INTRODUCTION

This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.

Dr. Jim Dahle:
This is White Coat Investor podcast number 366 – Tax Questions.

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All right, let's get right into your questions today. Our first one comes off the Speak Pipe from Diana.

WHEN ARE IRA CONTRIBUTIONS TAX DEDUCTIBLE?

Diana:
Hi, Dr. Dahle. I'm currently a physician working full-time, and my spouse is a stay-at-home parent. My question is, are his traditional IRA contributions still tax-deductible, even if we make more than the modified adjusted gross income limit for a married couple filing jointly?

The way I read it, it appears that they would be. However, my backdoor Roth or traditional Roth to backdoor conversion obviously would not be tax-deductible. Let me know if you think I'm interpreting this correctly. Thank you so much.

Dr. Jim Dahle:
All right, this is actually an incredibly complicated question, and it's hard to remember all the rules and keep them all straight. Before we get too far into it, I just want to point out that maybe this is just a good opportunity to just do a backdoor Roth IRA for your spouse too.
That's always an option. Whether that IRA contribution is deductible or not, you can still do a backdoor Roth IRA. If you get a tax deduction for the contribution while you pay taxes on the conversion. If you don't get a deduction on the contribution, you don't pay taxes on the conversion, it all works out the same. So that's always an option is just do a backdoor Roth IRA for your spousal IRA.

For those who don't know what we're talking about with the spousal IRA, there actually is no such thing. There's not a special account called the spousal IRA. It's just an IRA. Remember IRA stands for Individual Retirement Arrangement, not account, interestingly enough, Individual Retirement Arrangement. But the first word is individual. So this is always something that is the persons. You don't have joint IRAs. There's your IRA, there's your spouse's IRA. So that's all we're talking about is your spouse's IRA.

But there's a special rule that allows somebody to contribute to an IRA using their spouse's income. So you don't actually have to earn money to contribute to a spousal IRA. If you are married, you can take advantage of your spouse's income to contribute to your IRA.

Now, obviously, if they're making an IRA contribution, they have to have enough income that it's more than both of your IRA contributions combined, but that's what's unique about it. So you can't do this for your domestic partner. It's a spousal IRA. You have to be married.

So, what are the contribution limits? Well, it depends. Depends how much income you earn together. Technically a modified adjusted gross income, the age of the spouse, and how the couple files their taxes. If you're under 50, the maximum spousal IRA contribution is the lesser of $7,000 in 2024, or the total amount of earned income by the couple minus the non-spousal IRA contribution. If you're 50 plus, you get catch-up contributions, obviously, for the spouse that is 50 plus, both of you, if you're both 50 plus.

Now, let's get to your question, which is how much of it can be deducted? And again, the answer here depends. It depends on two things. The first is whether the working spouse now is covered by a retirement plan through their employer, like a 401(k) or 403(b), and how much income the couple earn together. If neither spouse is covered by a retirement plan, then both spouses may fully deduct contributions to their IRAs, no matter what their income. If one spouse is covered, the ability for the spouse without a retirement plan to deduct their contribution has a phase-out, and it goes up each year with inflation.

I ought to find this current one. It's in IRS Pub 590-A. It's Table 1-3 last time I looked it up. Let's see if we can find Table 1-3 in the current publication, so I don't give you information from a prior year. All right, here it is. Table 1-3. It's on page 14 of Pub 590-A. The effect of modified AGI on deduction if you aren't covered by a retirement plan at work.

Okay, so let's go through this table. If you're a single head of household or head of household, and your modified AGI is any amount, then you can take a full deduction. If you're not covered by a retirement plan at work, remember that applies to everybody in this table.

The second one is if you're married filing jointly or separately with a spouse who isn't covered by a plan at work, any amount of income, you get a full deduction. However, if you're married filing jointly with a spouse who is covered by a plan at work, and your modified adjusted gross income is less than $218,000, you get a full deduction. If it's $228,000 or higher, you get no deduction, and it phases out in between those amounts.

If you're married filing separately with a spouse who is covered by a plan at work, you get a partial deduction if your income is under $10,000, and no deduction at all if it's $10,000 or more. This is actually what catches a lot of people who don't realize they need to do a backdoor Roth IRA when they're filing married filing separately during residency to play some games with their student loans, try to maximize their PSLF. If you're doing MFS, you almost surely are going to need to be doing a backdoor Roth IRA.

But I think to answer your question, if your spouse is covered by a plan at work, the working one is covered by a 401(k), then you need an income under $218,000 to take that deduction. If it's over $228,000, then you do not get any deduction at all. I hope that's helpful. Sorry the answer is so complicated. I don't make the rules. I just tell you what they are.

Our next question comes from Mike. Question about FICA taxes.

FICA TAXES

Mike:
Hi, Jim. This is Mike from Ohio. I have a side gig where I make around $250,000 per year. My main job, I make in the low seven figures. My wife does not formally work, but she does help with bookkeeping and other tasks with my side gig. Would it be worthwhile for me to add her to payroll so she can contribute to the company 401(k)? If I did add her, would I need to pay the approximately 15.3% FICA tax on her entire salary or just the portion that isn't put into the 401(k)?

Since I've already hit the social security wage limit at my W-2 job, I would only need to pay 3.8% FICA tax. And since we anticipate being in high tax bracket now and in retirement, I'm not sure if it's worth paying the 15.3% FICA tax now to give her access to the company 401(k). Am I missing something here or do you think it's beneficial to add her to payroll?

Dr. Jim Dahle:
Okay. I've got a post that's going to be published soon on this topic and I've written on it in years past as well, but there's this weird idea out there that somehow you're going to save a whole bunch of money by hiring your spouse. It's probably a bad idea.

Now, keep in mind hiring your kids is usually a good idea. If your business is not a corporation and the only owners are their parents and their minors, you don't have to pay payroll taxes for them. They probably won't earn enough, but they have to pay any income tax and you can put everything they earn into a Roth IRA. That's a pretty slick move. Obviously, you have to pay them a fair rate and do all the paperwork and all that. You have to get all that right.

