What Is the Price to Earnings (P/E) Ratio – Definition, Formula & Limitations

Before you start investing, you should know a few things about the stock market. One of the most widely known concepts is that you should buy low and sell high, making a profit in the middle. This is a widely-used strategy known as value investing.

But how exactly do you know what a “low” price or a “high” price is?

Successful value investors use a wide range of valuation metrics to determine whether a stock is undervalued, priced at par with its market value, or overvalued.

One of the most commonly used valuation metrics is known as the price-to-earnings ratio, or P/E ratio. The P/E ratio compares the current stock price for shares of a company to the amount of net profits, or earnings, the company generates per year.

The idea is that by comparing how many years’ worth of the company’s earnings it would take to buy the company outright, you can get a good idea of whether the price of the company — and therefore shares of the company — are trading at, below, or above its true market value, also called the intrinsic value.

What Is the Price-to-Earnings Ratio?

In simple terms, the P/E ratio is a valuation metric that helps investors make educated investment decisions. But how does it work?

Price-to-Earnings Ratio Formula and Calculation

The P/E ratio formula is a relatively simple one:

Share Price / Earnings Per Share (EPS) = P/E Ratio

For example, a company’s stock currently trades at $100 per share. The company’s earnings during the past year came in at $20 per share. In this case, you would divide the $100 stock price by the EPS of $20, and you would come to a P/E ratio of 5.

In this example, if the company’s earnings per share remain consistent and you purchase the stock right now, it would take five years for the company to generate enough profits to cover the initial cost of purchasing the share.

In general, stocks that trade at a discount trade with low P/E ratios, while stocks trading at a premium trade at high P/E ratios. Nonetheless, as you will learn below, there are some exceptions to that rule.

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Different Types of P/E Ratios

When talking about price-to-earnings ratios, investors generally default to the current, or trailing, P/E ratio.

However, there are actually three different P/E ratios that some of the most successful value investors follow, along with a related measurement known as the PEG ratio that takes valuation analysis to the next level.

1. Current or Trailing P/E Ratio

The current, or trailing, P/E ratio is the traditional calculation described above. This P/E ratio compares the current price to the 12-month trailing EPS.

2. Projected or Forward P/E Ratio

The forward P/E ratio is more of a speculative valuation metric because it attempts to predict the future. The idea is that if a company does well, it will grow, and investors can expect more out of future earnings than current earnings.

Therefore, by comparing the current share price to projected future earnings, you get a more detailed view of the current valuation of the company, taking its growth prospects into account.

There are two ways the forward P/E ratio can be calculated:

Current Share Price / Median Guided EPS = Forward P/E Ratio

Using this formula, you would divide the current price per share of the stock by the company’s estimate for EPS in the coming year.

Companies usually provide their expectations — or guidance — for the coming quarter or year in their shareholder reports. In most cases, guidance is displayed as a range. For example, a company may say it expects to earn between $10 and $15 per share over the next year.

Find the center point in the guidance by adding the two extremes together and dividing your total by two. In this case, you would add $10 and $15 to come to $25, then divide $25 by two to come to median guided EPS of $12.50.

You can also use the following formula:

Current Share Price / Analyst Median EPS Expectations = Forward P/E Ratio

Stock market analysts provide all kinds of predictions about publicly traded companies, including where the market price is headed, revenue expectations, and earnings expectations.

Using the formula above, you would ignore the company’s own guided expectations and rely on outside analyst projections, dividing the current share price by the median EPS expectations among analysts that cover the stock.

Of course, these two approaches will generally result in different forward P/E ratios.

3. Mixed P/E Ratio

The mixed P/E ratio, also known as the relative P/E ratio, takes both past earnings and expected future earnings into account using the following formula:

Current Share Price / (Past Two Quarters’ EPS + Future Two Quarters’ EPS) = Mixed P/E Ratio

This formula mixes the two formulas above by using the trailing EPS for the past two quarters rather than the past year and using the forward EPS for the next two quarters rather than the next year.

When calculating the mixed price-to-earnings ratio, you can either use the company’s guided earnings for the next two quarters or the analyst expectations for the next two quarters.

