap 3: Closing No Longer Used Credit Cards

As you go through your purchase needs and take advantage of the initial credit card opening promotions, it is common to cycle out of certain cards as they became less attractive (e.g. smaller rebates) than newer cards. In order to reduce the number of cards you need to manage and store, does it make sense to close the unused cards?

Before you close your next unused card, think about how this will impact your credit score. When you close an account, it will decrease your credit capacity and effectively increase your credit utilization ratio. Remember, the credit capacity is the total amount you are able to borrow across all your credit lines, so you want that number to be as high as possible. If your ultimately goal is to maintain a top credit score, consider leaving the account open (and storing the cards in a safe place).

The Greek Parliament, Athens, Greece, 2012

Bonus Tip: Credit Quick Fixes

Lender typically report a late payment to the credit report agencies after it is 30 days past due. If you are ever late on payment, call your lender and ask whether they have reported your late payment to the credit reporting agencies. If your lender has not reported it, your late payment won’t show on your credit report.

If you have very good or exceptional credit score, kindly ask the representative on the phone to reverse the late fee (chances are they would as they want to keep you happy). If your lender has already reported the late payment, try to negotiate to see if you can have them modify that record and count it as current payment. Most lenders are reasonable and it never hurts to ask.


Dear readers, have you fell for one or more of these traps? After reading this post, what would you do differently to protect your credit score?


Credit Score Part 2: Improving Your FICO Score

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In my last post I focused on understanding and tracking FICO credit score. In this post, I am excited to share with you some of the (easy) ways to improve your score. Hopefully you can strengthen your score over time and lower your interest rate on your mortgage and improve your financial health.

Remember from my last post, under the Equifax credit system, your score is based on five factors: payment history (35%), amount you owe (30%), length of credit history (15%), type of credit (10%), and new credit opened (10%). Out of these five factors, you can control at least four of them. Below I give you detailed tips on improving the four key factors that account for 90% of your credit score. With my strategy, even with the same income profile and greater spending needs, I was able to improve my score from 796 (very good) to 862 (exceptional).


Source: Equifax, Citi, and Finance Cappuccino

Tip #1: Improve “Payment History” Factor Always Pay Full Balance on Time

Misconception: Paying the minimum amount due each month is good enough.

Among the factors determining your credit score, having a pristine payment history is the most important, accounting for 35% of the score. This is also the factor that is most within our control. My recommended approach is to pay the full credit card balances on time or before the due date.

One good way to always pay mortgage and credit cards on time is to set payments on autopay. Most lenders give you that option online. Simply create an account and set payments on autopay. Funds will be deducted automatically from your checking accounts on the payment due date. Make sure you are paying the FULL amount and not the minimum payment due. Do not fall asleep during this step as it is easy to click on the wrong button and inadvertently select the wrong option. Once you receive a confirmation, go back to the account and check.

In today’s (still) low interest rate environment, we are getting almost 0% interest on our checking accounts so if you have the cash, I would recommend paying off the balances early.

Tip #2: Improve “New Account Opening” Factor Open New Accounts Sparingly

Misconception: Fewer accounts are better; don’t apply for new credit that you don’t need

When you are reviewing your credit report and notice that your scores are lower than what you expected even though you pay all balances off on time, a common culprit is that you have too many new accounts open. Having too many inquiries in your credit report could temporarily lead to reductions in your credit score. I would recommend opening accounts sparingly and try to group them around the same time to minimize the exposure of credit inquiries. This is especially important if you expect to be shopping for mortgage rates in the near future.

Having few accounts does not necessarily mean higher credit score; having more accounts can have positive effects as well. I will discuss more in detail in Tip 3. To give you an example, my dear husband and I have many shared accounts and our credit profile are similar. However, I have more than two times the number of credit cards open than he does, yet I have consistently had higher credit score.

In short, I think it is ok to have new and more accounts as long as you are opening them sparingly and for good reasons. After all, the “New Account Opening” factor only accounts for 10% of the credit score. I typically open new credit card accounts to take advantage of account opening bonus, higher rebates, or merchant discounts. I will do a separate post on the best small business and individual credit cards at a future date.

Tip #3: The “Amount You Owe” Factor – Aggressively Pay down Your Credit Cards

Misconception: You can’t change amount you owe

One key ratio that determines 30% of your credit score is Credit Utilization, which is equal to the amount you owe divided by total credit capacity. The smaller your utilization, the better your credit score.

Ideally, you want a small numerator (amount you owe) and big denominator (total credit capacity). The amount you owe is a function of your spending and total credit capacity is a function of the total credit limits for all your credit cards.

To raise your credit capacity, you need to have enough credit cards (see Tip #2). Remember if you apply for new cards, please do so sparingly (and only if you are also getting a financial incentive). However, over time you should be able to build up your total credit capacity.

To lower my credit usage, I pay all of my credit cards once or twice per week. My average credit balances are near 0 and sometimes even going into the negative territories.

