Over the last few months, I developed plans to minimize my tax bill, earn more money, and invest in the stock market. Much of this financial planning is motivated by an upcoming tax burden that’s sure to sting.
The problem starts with self-employed earnings. These are filed under Schedule C of the U.S. tax code. Unfortunately, those earnings don’t include withheld funds that support Medicare and Social Security. To account for this, the federal government requests about 30% in self-employment taxes.
As someone who’s funneled as much cash as possible to swiftly pay off student loans, I don’t necessarily have a lot of liquidity or extra funds to pay this tax bill (yet). The U.S. government doesn’t adequately account for someone paying off student loans when asking for the tax bill at the end of the year (and this is just the tip of the iceberg for financial aid concerns).
With these worries in mind, I took time today to restrict my spending ability, increase my regular income, and provide a bit of a tax shelter. And it all starts with dividends.
One of the most contentious elements in our tax code has to do with capital gains and dividend taxes. Whereas normal income from work is taxed at steep, progressive rates, these stock-affiliated earnings receive an artificial discount. If you make over $406,750 as a single person, you pay only a 20% tax on dividend earnings. And if you hold stocks/assets for over one year, you also qualify for this reduced rate.
For me, as a single filer with projected earnings of less than $36,900 for 2014, I’m looking at a brilliant tax rate of 0%! You heard me right: zero percent! That means for every stock that I hold onto for over one year or qualified dividend I receive, I should be able to keep the entirety of that income. Here’s where nifty financial planning will help lower my tax burden and increase the money in my pocket.
Today, I made a small (large for me, though) investment in Apple Inc. (AAPL). The stock is currently valued at $95.25, as of August 5, 2014. At that value, it is hardly one of the greatest income earners, but it pays a substantial 2% dividend yield. Simultaneously, Apple is still highly favorable among stock analysts — Yahoo Finance suggests that the collective price target is $104.79 within 1 year.
Based on stagnant yield growth, I should make about $31.96 per year from dividends. That’s all income that should receive a 0% tax due to those gains. Based on about a 10% (possible) appreciation in Apple for one year, any gains will be completely protected from taxation — even after I sell the stock. I will again have the 0% tax liability.
The political climate around changing capital gains taxes is terrible. The regulations should change — they need to stop benefiting the wealthy. Warren Buffett has frequently complained about this tax code inconsistency, and suggested that it unfairly rewards the wealthy. I think he knows a thing or two about investing, too! Until then, and as a low-income earner, I need to use this system to my advantage to reduce my tax liability and increase earnings.
What a coincidence I have been reading up a lot on dividend stocks lately myself. What interests me is that a portfolio of strong dividend yielding stocks could eventually build you a stable monthly income that will most likely beat inflation every year. This seems like a great way to have enough income for retirement, while using your 401k, IRA’s and social security as “fun” money. I’m looking forward to starting this but am making sure I read up on the important points since it will be my first foray into individual stock picking.
Best of luck with (legally) avoiding the tax man!
I so agree that it needs to be reevaluated, but great job on taking advantage of it since it exists! Will you be pocketing the dividends or reinvesting them?
Sam Lustgarten says
Great question! For right now, I’m using a DRIP (Dividend Reinvestment Program) to put these dividend earnings back into the stock. That way, I can get the income and turn it into future earnings. That compounded growth is the best investment strategy, too! Hope you are! 🙂
Well done! I’m exploring more and more into dividend investing lately, so this comes at a good time for me. I’m going to have to keep this in mind, because taxes and dividents and ROTH IRAs and all of the implications have been on my mind.
This is a very timely article as I just wrote a piece titled, “Benefits Of Dividend Investing,” a few days ago. Clearly, there are so many benefits to investing in dividend paying stocks that I’m still not sure why it isn’t a more popular investment theme. Taxed at lower rates and able to compound tax free in retirement accounts dividends can help fund and provide income in retirement. Thanks for sharing.
Addison @ Cashville Skyline says
Great job, Sam! I’m badly in need of a reduction in taxes. I’ll have to look into this more and make sure I’m taking full advantage.