It’s a good general rule of thumb to calculate it both ways for a full understanding of mixed P/E valuation.

4. PEG Ratio

The PEG ratio looks at the price-to-earnings ratio while factoring in growth. The formula for the PEG ratio is:

P/E Ratio / ((Earnings This Year / Earnings Last Year)-1) = PEG Ratio

By factoring in earnings growth, investors get a more accurate picture of whether the stock is overvalued, undervalued, or trading at fair market value.

A PEG ratio of 1 is considered fair market value. When the PEG ratio falls below 1, the stock is considered to be undervalued and likely represents a strong buying opportunity.

Conversely, a PEG ratio above 1 suggests that the stock is overpriced, indicating that you’ll want to look elsewhere to find strong future growth opportunities.

What Does a P/E Ratio of 0 Tell You?

Often when digging into P/E ratios, you’ll find that the ratio is shown as “0.” A P/E ratio of 0 means that the company is currently generating negative earnings, or operating at a loss. Therefore, the P/E ratio cannot be calculated.

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What Is a “Good” P/E Ratio?

There is no static number that acts as a good P/E ratio across the market. Companies in different sectors tend to grow at different rates.

So, to determine if the P/E ratio of the stock suggests over- or undervaluation, it’s important that you look at the average P/E ratio across the sector that particular stock lives in.

Here are the average P/E ratios by sector based on December 2020 readings:

  • Technology Stocks P/E Ratio: 59.54
  • Service Stocks P/E Ratio: 213.18
  • Consumer Staples Stocks P/E Ratio: 50.94
  • Energy Stocks P/E Ratio: 0
  • Health Care Stocks P/E Ratio: 72.68
  • Biotech Stocks P/E Ratio: 49.48

It’s best to check industry averages at the time of your investment; you can use a resource like CSI Market’s valuation by industry to do so.

Is a High P/E Ratio Always a Bad Thing?

Naturally, investors look for lower price-to-earnings ratios when looking for opportunities to buy undervalued stocks at a discount. But is a higher P/E ratio always a bad thing?

Not necessarily.

P/E ratios are based on the current price of common stock compared to reported earnings over the past year. However, reported earnings and future prospects are two completely different topics.

In the technology and biotech sectors, it’s common to find stocks with what seem to be exorbitantly high P/E ratios. However, these higher ratios are generally justified by expectations of higher earnings.

For example, a biotechnology company currently may be generating little by way of profits but trades with a P/E ratio of 250. Consider that the average P/E ratio of biotech stocks is about 50 at the moment. With a ratio of 250, the stock is obviously overvalued, right?

Not always.

If the biotechnology company has a new drug application with the FDA for a new cancer therapy that proved to be more effective in clinical trials than the current standard of care, earnings will likely climb dramatically soon when the FDA approves the drug and the treatment hits the market.

Although this type of situation is generally seen in the technology and biotechnology sectors as a result of the industries being driven by innovation, any expectations of a coming blockbuster product, accretive acquisition, or anything else that will drive earnings higher can lead to higher P/E ratios that are entirely justified.

Is a Low P/E Ratio Always a Good Thing?

With the idea being to buy stocks at a low price and sell them at high prices, a low P/E ratio is naturally a good thing — right?

That depends on various factors.

For example, let’s say a technology company is doing relatively well. However, it’s trading with a P/E ratio of 10. That stock has to be a buy, right?

In many cases, yes. However, if the company has failed to innovate and produce compelling new products over the past couple of years, it may be quickly losing market share.

In this case, earnings are expected to fall, so a P/E ratio in line with the overall tech sector simply wouldn’t be justified. The low P/E ratio is more of a warning of painful times to come rather than a red sticker with a discount printed on it.


Is the P/E Ratio the End-All in Valuation Metrics?

Valuation is an interesting topic because the valuation of any stock on the market is relative. The value of anything — whether it be stock, a car, or a slice of pizza — is what someone else is willing to pay for it.

Considering the relativity of valuation, it’s impossible to tie down exactly what the value of any share of stock should be. Nonetheless, successful investors use various valuation metrics to give them an idea of whether they’re getting a good deal when buying shares.