Hiring your kids can be a very savvy move. Hiring your spouse, usually not the case. Now, if you need your spouse to work in the business, fine, hire them, but don't expect to be some sort of huge tax break. And here's the reason why. There are some benefits. Obviously, you get their help. That's a benefit. They also get to increase their social security benefit because they're going to be paying FICA taxes on what they earn and so that increases their social security. Of course, as you mentioned, you can make a 401(k) contribution for them.

It's not a dumb thought to think about this because obviously, there are some benefits, but it's a bad idea most of the time. Let me explain why. I think you're recognizing that based on your question. It's the FICA taxes. You're making seven figures. Congratulations, by the way, you have a fantastic income. When I hear about a side gig making a quarter million dollars, I know you're killing it. Congratulations on that.

But the point is you've maxed out your FICA taxes. You've maxed out your social security taxes. You haven't maxed out your Medicare taxes. There's no max on that. Whatever additional money you earn, you just have to pay Medicare tax and of course, your income taxes.

Well, if your spouse makes money, your spouse also has to pay Medicare tax and income tax, at the same rate you would have to pay if you earned that money instead. But in addition, your spouse has to pay social security tax. On the first, it's about $160,000 this year. You have to pay social security tax on that. If you're self-employed, that's not an insignificant amount of social security tax. 6.2% employee, 6.2% employer, that's 12.4% of $160,000. What's that work out to be? That's like $20,000 in taxes that if you earn the money, you wouldn't pay. If your spouse has earned some money, you're going to pay. $20,000. There's got to be a huge benefit for using a 401(k) that is worth paying $20,000 in tax that you don't give back except possibly as a social security benefit down the road.

In general, the math does not work out. Don't hire your spouse just to get an additional 401(k) contribution. It just costs you too much of social security tax to be worth it. Now, if your spouse already has another job and they're maxing out their social security tax there, maybe it makes a little bit more sense.

Even then, particularly if they're on a K-1, but if they're a W-2 employee, well, what ends up happening is you end up paying the employer half of social security when you hire your spouse. If they come on as a partner, that's not necessarily the case. They come on as an employee, it just doesn't mix well to have two employee jobs because you end up paying extra tax on it. The employer does. You can get back the employee portion of social security tax that's paid at the second job, but you can't get the employer half back. It just doesn't make sense for the most part.

Good idea. I would not do it. And just hiring them as a contractor doesn't really work as well because if they're a contractor, they're in business for themselves. Again, they're going to be paying payroll taxes and what they're earning. So, hire your kids, not your spouse. That's the bottom line if you're looking for a tax break.

All right. Thanks for those of you out there. I know we try to optimize our financial situations around here in the White Coat Investor community and try to make more money and save more money and invest it better and not waste our money and keep it protected and all that.

But at the end of the day, what really matters is what you're spending your day doing. I had a couple of shifts the last couple of days. Today's all WCI work. The last couple of days, I was in the ER. That's a good reminder for me to go in there.

Do I enjoy it? Yes, but a lot of that work is what I call number two fun. It's fun afterward. It provides purpose. I'm glad I did it. I like what it does for me personally and in my life. I think it makes me a better person to continue to work in there. But is it super fun? No, it's not endorphins like playing a video game or going and playing ice hockey or something. I don't like it like that, but it is enjoyable.

It reminds me that I'm just incredibly blessed in my life. I see the difficult situations people are in. I had a row of rooms yesterday of people with suicidal ideation. They are feeling so terrible about their lives that they've either already tried to hurt themselves or are thinking about it. It just always reminds me that I've got a lot of things to be grateful for in my life, and I bet you do too.

But thanks so much for serving those who are struggling with whether it’s mental health or physical health or an injury or illness or whatever. Thanks for what you do each day.

All right. Another tax question, this one from Jeremy. Let's talk about quarterly estimated tax payments.

QUARTERLY ESTIMATED TAX PAYMENTS IN REGARDS TO TAXABLE ACCOUNT DIVIDENDS

Jeremy:
Hi, Dr. Dahle. My name is Jeremy. I'm a pediatric hospitalist from the Northeast, longtime listener of the podcast and reader of the blog, and I'm so appreciative of all you have done for my family with regard to financial literacy.

My question for you is regarding quarterly estimated tax payments. I haven't been able to find the answer to this on your blog, and I don't remember hearing about it on the podcast but may have missed it.

My wife and I are W-2 employees, so this is not about payments related to job income. But as our taxable account grows, the dividends will also continue to increase. And while there is an estimate on the account about what the dividend might be for the upcoming year, it certainly is not always going to be right. What do you see as being the right way to approach estimating this in order to avoid penalties?

I certainly understand the rule of simply paying 110% of our prior year's taxes as an easy answer, but I don't want to reflexively just give the government an interest- free loan either. Any thoughts you would have on this would be much appreciated. Again, thanks for all you do.

Dr. Jim Dahle:
All right. Well, the 110% rule works really well for the self-employed. It doesn't work very well if you have W-2 income where taxes are being withheld from it. If you're all self-employment income, you just go, what did I owe last year? I owed $110,000 or $100,000 in taxes. So I'm going to multiply that by 110%. That's $110,000. And divide that by four and pay $27,000 every quarter and call it good. Super easy if that's your situation.

When you have got money being withheld, it's just more complicated. A lot of it is guesswork. Let's be honest, it's guesswork. If you're not having that much in dividends, you can just decrease or increase how much is withheld at your job. No big deal. Just say, “You know what? Withhold an extra $500 every pay period, and that'll get you there.” You can do that and that works really well. If you're starting to get a lot of outside income, maybe you can't quite do that as easily.

But that's the first thing I do. Just have a little bit of extra income. As it gets bigger, maybe you do have to start making quarterly estimated payments. It's no big deal. You make them April and June, September and January 15th. The one that always gets me is the June one. Because there's only two months between April and June. So it always feels like we're making two payments pretty close together. And that can stress cash flow for a lot of us.

But it's no big deal to make those quarterly estimated payments. You fill out a 1040-ES, which is like, I don't know, eight or 10 lines on it. It's basically just your address and name and social security number and how much you're sending them. And you can actually make the payments. You don't even have to do that. You make the payments on the EFTPS system online. That's how I make my quarterly estimated payments. And it's really not that big a deal.

