Wednesday, October 1, 2008

Tis Better to Owe than to Receive


When the gentleman sitting next to me found out I majored in International Economics-he asked what I thought of the current state of wall street. I have many an opinion of the bail out- but my specialty is practical day to day econ. How economics affects the little decisions you make every day- ie cost per wear.

He wasn't familiar with the concept of time value of money - a dollar today is worth more than a dollar tomorrow. A dollar today is worth a great deal more than a dollar a year from now. And this is where I was able to give him one piece of solid financial advice.

In tax season it is better to owe the government than to be owed. If you receive a tax refund- you lost, the more you owe, the more you win. Most Americans don't think that way.

Let me explain: If you get back from the government $1,000- then the government borrowed $1,000 from you for a year with out paying you any interest. If you owe the government $1,000 then you borrowed $1,000 from the government for a year with out having to pay any interest. If you took that $1,000 and put it in the bank and saved it because you knew you were going to use it to pay taxes, and got paid 3% interest for the year, then in the end you made $30.

Not only that it is better for you to have that $1,000 today rather than in April because that $1,000 is worth a lot more today.

This requires you to have some self control and methodically put aside money each month for taxes, but it is much better for you to be getting paid interest on your money than the government. It is better for you to have your money today, than tomorrow. Go maximize your exemptions, and if you get money back from the government in April, instead of thinking you won, realize- you lost.

25 comments:

JustRandi said...

You majored in international economics??
I. Am. So. Impressed.

Steve said...

I agree 200% and I am sooooooo turned on right now! haha

Seriously, and no disrespect to your other posts, but this is one of the smartest blog posts I have ever read!

What century was this guy born in not knowing "the time value of money"?!?!

davers said...

Great post. What's worse is this ... apparently the state has like 10 years or so to hit you for underpayments along with a 13%/yr interest rate, but if you overpaid you only have 5 years to claim the underpayment and of course no interest.

We found that out the hard way. I believe in paying taxes as a valuable service is given in return, but some of the IRS policies are just patently wrong and profoundly unfair and corrupt.

davers said...

Correction ... you only have 5 years to claim an under-refund and there is no interest in the under-refund.

crazy4danes said...

Great post! And another reminder that you are definitely my SMARTEST girlfriend!!! You rock! :D

Allie said...

I try not to get a refund. We keep upping deductions, apparently not enough.

Maybe now that we're no longer "students" it will work out better.

The other thing I'd add- stop paying money to an escrow company for your home insurance and property taxes. Pay them yourself and put the money in a nice ING account.

Salt H2O said...

JustRandi- I'm always looking for opportunities to drop impressive facts into blogs/conversations, now if I can just figure out a way to casually let people know I was an honors student in the 6th grade...

Steve- This must be why we are friends- since we have little else except our love for Vanilla Ice in common (and I think my Yo VIP post is by far the smartest blog post I've ever read :) The guy was a college professor at the U of U, he taught outdoor rec and youth management.

Davers- I have no problems with paying taxes (ok that's a lie, there are a lot of problems I have with paying taxes), but if the government is going to give me a free loan for 12 months- I'm going to take it. Thanks for the information on the under-refund. It's good to know.

Danes- You need more female friends! (sadly, so do I)

Allie- Good information on the escro and property taxes- I hadn't thought of that!

cropstar said...

Brilliant.
Unfortunately I have no self control.

Della Hill said...

I swear My IQ has gone up 10 points since I started reading your blog.
-Della

Melissa said...

You give good advice.

Totally OT, but guess what? I followed a commenter of your blog and realized he is my cousins son! Such a small world. (Drew Conrad) It is like we are all related now right?

Steve said...

Allie - That is good advice about the escrow for taxes and insurance, but some mortgage companies require you to have X%, I think ours is >50% equity in the house before they will let you take the responsibility.

Swieda said...

Econ was never my best subject, so I need some help here. I give the government a dollar today in taxes, isn't that worth less than a year ago, but more than a year from now? Looking back, it seems like a good idea to owe, but looking forward not so much. Isn't the best solution to neither owe nor be owed?