Some of the most common valuation metrics used on Wall Street are listed below.

Other Valuation Metrics to Consider

  • Price-to-Sales Ratio. The price-to-sales ratio compares the price of a single share of common stock to the revenue generated from sales by the company over the past year. It’s a strong metric to use with more established companies that are generating consistent revenues.
  • Price-to-Book-Value Ratio. Price-to-book-value compares the current price of the stock to the value of assets the company has on its balance sheet. This is an important valuation metric because it gives the investor an idea of what the company would be worth if it was forced to liquidate its assets due to financial instability.
  • Price-to-Free-Cash-Flow Ratio. Finally, the price-to-free-cash-flow ratio compares the current price of the stock to the free cash flow generated by the company on an annual basis, providing a comparison of the stock price to the liquid cash the company generates.

Final Word

As you dive deeper into the stock market, you’ll quickly find that taking the time to understand current valuations of the stocks you’re interested in buying is a fruitful endeavor. At the end of the day, if you are blind to valuation, it’s easy to make the mistake of buying a stock that’s overvalued and doesn’t have much room for growth.

Although the P/E ratio is one of the most widely used valuation metrics, it’s far from the only one. Moreover, considering that valuation is a relative metric, it’s important to use as many tools as possible to get an understanding of the current value of any stock before making a purchase.

In conclusion, valuation is important, but it is only one part of the due diligence process investors should take part in before risking their hard-earned money.

Before buying any stock, make sure to research the company’s financial stability, market penetration, and continued innovation with the goal of cornering the market in the future.

Source: moneycrashers.com

Buying Silver vs. Gold as an Investment – What’s Better?

When most people think about investing, they likely think of buying pieces of companies on the stock market. Indeed, stock market investing has helped countless people build wealth over the years.

However, the most savvy investors know that the stock market is a battle between the bears and the bulls — one in which prices fluctuate significantly, resulting in risk. To balance that risk, most successful investors look to safe-haven investments as a reliable store of value.

One of the most common ways to hedge against stock market risk is investing in precious metals, the most popular investments of this type being silver and gold. But what’s the difference between gold and silver, and which represents the better addition to your investment portfolio?

The Gold-Silver Ratio

Investors often use ratios when predicting where the values of assets are likely headed. For example, equity investors look at the price-to-earnings, price-to-book, and price-to-sales ratios when determining whether a stock is undervalued, overvalued, or trading at a fair market valuation.

But silver and gold aren’t companies. They don’t generate profits and have no earnings, book, or sales to value.

Instead gold and silver investors have looked at the gold-silver ratio to help value these precious metals. This ratio compares the price of gold to the price of silver based on the idea that their historical valuations follow predictable patterns.

For example, if the gold-silver ratio is 10-to-1, it means that gold is currently trading at 10 times the value of silver. Before the 1900s, this ratio stayed generally flat at 16-to-1 through history, meaning that if an ounce of silver was worth $5, the price of gold would be $80 per ounce, according to Provident Metals.

Today this ratio suggests significant potential for growth in the price of silver. Over the past five years, the ratio has been as high as 120-to-1 and as low as 64-to-1, with the current ratio sitting closer to 68-to-1, according to BullionByPost. Many believe the incredibly high ratio suggests the price of silver has room to climb substantially to eventually return closer to the 16-to-1 level it held for more than a century.

Although the past performance of an asset isn’t always indicative of what you can expect to see in the future, there is a strong argument that silver is significantly undervalued compared to gold.


How to Invest In Silver and Gold

Regardless of whether you choose to invest in silver, gold, or a mix of the two, you’ll need to know how to go about making those investments. There are several ways you can gain exposure to these assets, with the most common being:

Buy Bullion (Physical Metals)

Bullion is, by definition, physical gold and silver bought and sold based on its value by weight rather than as a coin or collectible. These physical precious metals, often referred to as gold and silver bullion, often come in the form of bars and one-ounce bullion coins.