Now, everybody is stressed out about this for some reason. I don't know why. I understand there's cash flow planning that is tricky. But for the most part, it doesn't matter if you underpay or you overpay. You settle up the IRS next April 15th. That's the way our tax system works. It's supposed to be pay as you go. And if you pay a little too much, well, they send you a check back. If you don't pay enough, you send them a check. If you really don't pay them enough, you have to pay penalties. And this sounds like some sort of terrible thing. “Oh, no, I'm getting penalized.”

Well, what is the penalty really? Basically, the penalty is the interest you should have earned on the money that you should have paid the IRS earlier in the year. The penalty is not like some huge number. It's basically just interest. You should have paid it to them last September. You didn't. You had the money for an extra seven months. So it's about as much as you would earn on interest in a good high yield savings account or a good money market fund. That's what the penalty is. It's not some huge amount. You just have to write a check for a little bit of extra interest because you were supposed to be paying as you went along. It's not like they come to your house and put you in jail.

There are terrible penalties in the tax code. If you fail to file your 5500-EZ every July 31st, terrible penalty. Forget to take out your RMD at the end of the year, terrible penalty. This is not a terrible penalty. It's like a little bit of interest. The lower the number that you missed your actual tax bill by, the lower the penalty is. The shorter the distance of time from the time you should have paid it until you paid it, the lower the penalty is. So it's not the end of the world.

I'm paying penalties every year, quite frankly. I think I filed in 12 states last year and I probably had to pay a penalty in three or four of them. And it's just not a big deal. It's a few dozen dollars or in my case, because I just didn't know much these states. But even if it's a more significant penalty, you had the money. So you benefited from the use of the money for six months or nine months or 12 months or whatever. It's not like you didn't get anything for paying that penalty. Basically you're just giving that interest you earned to the IRS, not the end of the world.

Try to get it right, but don't stress over this. People stress over this way too much. And after having trying to guess how much I owe on taxes every year, I stopped stressing over this. It's just not worth it. Do the best you can and call it good at that point.

All right. Let's take a question now from Rob. This one's asking about working in different states in a single year.

TAX CONSIDERATIONS IF YOU ARE LIVING AND WORKING IN TWO DIFFERENT STATES IN ONE YEAR

Rob:
Hey, Dr. Dahle. This is Rob from Chicago. My question is, are there any tax or other financial considerations for soon to be graduating residents or fellows who will be living and earning income in one state for one half of the year and a different state for the other half of the year?

Regarding my circumstance, I will be graduating residency in Chicago in June and completing a one-year fellowship in Minnesota starting in August. My wife and I currently own a home in Chicago and plan to return to it after fellowship. My sister-in-law will be renting our home from us during my fellowship year. My wife works for a marketing agency that is based in Chicago, and she will be continuing this job remotely from Minnesota. Thanks so much for your help.

Dr. Jim Dahle:
All right. Good question, Rob. You got all kinds of things going on in your financial life right now. There's not going to be a huge tax arbitrage. Illinois is kind of a high-tax state and Minnesota is kind of a high-tax state.

A lot of times when people change from one state to another, there's opportunities to save taxes by trying to get income assigned to the new state, the new low-tax state instead of the old high-tax state. If you're moving from Illinois to Florida or something, you might be trying to work that sort of a thing out.

And obviously, you can't be fraudulent. Money earned in one state has to be taxed in that state, and money earned in another state has to be taxed in that state. But if you can delay income until you're in the new state, you could justify that being taxed at a lower rate, those sorts of strategies.

Keep in mind, also, there's often a chance to get better prices on your disability insurance as you change states. New York and California in particular have pretty high prices for disability insurance. So if you were leaving one of those places and going to a new one, you might wait to buy your disability insurance at the new state or vice versa. If you're moving from a low-cost state to a higher-cost state, you might make sure you buy it before you leave. That would be another consideration.

There are also some rules on if you are going away temporarily to work somewhere else. And the cutoff for that is 364 days. You mentioned you're going to do a fellowship for a year. There are some people that only go do a fellowship for 364 days in order to be able to write off those expenses as essentially travel expenses, business expenses to go out and do that. So, that might be worth looking into. But it sounds like you're going to rent out your home anyway, and you're really moving. It's hard to justify if you're putting somebody else in your home while you're gone. It's a little bit harder to justify that as business travel expenses. But that might be something to look into, as well.

Otherwise, I don't think you're going to have a lot of complications in this situation. Presumably, you'll remain a resident of Illinois, and so you'll file your Illinois taxes as a resident, and you'll file your Minnesota taxes as a non-resident. I guess you could do part-year residence for both of them, but the way you'll probably do it is an Illinois resident the whole time, and then file a Minnesota non-resident tax return. That should give you a tax credit for the taxes you pay to Minnesota when you go to file your Illinois state income taxes.

I don't know. That's all I can think of that would apply to your situation. I hope that's helpful to you, Rob. Have a great fellowship, and I'm sure the people of Illinois will be very glad to have you back there.

Illinois is one of those places a little bit like Northern California that I wonder why there are any docs there. It tends to be lower pay for docs, higher taxes, and, particularly in the Chicago area, fairly high malpractice risk. You don't have to drive very far away from Chicago to dramatically lower your risk of malpractice lawsuits, a little bit like Dade County, Florida, that way.

Okay. For those of you who are not aware, we have a whole bunch of social communities. Everywhere you are on the internet, we probably have a community. We've got an Instagram that's growing like crazy. We've got a Facebook group as well as a Facebook page.

We're on Reddit. If you want to check out our subreddit, it's one of the fastest growing parts of White Coat Investor. We'll probably pass up our Facebook group in a year or two at the rate it's going. I think there's almost 70,000 people on our subreddit now.

On X, formerly known as Twitter, we've got tens of thousands of followers there. We even have TikTok. If you're into TikTok, hopefully the advice you get there is better than most TikTok tax advice out there. And of course, the WCI forum has been around for many, many years and is really a high, knowledgeable, in-depth community that can answer your questions.

Ask your money questions to others in the White Coat Investor community or help others out. There's almost 100,000 in that White Coat Investor Facebook group. It's pushing 70,000 from the White Coat Investor subreddit. And of course, you can find this @whitecoatinvestor on all channels. I should mention the YouTube channel as well. It's growing like crazy.