Allie said...

Wow Steve 50% is crazy.

Ours is 20%.

Salt H2O said...

Swieda- I'm not following you.
Why would you be giving the government a dollar today for last year's taxes? You either give the government a dollar today, or April of 2009.

Allie said...

Swieda- I think it's better to owe based on the idea that you take the money you will owe in taxes and put in some sort of savings account (I'll plug ING again here) rather than spend it. Then when it's time for you to pay taxes you're that much interest ahead of where you would be if you didn't owe anything,

Many aren't disciplined enough to do that, and are smarter to try to neither owe nor get a refund.

Cameron said...

What's especially cool with the current tax system is that you can find out what your estimated tax will be (go to irs.gov and search for tax calculator), and then find deductions that reduce that tax bill.

Then get it to as close to zero as possible.

Then take the child tax credit or even the earned income credit and get back money you never even paid in the first place.

Now that's economics!

ray said...

Nothing on the bailout, really? Nothing on the democrat baby, the Community Reinvestment Act? The paradox of Pelosi calling GSE's "deregulated"? How McCain tried to rein in Freddie and Fannie in 2003 and democrats blocked it saying "nothing is wrong"? Surely you miss an opportunity...

Salt H2O said...

Ray,
I have to direct you to my post about how the baby hates politics.

Believe me, that is a fight I wanted to jump into- but it's a really really emotional issue for me. Very much heightened by the additional hormones running through my body.

I could go on about the bribery in Washington, about how we got a half assed bill and then in order to get it passed they added pork to bribe for votes.

The spin of congress is driving me nuts - the nation being so willing to blame the president when congress had all powers....people want to blame one guy and move on not realizing that those that made this mess still have jobs.

But I can't get into it- I need to reduce my stress in the next 3 months- so I can only blog about political issues that I don't feel so passionately about.

Salt H2O said...

Cameron-
You're still loosing money.

"income credit and get back money you never even paid in the first place."

You DID pay those taxes, they were deducted from your paycheck each month. Just because you don't owe anything in April doesn't mean you didn't pay any taxes- you actually gave a load of money to the feds.

If you want to come out to zero, calcualte what your child tax credit will be, make sure that's what you owe at tax time and then you'll come out to zero and you will have gotten that tax credit months in advance (in the form of money NOT deducted from your paycheck) when it was worth more.

That child deduction credit is yours- $1,500 that the government borrowed from you through out the year- $1,500 they kept taking out of your pay check in small increments, didn't pay you any interest and then gave back to you. Don't pay so much in taxes each month and keep your money now because it's going to be worth a lot less 6 months from now.

Cameron said...

Salt,

What I'm saying is that you can get your withholdings down to zero, and still get back thousands of dollars if you do it right.

Salt H2O said...

You can get your with holdings down to zero and then get money back? That's pretty impressive.

The only people I know that can do that are my two nieces that are on welfare- they got 10 grand back from the governement with out putting a dime into the system. But they intentially live a welfare lifestyle.

ray said...

salt h2o, I've been where you are 4 times and you have my congratulations and sympathy. If this is your first time, which it sounds like it is, this is just the beginning of your lifestyle adjustments. Good luck.

Cameron said...

You can even get the Earned Income Credit early - you don't have to wait until next year. Take that tax income when you've "earned" it - right now.

Allie said...

(I finally took my own advice today and called my mortgage company. It took about 30 minutes with about 5 of that actually speaking to someone (two different people).

We'll be getting a nice sized check in a few days which we'll put in our ING account until taxes and insurance are due.

Our mortgage payment goes down by about $200 a month and that extra money will also go into ING.

Now I just have to see if I can pay our taxes with my amex card to get the cash back...

Thanks for the push to get that taken care of Kory.

Steve- I'd look into that 50% again. That just seems outrageous. It's your money, they shouldn't be able to hold it hostage like that. All the things I've read online say it's 20%.

Steve said...

Allie - Will do, thanks!