For example, if you want gold bullion, you can purchase gold bars or gold coins on an exchange that sells bullion, based on the current spot price of the metal plus a service fee. If you wanted physical silver, or silver bullion, you can purchase silver bars and silver coins on an exchange at the current spot price of silver. Some of the most popular exchanges include:

  • Vaulted
  • Money Metals
  • American Precious Metals Exchange (APMEX)
  • JM Bullion
  • Gold Eagle Coins

There are benefits and drawbacks to purchasing physical precious metals. First and foremost, physical valuables can be stolen or lost. You’ll need a safe place to store the metals, and a standard safe in your home or a safety deposit box may not be enough space. Many investors enlist services that safely store the metal for them — at an additional cost of course. And unless they are specifically insured through a private insurer, most standard homeowner’s or renters insurance policies don’t cover theft of gold and silver bars or coins.

On the other hand, when you purchase physical metals, you’re able to touch your investment and hold it in your possession, unlike when you buy paper or digital forms of these assets, which can give investors peace of mind.

Buy Gold and Silver ETFs

Exchange-traded funds, or ETFs, are a popular investment option for those looking to invest in a diversified group of stocks, but many don’t even think about them when investing in assets like silver and gold. The firms that manage these funds pool money from large groups of investors and buy large amounts of the assets they target, often giving them an edge in the market.

Although most ETFs are focused on assets like stocks and bonds, there are plenty of funds that make investments in precious metals. By investing in these funds, you’ll gain exposure to these safe-haven assets without having to handle the buying, selling, or storage of physical bullion.

However, there are cons to consider here. Investment-grade funds are managed by experts, which comes at a cost in the form of the fund’s expense ratio. Moreover, when investing in ETFs, you won’t have any physical metals in your possession, which is a factor many precious metal investors enjoy.

Many precious metal ETFs trade on major stock exchanges like the Nasdaq and New York Stock Exchange. Some of the most popular precious metals ETFs include SPDR Gold Trust (GLD), iShares Gold Trust (IAU), and iShares Silver Trust (SLV).

Buy Mining Stocks

If you’re interested in gaining exposure to the safe-haven features of silver and gold investments but you also want exposure to the growth the equities market provides, you’ll be able to find a nice blend by investing in mining companies.

Some mining companies are focused on gold, others on silver, and some focus on a mix of the two. Whether you want exposure to one or the other, a good mix of both, or to any of the many other valuable metals out there, you’ll be able to find quality mining stocks to invest in.

Investing in these stocks not only gives you exposure to the metals they mine, but access to the capital appreciation that equities have the potential to achieve. On the other hand, equities come with increased volatility risk compared to physical bullion or investments in highly-diversified ETFs focused on investing in these assets.

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Key Features

Whether you plan to invest in silver or gold, there are a few factors you should give serious consideration. Although both investments are considered safe and relatively liquid, there are key differences between the two that will make one more appealing than the other to different investors.

Safety

As mentioned above, silver and gold are both generally good investments for safe-haven investors looking for a relatively liquid store of value. However, even among assets considered to be havens, levels of risk differ. Here’s how gold and silver stack up in terms of safety:

Silver Experiences More Volatility

Investors who look to the gold-silver ratio generally do so to get an idea of the relative valuation of silver, with gold recognized as the more stable asset. That means the silver market tends to experience higher levels of volatility.

This is a benefit to many who believe silver is highly undervalued and will make a comeback in relation to gold, but it does increase the risk associated with an investment in silver. After all, volatility is a measure of the pace at which growth or losses take place, meaning assets with higher levels of volatility generally experience losses or gains at a faster rate than more stable assets.

Gold Is the More Stable Asset

Investing in gold is a far more stable option and acts as a solid store of value. Gold prices tend to move at a slower rate. The stability in gold’s spot price adds a level of safety for investors.

When the price of gold falls, it tends to fall at a slower rate than silver. If you’re looking for the safer of the two options, gold is definitely the way to go.


Growth

If your ultimate goal in investing is to allow your money to work for you, you want growth. Granted, when investing in safer assets, growth is relatively slow compared to equities and other riskier assets, but the rate of movement in the upward direction is important nonetheless.