All right, let's take a question from Ashley, who's trying to help grandma with taxes.

HOW TO REDUCE TAX BURDEN FOR 85 YEAR OLD

Ashley:
I'm trying to help my 85-year-old grandmother with her taxes. She is well taken care of thanks to her late husband, but has six sources of required minimum distributions between social security, 401(k), annuity, pension, dividends, and DFAs. She's using less than 10% of her current income for her budget, but she's paying 22% of her income in taxes.

Most recommendations to decrease taxes I can find refer to HSAs and Roth IRAs, which I believe she's too late for. So we are looking into switching her annuity to an IRA and just paying taxes for that conversion so she can do charitable donations. But I was wondering if you had any other ways of moving her money around to make it more efficient for her? Thanks so much.

Dr. Jim Dahle:
All right, Ashley, great question. Thanks for helping out grandma. It's very kind of you. By the way, grandma has enough money she can hire a professional tax advisor if she wants to. Clearly, she's doing great. She's only living on 10% of her income.

This is the classic person that complains about their RMD problem because they're paying all this money in taxes in retirement. Well, the RMD problem is the greatest tax problem in the world to have. Nobody ever complains about having too much income during their working years, but apparently once you're in retirement, having too much income is worth complaining about.

You hear it all the time from retirees. “Oh, I hate these RMDs. I got to pay taxes on them.” Well, I assure you there are plenty of people out there that would love to have your RMD problem. 40% of Americans are living on nothing but social security in their retirement. So this is a great problem to have.

Could you simplify some things? Absolutely. I'm not sure why there's money in a 401(k) still. At 85, very few people still have money in a 401(k). It's got to be a very special 401(k) to still have money in it at 85. Most people will have rolled that over to an IRA at that point. So that might be one simplification that you could do.

I don't know where this annuity is either. Is this an annuity inside a retirement account, AKA a qualified annuity, or is it a non-qualified annuity? Now, if it is an annuity in a retirement account, I guess you could get the money out of the annuity while still leaving it in the retirement account and then do QCDs with it.

It sounds like grandma is pretty charitable. Well, that's cool because there's lots of cool things you can do with taxes when you're charitable, like give it away. You give your money away, you get a tax break for that. You can give up to $105,000 this year, and that number is now indexed to inflation, to charity via a qualified charitable distribution. So that would take care of the RMDs from the 401(k) unless they're more than $105,000 a year. Maybe they are. Grandma's doing really well. But that would be an option.

Even beyond that, though, you can still take the money out, pay taxes on it, donate it to charity, and take a deduction for what you donated. If you're donating cash, I think it's 60% of your adjusted gross income that you can take a deduction for. So grandma could certainly give lots of money to charity. That's the main deduction probably available to most people in her situation. And since it's something she wants to do anyway, it sounds like it would work out great. I would take advantage of that sort of a thing.

As far as these other sources of income, a pension, there's not much you can do there. Your dividends in a taxable account, you're going to pay taxes on that. The good news is you're paying them at your dividend tax rate. If you can lower your other taxes, you might even get into the 0% dividend bracket. I'm guessing not, given her success.

You mentioned at the end DFAs. I don't know what you're talking about with that. There's a DFA company that does mutual funds, dimensional fund advisors. They do mutual funds and now ETFs. There are also DAFs, which are donor advised funds, but I don't know why they would be giving your grandma any sort of an income distribution or RMD. I don't really know what you're talking about there, nor of any angles you can take there.

On the social security, your grandma is probably only getting about 15% of that tax-free. The other 85% is probably fully taxable for her. There's probably nothing she can do about that. For the most part, I think all grandma is going to be able to do here is give more money to charity to get a tax break for that, which is fine. She's only living on 10%.

I guess what she really needs to do is figure out what she wants to do with the rest of that money. Now, maybe she's so well-to-do that she has an estate tax problem. I'm guessing not, but if she does, it's certainly worth seeing the estate planning attorney in her state, see if there's some ways she can save on estate taxes. But I'm guessing she's not quite that wealthy, especially since most of these sources of income will go away at death, like the pension. And if it's an immediate annuity, that'll go away at death. And of course, social security goes away at death. I don't know what these DFAs are, but that's the way I think about it.

I wish I had some super-secret way to lower our taxes. Everybody's looking for that one crazy tax trick the IRS doesn't want you to know about to lower their taxes. But for the most part, that sort of thing just doesn't exist. When you make more money, you pay more money in taxes.

All right, our next question comes from Alan. Let's take a listen.

CAN YOU USE A CPA OR FINANCIAL ADVISOR TO DO TAX PLANNING?

Alan:
Hi, Jim. This is Alan from the Midwest. For your average Boglehead, asset allocation really isn't an issue. But when it comes to tax planning, that is where I have some questions. When thinking about who to discuss tax planning with, what different things would a financial planner provide versus just your run-of-the-mill CPA? Seems like a CPA would have a better understanding of the intricacies of the tax code. But I often hear financial planners offering tax planning services as a major selling point.

Dr. Jim Dahle:
Good question. The typical CPA doesn't do a lot with tax preparation. Let's be honest, there's lots of CPAs out there and they are accountants, they're not doing tax preparation. So if you're just going to a CPA, you may not be getting good advice at all.

As a general rule, most tax preparers, whether they are a CPA or an EA, an enrolled agent, do tax preparation. They don't do any sort of proactive looking forward tax planning. Everything they do is retrospective. Maybe they give you a tip or two at the end of the year that might help you. But for the most part, they're not meeting with you in advance and making suggestions on what you can do to lower your tax bill.

Those people are actually fairly rare. They are out there. We have a list of them on our website. They call themselves tax strategists for the most part. Some of them will help you set up retirement plans at your practice. Some of them will make other suggestions, meet with you throughout the year to try to lower your taxes, that sort of a thing.

It's not necessarily cheap. Sometimes it costs more than what a financial advisor would charge you to do financial planning and investment management. I've seen a few people that they routinely charge five figures a year to do that service.

