Frugal Millionaires on Taxes and Accountants

Here's an excerpt from the book The Frugal Millionaires: 70 millionaires anonymously share their ideas about money to help each other and you. Today we're seeing what the millionaires have to say about taxes and accountants. Since I use a CPA to do my taxes, I'm on the same page as they are.

FYI, these are some representative tips from The Frugal Millionaires. There are over 800 tips in the book. The frugal millionaires are only referenced by their initials. The author signed a confidentiality agreement that the millionaires' identities would never be disclosed in exchange for them saying whatever they wanted. If they chose not to have their initials used they were given the initials AFM which is an acronym for Anonymous Frugal Millionaire.

Here's the excerpt:

Taxes

Paying taxes is not everyone’s favorite topic, but it’s a fact of life in a civilized world. There are no magic bullets or secret schemes below on how to not pay taxes. They are an expense, like a lot of other things that can keep you from growing your net worth.

Frugal millionaires are willing to pay their fair share of taxes, but not more than that. And avoiding taxes doesn’t mean evading them. Many of the legal “loop holes” have been eliminated over the years, so it’s back to using the basic common sense principals of planning ahead, knowing what you’ll be in for, and minimizing what you’ll owe. The frugal millionaires have adopted an attitude towards taxes that makes them a lot less frustrating to deal with.

• FJC – Just pay the taxes. I got burned several times trying various tax shelters based on the advice of friends and financial advisors (including real estate shelters, oil and gas shelters and commodity straddles).

• AFM – Avoid filing extensions and always pay your taxes on times. The penalties are a waste of money.

• MG&DG – You’ve got to do it. Don’t cheat the government. It will catch up with you.

• DTA – You have to do it. Don’t sweat the stuff you can’t control, but do minimize when you can. Don’t lose sleep over your taxes.

• AFM – The government is a bad investment, unfortunately it’s a necessary one. Explore your options, take no risks and carefully pay as little as possible.

• JSB – Pay them if you have to…be careful setting up elaborate shelters as AMT gets applied very quickly now and disqualifies nearly every write-off.

DEFINITION: Alternative Minimum Tax (AMT): An extra tax some people have to pay on top of the regular income tax. The original idea behind this tax was to prevent people with very high incomes from using special tax benefits to pay little or no tax. The AMT has increased its reach, however, and now applies to some people who don’t have very high gross income (now $75,000) or who don’t claim lots of special tax benefits. Proposals to repeal or reform the AMT have languished in Congress for years, but effective action does not appear to be on the horizon. Until Congress acts, almost anyone is a potential target for this tax.

The name comes from the way the tax works. The AMT provides an alternative set of rules for calculating your income tax. In theory these rules determine minimum amount of tax that someone with your income should be required to pay. If you’re already paying at least that much because of the “regular” income tax, you don’t have to pay AMT. But if your regular tax falls below this minimum, you have to make up the difference by paying alternative minimum tax. (SOURCE: Fairmark.com, with edits)

Accountants

• JKB – Tax laws are written to favor the government, not you. Seek the advice of a professional to minimize the impact and always consider additional taxes and save for them.

• AFM – I don’t spend large amounts of time and consideration here trying to save on taxes beyond my accountant’s advice. Try to keep your life simple and just take the hit.

• JC – Don’t waste your time preparing your own tax return. Hire an expert to file for you. Be careful of AMT.

Comments

[Jim]

"Until Congress acts, almost anyone is a potential target for this tax."

That explanation of AMT seems misleading or maybe just outdated. Congress has adjusted AMT multiple times in the past few years. IN the past 9 years they've raised the exemption levels over 50%. Its not an impending doom situation since they up the limits annually. Right now only a small % of high income Americans pay AMT so its not "almost anyone" by a long ways. In 2005 only 3% of filers paid AMT. Just cause you pay AMT doesn't mean all that much as the difference between AMT and their normal tax bill isn't necessarily that much. Its not as if out of the blue if you make over $75k that your tax bill will double or something ridiculous like that.

Jim

[rwh]

I echo Jim's comments.

[Otis]

I think the real question is, what income level does hiring an accountant become worth more than what you have to pay the accountant? Like many things in life, it's likely not worth the money unless you have a lot more money to protect.

Also, what's the average price for an accountant? I might be in my first situation to need one, I'll most likely hire one, and do everything myself and see who came out ahead, then use that as a guide for future years.

[kitty]

@Jim - what you say about AMT is true. However, there are things about AMT that are totally illogical. For example, AMT can affect you just because you live in a high tax state like NY or because you have a lot of kids. Now, it's not like only rich live in high tax state or have a lot of kids, so why are these provisions even in the AMT?

Additionally, while AMT may only affect a small percentage of people, there were people whose lives were destroyed and their savings wiped out by it. This happened especially after 2000s crash. Many of the tech start ups were paying part of the salary to their regular employees in Incentive Stock Options (ISO). At the time you didn't have to be a high earner to get those. Since many of these people didn't have very high salaries otherwise and hadn't been affected by AMT before, they didn't know that exercising of their ISO triggered the AMT but was a non-event for regular taxes. When internet companies were booming the stocks of the companies cost a lot, some of these people exercised their options but decided not to sell stocks for a year to take advantage of long term rather than short term capital gains. But they didn't know about AMT, at least not until they had to do taxes the following year. So the following year, they had to pay AMT on the difference between the option price and stock price at the time they exercised their options. Except for by this time the internet bubble burst and their stock was worse nothing. In some cases, the people owed high 6-digit amounts to the government on the money they had never seen and had no prayer of recovering. One family had to give every penny they had including their children college fund and still owed a large amount to the IRS. Sure, you can say they should have known about it and sold their stock immediately after exercising, but really, how many people who aren't rich even know about AMT? Even some "experts" don't have a clue - I heard Suze Orman on TV a couple of years ago advising a caller who mentioned ISO to hold on to her stocks for a year to get long term gains, and that there is no tax hit until the stocks are sold.

While the idea of AMT may have made sense when it was introduced some of its provisions didn't make sense. Also, if the purpose was indeed to tax the rich, why couldn't it have been indexed for inflation. AMT was introduced in the 60s. Between then and now, we had the double digit inflation of late 70s and early 80s. Also, the tax code was different then. For example, in the 60s there was income averaging, so if one year your income jumped e.g. because of capital gains you could average it over 5 years. Now, you can't so your one time gains can put your income in the AMT range even though the following year your income would drop back to 50K a year.

[Tony]

The question of whether a CPA has sufficient value is simpler than "what income level does hiring an accountant become worth more than what you have to pay the accountant?" - the more precise question is, did the guy wind up saving you more than he cost for that return? Sadly, only one way to find out. Adding to that, however, is a value harder to define: How much SAFER from audit did your tax return become when blessed by a CPA?