Silver Has More Potential For Growth Than Gold

If you’re looking for growth, silver may be the better way to go. As explained above, the gold-silver ratio suggests silver may be significantly undervalued at present. As any value investor will tell you, investing in undervalued assets provides the potential for significant returns as the price of the asset climbs back to a fair market valuation.

Although there’s no telling when the ratio between the two metals will fall back to 16-to-1, with it sitting above 60-to-1 at the moment, it’s clear that there’s plenty more room for growth in silver’s price relative to gold, at least from a historical value perspective.

With that being said, historical data is not always indicative of future performance. Although the potential for silver’s price to climb at a higher rate than gold’s, the market moves in mysterious ways, and growth isn’t ever guaranteed.

According to Statista, in 2020, silver gained around 20% while gold was up 25%, showing that gold can still grow faster than silver in some cases — especially when the industrial utility of silver experiences slowing demand.

Gold Experiences Slower Growth

On the other side of the coin, gold is a more stable investment, but that stability comes with a trade-off. The commodity is a slow-growth asset. Sure, there are times when gains in gold will outpace those in silver, but for the most part, the low-volatility, slow-moving nature of gold prices results in lower profitability.


Cost

Affordability is important. After all, a well-diversified portfolio will only have a relatively small portion of its assets tied up in either gold or silver. If you’re building a portfolio with $5,000, allocating 10% of your assets to these investments would only allow for $500 to invest in the precious metal of your choice. And there’s a huge difference between gold and silver prices and thus how much of each you can buy for that amount.

Lower Prices Make Silver More Accessible

The price of a troy ounce of silver was around $26 in late April 2021. That relatively low price makes the commodity far more accessible than other, more expensive investment options. At that price, 10-ounce silver bars cost about $260 each.

As a result, silver investments tend to be the choice among younger investors that are just starting out and don’t have thousands of dollars to invest in safe havens.

Gold Is Far More Expensive

If you want to get involved in buying gold, you need to have a meaningful amount of money to make your initial investment. In late April 2021, one ounce of gold was worth about $1,780.

Given the example above, with $500 to invest in precious metals, you wouldn’t have enough money to buy even a single ounce of gold, let alone 10-ounce bars. Sure, you can buy gold by the gram, or even by pennyweight, but buying smaller quantities increases your overall cost, making these investments less advantageous.


Causes of Price Fluctuations

Before making any investment, it’s important to get a detailed understanding of what makes the price of the asset you’re investing in move. This will help you make your decision as to when to buy what assets, and what to expect as a potential result of your investment.

Silver Catalysts

There are several catalysts that have the potential to move the price of silver either up or down. Some of the most significant fundamental signals to look for include:

  • Market Conditions. While silver is more volatile than gold, it is still a safe investment when compared to equities. As a result, when market conditions are poor, investors tend to sell their shares of stock and flock to these types of assets, tipping the scales of supply and demand and sending the price of silver upward. Conversely, when market conditions are positive, investors tend to ditch silver and other safer bets to free up funds for investments in the stock market. This leads the price of the commodity down as demand shrinks.
  • Economic Conditions. Silver is a great store of value, and it becomes a hot commodity when economic conditions are negative, often sending silver prices up. When investing in silver, it’s important to pay attention to economic reports like jobs and GDP reports, as well as statements from the United States Federal Reserve surrounding the state of the economy.
  • Industrial Demand. When you think of silver’s uses, you may instantly think of jewelry or silverware, but the versatile metal is used for far more than that. A significant portion of the demand for silver comes from industrial uses. Due to its lack of electrical resistance, silver is a key component of many solar panels. It’s also commonly found in contact lenses, fuses, switches, and other electrical devices. When demand is high for these types of products, demand for silver naturally increases, leading to gains in the price of the commodity.