Whether that's worth it or not, I suppose is up to you. It seems to me that a lot of things you can learn about taxes, you can pay for once and then you know it and don't have to keep paying ongoing fees for it. But I'll leave that up to you as to how much that sort of a service going forward is worth.

Typically, the more complicated your financial life, the more value they can add. If you're self-employed, if you've got 20 K-1s, if you're building a real estate empire, you may want someone who also has a real estate empire as your tax preparer and your tax advisor. They can advise you on getting real estate professional status and how to use depreciation best and how to do cost segregation studies and those sorts of things. I think that can be really valuable.

If you're a W-2 employee and you do a tiny bit of moonlighting and you have a taxable investment account, there's not a lot of advice they're going to be able to give you that's going to save you a ton of money. There's just not that much you can do because your situation is not that uncommon.

Now, financial advisors, they're not always the best with taxes, but at least they usually think about the tax implications of investing stuff. If you're doing 401(k) contributions and HSAs and managing your taxable account in a tax-efficient way, if they're a good financial advisor, they'll be taking a lot of that into consideration. But whether they will advise you to hire your kids at your non-corporation business to try to lower your tax bill, I don't know that I'd necessarily expect that degree of advice about taxes from a financial advisor.

It really depends on how much you're willing to spend, what kind of advice you're looking for. You might start with our recommended tax strategist list. You can find it at whitecoatinvestor.com and see if that doesn't meet your needs. But I agree, taxes and tax preparation can be a heck of a lot more complicated than just managing a portfolio of index funds.

QUOTE OF THE DAY

Our quote of the day today comes from Rob Arnault, who said, “Investing what is comfortable is rarely profitable.” And that's often the truth.

Okay. Let's talk about K-1s and tax preparation. This question is from Aaron. Can you tell all these questions today came in just before the 15th of April? Keep in mind, there's a delay. It takes us a while to make these podcasts. So if you're asking questions that you want answered before April 15th, you got to ask them way before April 15th, if you want to hear them on the podcast.

INTERPRETING K-1S AND TAX PREPARATION

Aaron:
Hi, Dr. Dahle. I have a question regarding interpreting K-1s and tax preparation. As a background to this question, I've invested in several local real estate syndications over the past several years. The general strategy of each of these syndications, which include individual apartment complexes/LLCs, is to buy the property at an assumed discounted price, renovate and restore the units within the property, and then rent the units out at a higher price within market value.

The subsequent plan is to perform a cash out refinance in three to four years, returning the initial investments, and then selling the property in eight to nine years with distribution of the returns.

My question involves the K-1 at tax season and how to prepare it. For example, for one of the syndications in year two, the K-1 shows my individual percentage share, box one with ordinary income of zero, box two with a loss of around $6,000, box 19 of net distributions of around $2,000, and about $9,000 in box 20N. The K-1 also shows a capital account analysis in box L.

How do I interpret these numbers? Given the distributions I have obtained, do I need to start making estimated quarterly payments or do I wait until my initial investment is returned? For full disclosure, I do hire a tax preparer each year. However, I would like some more information to understand this myself. Thanks for everything you do.

Dr. Jim Dahle:
All right, Aaron, a lot of great questions there. The two things that tend to drive people to professional tax preparation are number one, K-1s, like you described, and number two, if they're managing a portfolio of direct real estate investments and they're having to do a bunch of Schedule Es and figure all that out.

It's just really complicated. It's just not the same as putting in your W-2 and uploading your 1099 consolidated return from Vanguard and putting in a K-1 maybe from your partnership, that sort of a thing. It's just more complicated. It's harder.

What finally drove me to get professional tax preparation is I couldn't figure out which states I had to file in. So I ended up paying money to a tax preparer. And that's a lot of money. Tax preparation is not cheap. I have to really think about that mentally as I subtract the returns from the things I'm doing that make my taxes so complicated as I consider that.

This is one of those reasons why it doesn't make a lot of sense to have a whole bunch of syndications if you don't have much money invested in them because you're going to be paying a whole bunch of extra money to get your taxes figured out whether it's your time or you're paying for somebody else's time. It's just not worth it unless you're getting a certain amount of return out of those things.

There are explanations of the K-1 in the IRS publications. Maybe it's worth walking through those that might help you to better understand a K-1. But we can pull up a K-1 and walk through it a little bit here and see if that helps you. We go to irs.gov, schedule K-1. This one's off a partnership. It's a 1065 K-1. There's also 1120 K-1s for S-Corps.

But you'll see box one is ordinary business income. And this is a cool one in that at least through the end of 2025, ordinary business income is often eligible for the 199A deduction. We made a change a few years ago in my physician partnership so that our income did not come as guaranteed payments, AKA box four on the K-1, and instead came in box one, ordinary business income. It allows you to take the 199A deduction on it for some of our partners, not me actually because I make too much, but if you were working very part-time and that was your only income, you might have qualified for that deduction.

Two is the net rental real estate income. With these syndications you're describing, for most of the years that you're going to own this syndication, this number is going to be negative. Basically, it's depreciation overcoming all of the taxable income coming out of this investment to give you a loss. That keeps you from having to pay taxes on it. It's great. A typical syndication of the income you're getting from this $2,000 a year you mentioned is basically coming to you tax-free.

Now that depreciation gets recaptured when it gets sold, that gets recaptured at a lower rate, etc., but for years until the property is sold, this keeps you, as a general rule, from having to pay taxes on that income. That means you don't have to make some big quarterly estimated payments on it because you're not getting taxable income.

Box three is other net rental income. Some other boxes you'll often see money in is 19. That's just distributions. That's just what they sent you money in. They might have sent you $10,000, but it's not all taxable. That's just distributions, but it's not really taxable income. The IRS doesn't care as much about that.

In box 20, you often have lots of other interesting stuff like your 199A deduction and those sorts of things. There's a code that's often assigned to that. It's usually a letter, and you can go through the instructions for the K1 to see what the letters mean. Trying to figure all that out, especially if you've got a 60-page K1 sent from the syndication, is tough. That's what drives a lot of people to go, “Hey, I need a professional to sort this out.” And they're right. At a certain point, it's no longer a do-it-yourself project.