As an example, say I owe $200 on my Citi credit card, I would pay $500 (effectively overpaying) and let my balance be -$300. It will take sometimes before my balance becomes positive again so I don’t need to pay on a daily basis. Note that Chase puts a limit on how much you can overpay. I like the Citi system better since I can freely overpay any (even larger) amounts.

To reduce the hassle of logging on and off on a computer, I prefer to use the Citi iPhone app. I can log into my account when I have a few minutes between meetings to get this done. If you have joint account owners, they can free-ride on your efforts of paying frequently.

Tip #4: Improve “Length of Credit History” Factor – Borrowing Someone Else’s Credit History

Misconception: Credit history must be your own.

This point is especially relevant to family members, e.g., children, who do not have lengthy credit histories. If you (the parent) have a long-standing higher credit score and a teenager without a lengthy credit history, you have two options:

1) Apply for a new credit card in your child’s name and add yourself as a guarantor, OR

2) Add your child to your existing card

Which would you choose?


Source: Finance Cappuccino

My recommended option is number two. With option number one, you child starts a new credit file and builds her credit history from scratch. But if you have a long credit history, and you are ok with paying all the expenses on the card, it would be much better to let your child automatically gain your decades-old solid credit history. Pick the card that you had the longest credit history and let your child piggyback on that. This will give your child a jump start in building her credit history, and may help her get a terrific mortgage rate in the future.

Dear readers, I hope the above tips are helpful. What is your credit score improvement strategy? Are you focused on getting a top credit score for yourself and your children?

Credit Score Part 1: Understanding FICO Score

What Is FICO Score

The acronym FICO stands for Fair Isaac Company, the original creator of the scoring system for a consumer’s creditworthiness. FICO scores are used primarily by lenders to make credit-related decisions such as mortgage, auto loan, credit cards, just to name a few.

The FICO score is based on an individual’s credit history, which is maintained by the three major credit reporting agencies Experian, Equifax, and TransUnion. The FICO scores from the three credit agencies for the same individual can vary. As an example, my credit score with Equifax is 862, but with TransUnion it is 813.

Equifax’s credit scores consist of the following categories:

  • 800 – 900: exceptional (well above the average US consumer’s score)
  • 740 – 799: very good (above the average US consumer’s score)
  • 670 – 739: good
  • 580 – 669: fair
  • 250 – 579: risky


Source: Equifax and Citi Bank

What Determines Your Credit Scores

In the Equifax credit system, your score is based on payment history (35%), amount you owe (30%), length of credit history (15%), type of credit (10%), and new credit opened (10%). The other two agencies have slightly different scoring methodologies.

Why Your Credit Scores Matter

For most of us, our biggest purchase is our own primary residence (or vacation home or investment property). The biggest cost of making this purchase is the interest cost, which is directly linked to the credit score. The higher the credit score is, the lower is the interest rate and interest cost – everything else being equal.

To illustrate, if you are purchasing a $1,000,000 home and borrowing 80% from a bank (i.e. borrowing $800,000) with a 30-year fixed mortgage, assuming an interest rate is 4%, your total interest cost over the 30-year period is $574,956 or approximately 57% of the purchase price. And if the interest rate is 4.125%, your total interest cost would be $595,791 or approximately 60% of your total purchase price. The difference in interest cost is $20,835 over 30 years. Hence, a very small difference in the interest rate means a meaningful difference in interest costs for a mortgage.

One key factor determining your interest rate on your mortgage is your FICO score. FICO score not only determines interest rate on your mortgage loan, it is also a key determinant of the interest rate of a variety of other debt. In my view, it is absolutely crucial to keep building your credit score.

How to Track Your Credit Scores

To check your credit score you can request a free credit report from one of the three credit reporting agencies here. Federal law allows you to get one free credit report from each of the credit reporting agencies in each 12-month period. Once you receive the credit report, read over the details and review for accuracy. If you see errors, make sure you correct these by following through the steps outlined on this website.

A number of banks (i.e. Citi and Bank of America) also track for your credit scores if you hold credit cards with them. To see your credit score, make sure you credit card is linked to your online account. Below is my historical credit score for the past six months from Citi. I love having the convenience of seeing my credit report when I log in my bank account online.



Source: Equifax, Citi Bank, Finance Cappuccino

One easy and comprehensive app I have been using is WalletHub. Once you create an account, it will track your credit score, and show how your score compares with those of other Americans, other residents in your state, other people your age, and other people in your income bracket. In addition, it will track the number of credit inquiries you had recently, the number of cards you have, etc. The app also tracks your mortgage loan balance, your credit card balances, etc.




Source: WalletHub and Finance Cappuccino

In my next post, Credit Score Part 2 – Improving your FICO Score, I will share with you practical tips for improving your credit scores.


Dear readers, how often do you track your credit score? What tools/apps do you enjoy using?

Disclaimer: the writer of this post does not receive any financial compensation from the credit reporting agencies, Citi, Bank of America, or WalletHub.