I'm a guy who did my own taxes for many, many years, but doing 20 K1s in multiple different states was just too much. I'm like, “I can't figure all this out. I need someone that this is what they do all day.” And so, I got somebody. They actually fired me after a while. They said, your tax return is too complicated for us. I had to go find somebody else that specializes in those complicated returns. Of course, I have to pay them more money than I was paying the first one.

Hopefully, that's helpful to you. I think you're probably okay not having to make quarterly estimated payments until these things start being sold. But that's a pretty typical strategy, a value-add strategy, cash-out refinance if you can, and then sell the property after eight or nine years. Lots of syndicators do that. It was very successful for the last 10 years. These days, multifamily is struggling a little bit. I would expect not to see as often those cash-out refinances. I would expect to see maybe some lower returns than what people might have had in the past on some of those.

Now, maybe things that are being bought right now, you're getting enough of a discount on them that it's still going to work out great. The properties that were bought in 2021, 2022, they might not have nearly as good a return as some of the stuff from the past.

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Dr. Jim Dahle:
Keep your head up and shoulders back. You've got this. We're here to help you. See you next time.

DISCLAIMER

The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.

INTRODUCTION

This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.

Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 169 – Homeless to a quarter million dollars.

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Welcome back to the Milestones to Millionaire podcast. This is the podcast where we take your experiences and your accomplishments and use them to inspire others to do the same. We'll celebrate anything with you, whatever your accomplishment might be, whether it's a net worth milestone, whether it's paying off some sort of a debt or making some purchase you've been saving up for. Whatever it might be, we'll celebrate it with you and use it to inspire others to do the same.

I want to make sure those of you out there who are still trying to become financially literate know about this great resource we have. We call it WCI 101 or the Financial Basics. You can sign up for this free resource at whitecoatinvestor.com/basics.

Basically, what you're signing up for is to get a bunch of short emails. You'll get every few days for a number of weeks, you'll get a bunch of short emails that will teach you finance. And if you read through these, by the time you get to the end of it, you will be dramatically more financially literate.

The combination of financial literacy and financial discipline is so powerful and so unusual in our world that it's like having a superpower. Anyway, you can get that whitecoatinvestor.com/basics.

INTERVIEW

All right, we got a great interview today. As you heard in the title, our podcast guest has actually spent some time homeless and is really now building wealth very rapidly. And so, I think it's a pretty interesting story, a little bit different from most of the ones we've had on this podcast. But stick around afterward. We're going to talk for a few minutes about risk, when it comes to investing and risk management.

Our guest on the Milestones to Millionaire podcast today is Josh. Josh, welcome to the podcast.

Josh:
Hey, how's it going, Jim? How you doing?

Dr. Jim Dahle:
Good. Tell us what you do for a living and how far you are out of your schooling.

Josh:
Sure. For the last 10 years or so, I've done what people refer to as technical coaching or agile coaching, basically helping software development teams and engineers work better together as teams to deliver worthwhile products to market. And I've been doing software development myself since 1998. And I graduated with my undergrad in 2006.

Dr. Jim Dahle:
Okay, so since 2006. And what would you say over that time period your income range has been?

Josh:
My income has ranged anywhere from, I would say around $14,000 all the way up to most recently was $136,000 per year.

Dr. Jim Dahle:
Okay, so pretty broad range.

Josh:
Yeah.

Dr. Jim Dahle:
And let's talk about what milestone we're celebrating today. You hit a net worth milestone recently. Tell us what it was.

Josh:
Yeah. My net worth hit and stayed at, the important part, it stayed there for a while, $250,000.

Dr. Jim Dahle:
Very cool. And what's that composed of? What's in there? How much is cash? How much is in retirement accounts? How much is a house? What is it?

Josh:
Sure. Right now it's roughly about 6% cash and the rest is all index funds in equities.

Dr. Jim Dahle:
In retirement accounts or just in a taxable account?

Josh:
Oh, that's fair. I do have a little bit in the Roth. I would say it's around $20,000 in the Roth. Most of it's in traditional because rollover from 401(k)s. And then there's about $60,000 or $70,000 in taxable.

Dr. Jim Dahle:
Very cool. Very cool. And you got any debts?

Josh:
Not anymore. Yeah. Unlike what happened with a lot of people during COVID, 2020 was actually a pretty good year for me. I got out of debt, completely out of debt at the tail end of 2020. And I started rigorously investing in beginning of 2021.

Dr. Jim Dahle:
What kind of debts did you have prior to that?

Josh:
I had about $120,000 in student loan debt and then about another $50,000 to $60,000 in credit card.

Dr. Jim Dahle:
Okay. So you had a cleanup job there.

Josh:
Yeah, yeah. Let's just say 2007 to 2010 was kind of rough.

Dr. Jim Dahle:
Okay. And you carried those debts from that time until close to 2020?

Josh:
Yeah. I think at that time I was making about $20,000 a year as a freelance web developer, business consultant. And then, yeah, I finally found gainful employment in 2011. And then, yeah, spent the next 10 years just getting out from under that.

Dr. Jim Dahle:
What do you think the nadir was? How low did your net worth ever get?

Josh:
When I actually started paying attention, so that would be my other piece of advice, I guess, would be pay attention. When I started paying attention again, I would say that my complete negative was $150,000, somewhere in that neighborhood.

Dr. Jim Dahle:
That's a pretty good swing from negative $150,000 to $250,000 on the positive. Well done.

Josh:
Yeah. Thanks.

Dr. Jim Dahle:
Well, you've had a little bit of a different journey, I think, than a lot of listeners. A lot of listeners to this podcast are doctors. They start out with these huge debts and then they come out, negative $400,000, but they have a good income. They have a big shovel, we call it. And they start making progress rapidly if they pay attention. That wasn't necessarily the case for you. You had a lower range of income than many of our listeners, and yet still are managing to build wealth. So tell us your journey a little bit.

Josh:
Sure. 2006, graduated with undergrad. 2007, I quit and decided that I was going to go run off and try to do freelance business consulting. And then during that time period, I was able to do that full time. And part of why I was able to do that was through starting graduate school to keep my student loans in deferment.

And then 2010, finally, the Great Recession finally hit my clients. And I ended up becoming homeless for that year. And then, yeah, it took me about a year to bounce back from that. I did some work with the Census Bureau during the 2010 census. While being homeless, I hope I don't get arrested for saying that. But yeah, it was definitely an interesting ride.

And then in 2011, I got fortunate enough to start with $70,000. Again, not a doctor's salary at all. But then, yeah, we just kind of stepped up and stepped up. I don't think I broke six figures until 2015, 2016. But after that, it went really fast. Because I also didn't get tripped up with the Diderot effect and the hedonic treadmill either. As my salary kept increasing, I was like, “Yeah, no, I'm still homeless, Josh, living in my car. It's fine.”

Dr. Jim Dahle:
I'm an emergency doc. I interact with the homeless all the time. And I know there's a broad range of the homeless. People have this image in their mind of the homeless as a bum sleeping on the corner, alcoholic, doing nothing, mentally ill, et cetera. But the truth is most homeless are not like that. They're much more in your sort of situation, couch surfing, staying in their car, trying to get work, et cetera, et cetera.

What experiences did you have when you were homeless that you think would be useful for our audience to hear?

Josh:
I think for me, the big thing that impacted me was what you just observed, which is just how many working homeless there actually are in the United States, because that's where I was. But I would sleep in my car at a truck stop. And every once in a while, people would pull up, and they would have these vans that had marketing logos for their business. One person I knew, I didn't know them, but who pulled up next to me one time was a computer repair person. They would drive out to somebody's house. But when they opened up the side of their door, there's a cot in the back of the van.

You would be surprised how many people are actually unhoused, but are doing very technical work. I ran into a woman who did virtual reality worlds. She was working with Kennesaw State University out in Georgia, making these virtual reality worlds. And she had a storage unit and a converted van that she lived in. So yeah, it's quite fascinating. But it's not something that normally you're just like, “Hi, I'm Josh, and I'm homeless.” That's not something that pops up in normal conversations.

Dr. Jim Dahle:
How did that imprint on you and the way you manage money now? Now you're making a pretty good income. You're making a six-figure income. You're building wealth. You're completely debt-free. How did that year or so when you were literally living out of your car, how did that impact how you make money decisions now?

Josh:
I found that I wanted for less, if that makes sense. I sort of became at peace with having less and less stuff. It wasn't about “What can I collect over here?” It became more about “What experience am I having?” and sort of the man's search for meaning, Viktor Frankl, where it's like, “How do I respond to this situation and not lose sight?” One of the things that I told myself when I first decided to become homeless was, “You're homeless, not hopeless.”

And so, keeping that vision on what a future could be, but not making it so grandiose that it was unachievable, with five cars and a 50,000-square-foot mansion or anything like that. It was just, “Hey, how can I have a better shirt today? And then how can I get into a studio apartment? And then what about a one-bedroom?” That sort of thing.

Dr. Jim Dahle:
You have a partner now and you're sharing expenses. What kind of an impact has that had on your ability to build wealth?

Josh:
That's a great question. I would say that the first thing that actually impacted my ability to build wealth was actually getting rid of my car in 2012. And then the second piece would be having someone that I could share and split bills with, because there's a fundamental difference between paying $1,500 a month in rent versus $750 split between two people. In a way, we're kind of house hacking, but we are romantic partners, so it is a little different.

Dr. Jim Dahle:
What advice do you have for somebody else? There's someone else out there who, for whatever reason, has been spinning their wheels. Maybe they're not living out of their car, but they've been spinning their wheels, not building debt. Maybe they're still with a negative net worth. They'd love to be where you're sitting, debt-free with a quarter million dollars. What advice do you have for that person?

Josh:
I think the biggest piece of advice that I have would be always be investing and taking advantage of what's available to you with regard to 401(k), everything like that. Because when I first started, I got some advice from we'll call it a financial advisor. And basically the advice was get out of debt first and then worry about investing. Because I was calling to talk about, “Hey, I'm gainfully employed now. Should I start looking at things like my Roth IRA and investing in that?” And the advice was, “No, just get out of debt.” And I did.

And so, by the time I actually got out, I don't know when I actually hit back to broke. But by the time I got out, I had $40,000 in cash and no debt. But I also had no investments, like none. Always invest something.

Dr. Jim Dahle:
Always invest. That's good advice. Now, a lot of trouble that people have sometimes when they come from a rough upbringing, if their parents were lower middle-class or if they've had some sort of traumatic financial episode in their life, such as you've had where you spent a year basically living out of your car, they develop what's called a scarcity mindset. And I think you've heard that phrase before. What have you done to try to not fall into that trap?

Josh:
Yeah. Scarcity mindset is actually something we get taught a lot in my profession as well, where it's just if this one domino hits, all of a sudden, the rest of the world, the sky starts falling. And I think for me, it really comes back to enjoying and appreciating what I have instead of wanting for what I don't have and really trying to chase that. Because I think scarcity comes more from paying too much attention to what you lack instead of really emphasizing what you have.

I once worked with somebody out of DOD, former military. I know you're a former military. My dad was military. Actually, are you still military? I can't remember.

Dr. Jim Dahle:
No, I've been out now for 13 years.

Josh:
Fair enough. One day I'm in the office and people are running around like they're on fire. And the cybersecurity guy is just sitting there as relaxed as can be compared to everybody else. And I walked over to him and I was like, “Okay, why are you not freaking out?” And he basically said, “Listen, I'm not trying to kill anybody. Nobody is trying to kill me, and I get to sleep in my own bed.” And I was like, “That's a great outlook.” As terrifying and hyperbolic as it is, it's still just like appreciate what you have and don't long for what you don't.

Dr. Jim Dahle:
Absolutely. Well, you've become a quarter millionaire. What's next for you in your financial goals?

Josh:
Yeah, next, two big things. One, I'm trying to get back into being more freelance, independent, corp to corp kind of work from a contract perspective. And then there's actually four more milestones that I have, because the quarter of a million is actually based off of what I call my coast 5 stack, which is basically just a bunch of numbers that I said, “Okay, if I don't save any more money I could retire at 70 and probably be okay.” And then build it back to 65 and then 60 and then 55 and then possibly 50. So, yeah, I'm just going to keep trying to get those going and see what we can do while enjoying the ride, I guess.

Dr. Jim Dahle:
Cool. Well, Josh, congratulations to you on your success and thank you so much for coming on the Milestones podcast to inspire somebody else to do the same.

Josh:
Yeah, absolutely. I appreciate your time. Thank you.

Dr. Jim Dahle:
Okay, I hope you enjoyed that episode. It's really quite a remarkable story. Sometimes we forget that a lot of us had a pretty significant hand up in life, just to be able to get a little help paying for school or to be able to go home and live with parents for a while or the income that we get pretty guaranteed once we make it into medical school. There are a lot of benefits that we have in life that maybe we ought to be a little bit more grateful for. And there's nothing like truly being homeless for a while to make you grateful for just about everything in your life.

FINANCE 101: RISK

All right, I promised you at the top of the podcast that we would talk about risk today. And there's a real problem in the financial world in that risk is often equated to volatility. Your investments going up in value, going up and down in value, going up, going down. And that's what risk is often in academic papers and academic journals.

But honestly, that doesn't really matter all that much. If you're investing for a goal that's 30 years out, does it really matter what the volatility is between now and then? So long as you can control your behavior enough to not do something stupid because of that volatility, then it really doesn't matter. That's not true risk. True risk is the permanent loss of capital, where it's not going to bounce back.

Now you've got that risk if you've decided to run the undiversified risk by investing in something like individual stocks. Individual stocks can do go to zero all the time. But if you're investing in an entire market via an index fund, that risk just really isn't there, barring an Armageddon-type scenario.

The real risks in your portfolio, if you have a portfolio of broadly diversified index funds, the real risks are the four horsemen of the apocalypse, as Dr. Bernstein has described them.

The first and most common one is inflation. And inflation is a big deal, not when it's 3% necessarily, although you do need to set up your portfolio such that you can overcome that sort of low rate of inflation that's pretty typical in today's financial societies. The big risk is that inflation gets out of control.

Now we all understand this a little bit better now than we did five years ago. Our inflation in this country, as measured by the consumer price index for urban consumers, peaked at just over 9% a couple of years ago. And at 9%, your wealth is really being eroded pretty darn rapidly. And so, I was pleased to see the Federal Reserve take pretty significant steps to try to rein that in. They can be criticized that maybe they should have done it a little bit faster, but at least they acted aggressively when it became time to act aggressively.

Now that's caused a lot of pain. It's caused pain in the real estate markets, both for investors as well as people trying to buy houses using credit. It's caused pain for businesses that haven't been able to get the credit as easily as they would like to because interest rates went up 4%.

But I assure you that all the pain in society now due to increased interest rates are far less than the pain we would have if we had let inflation continue to be out of control. All you have to do is look at a society like Argentina and what they're dealing with right now. They're literally having votes trying to decide whether to even use their own currency. They may just start using ours because it's viewed as being more stable.

Hyperinflation is a real risk. It's the most common of these four horsemen of the apocalypse, and your portfolio should be designed to withstand it. And you can do that by having a healthy allocation to assets that typically beat inflation. Things like stocks and real estate, things with higher returns than inflation has typically been.

On the fixed income side, you can do things like keeping your durations short. That reduces your risk should interest rates need to be increased rapidly, and it helps you get the current going rate on those interest rates. Also, you can get inflation indexed bonds. You can get I bonds. You can get TIPS. Those sorts of things help you to keep up with inflation.

Sometimes people make an allocation to other items in their portfolio, typically speculative assets. These might be commodities. It might be precious metals like gold or silver or platinum. It might be a crypto asset like Bitcoin. I would encourage you to limit your allocation to those sorts of speculative investments, but they can play a role in beating inflation.

The next of the four horsemen is deflation. And the classic scenario historically to think about this is the Great Depression. This is a time of economic contraction. And it really did a serious number on people's wealth. Now, those with long-term bonds actually did pretty well in a deflationary scenario. But equities dropped 90%. Properties dropped dramatically. Some insurance companies didn't pay as they were supposed to. A number of banks failed. This is a real risk to your wealth to go into a real period of deflation.

The next one is confiscation. We all think we're dealing with confiscation every April 15th. And I suppose in some small way, you are. But governments can do much more than what our government does to us April 15th of each year. They can increase taxes dramatically. There are some societies in our world that have tax rates of over 50%. And they can go higher and higher and higher.

In addition to that, sometimes private assets are simply taken by the government. You've heard the phrase eminent domain. They're going to put a freeway through and they can just seize your house. Typically, the fair thing to do is pay your market value for the house. But there's no guarantee that the government will actually do that.

If you look at a period like 1918 in Russia, basically this communist revolution took place and people just lost their private assets. They were confiscated by the government. Serious risk, difficult to protect against, not nearly as common as inflation. But you can see why some people do things like put a little bit of their money into Bitcoin. The idea being that maybe you can hide that from the government in a confiscatory scenario.

The final big risk to your portfolio is devastation. Just widespread economic, political, social devastation. Imagine you're in Germany at the end of World War II or Japan at the end of World War II and your cities have just been firebombed. Someone's dropped nuclear bombs on the cities in your country. GDP is dramatically contracted and it's devastating. Your entire house has been blown up and no insurance company is going to rebuild it. That's a true risk. Very hard to defend against. I guess you can spread assets out in multiple countries across the world, but even then there are no guarantees.

But when you think about risk, those are the big risks in your life. It's not the little risks you see when you're looking at some financial study that shows a little bit of volatility of your investments. So, keep that in mind as you invest. Try to deal psychologically and emotionally with your volatility, putting it in an appropriate place, but keep in mind what the true risks are to your financial life.

SPONSOR

Our sponsor for this episode is Resolve. They are the number one rated physician contract team, reviewing 1,000+ physician contracts every year. They empower physicians with location specific compensation data, which leads to unparalleled leverage during the physician contract negotiation process.

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Thanks for being part of the White Coat Investor community. Thank you for listening to the Milestones to Millionaire podcast. If you'd like to be a guest on it, you can apply at whitecoatinvestor.com/milestones.

Until then, we'll leave you with these words. Keep your head up, shoulders back. You've got this. We're here to help. Take off your milestones one by one and you too can reach your financial goals.

DISCLAIMER
The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.