Gold Catalysts

Gold has many significant catalysts that fall in line perfectly with those of silver. However, there are some unique differences. Here are the factors that tend to lead to movement in the price of gold:

  • Market and Economic Conditions. Like silver, gold is considered a safe-haven investment. As a result, when economic and market conditions are poor, investors tend to flock to gold, leading to an increased price.
  • Cultural Events. Gold is a significant metal in various cultures around the world, used in everything from architecture to art, and even in weddings. During the Indian wedding season in India, spanning from January through March, demand for gold for use in weddings often leads to a noticeable increase in global demand, which can drive up prices.
  • Inflation. The inflation rate also plays a role in the growth of gold’s price. When inflation is high or threatening to rise, investors often look to gold as a way to hedge against inflation. Gold investors hope to maintain the value of their investments by owning a commodity that’s known for holding its value while cash loses buying power to inflation.
  • Geopolitical Conditions. Sure, major currencies like the U.S. dollar and the euro can be traded for fair market value just about anywhere around the world. However, many developing countries’ currencies don’t enjoy the same flexibility. As a result, gold is increasingly important in the global economy and as a measure of any country’s wealth. When geopolitical conditions are unsettling, government demand for gold will generally increase, leading to gains in the price of the commodity.

The Verdict: Should You Invest In Silver or Gold?

As you can see, there are clear benefits and drawbacks to investing in both silver and gold. So, how do you make the decision? Which is better?

Consider your investment objectives, the amount of money you have to invest, and the amount of risk you’re willing to take on the safer side of your asset allocation.

You Should Invest In Silver If…

You might prefer silver if you’re the kind of investor who wants exposure to safe assets in your portfolio, but you also want the ability to realize larger gains on these assets and are willing to accept a slightly higher level of risk. The best candidates for silver investments:

  • Have a Total Portfolio Value of Under $35,000. Silver comes with a much lower price per once and is therefore more accessible than gold. Those just starting out with relatively small investment portfolios will likely be better served choosing silver over gold.
  • Want Larger Gains. Although there are times when gold will increase in value faster than silver, there’s a strong historical argument that silver’s value has room to run in the future. If you’re looking for stronger growth in your safer assets, silver is likely the way to go.
  • Are Risk Tolerant. Silver is a safer asset than equities, but there are risks involved. Silver is more volatile than other safe assets like gold, Treasury bills, and many bonds. This volatility increases risk.
  • Are Willing to Put Time In. Because price swings happen in silver faster than they do in gold, it’s important that you pay close attention to market movement, economic reports, Federal Reserve statements, and industrial demand for clues as to when to buy and sell.

You Should Invest In Gold If…

Gold may be right for you if you’re an investor with tens of thousands of dollars or more to invest in the asset class and you want to add stability to your portfolio or are looking for a store of value during tough economic times. Gold investments are better for investors who:

  • Have a Few Thousand Dollars to Invest. Gold is a highly valuable asset. Because commodities are cheaper in higher quantities and tend to make up less than 10% of a well-diversified investment portfolio, it’s important to have enough money in your portfolio to purchase a couple of ounces or more at a time. At today’s prices, a pair of one-ounce gold bars requires about $3,500.
  • Want to Hedge Against Inflation. Gold has historically grown in value at a rate faster than the U.S. dollar has lost value to inflation. As a result, the yellow metal makes a great hedge against inflation-related risks.
  • Want Stability in Your Portfolio. As an asset known for generating stable growth, gold is a great option for those looking to add stability to their portfolio in order to balance out the risks associated with other investments.

Both Are Great If…

Why choose one or the other when you can invest in both silver and gold? Exposure to both metals may be best if you’re an investor who has a reasonably sized investment portfolio and wants to diversify your safer holdings. This gives you the growth opportunity represented by silver and the higher level of stability that gold can provide. The perfect candidates for gold and silver investments:

  • Have a Portfolio Value of $40,000 or More. Because gold is relatively expensive and best purchased in quantities of multiple ounces or more, it’s important to have a sizable investment portfolio if you’re going to invest in physical gold. To mix silver in, your portfolio will need to be even larger in order to maintain the ratio of no more than 10% of your assets allocated to precious metals.
  • Want Both Growth and Stability. If you want access to the potential growth of silver but aren’t willing to give up the stability gold provides, a mix of the two investment options is likely your best bet.
  • Are in Tune With Movements in Commodities Markets. The best investments are made by investors who have taken the time to educate themselves about the assets they own. Keeping tabs on what’s going on with either gold or silver takes time and research. To invest in both, you’ll have to be willing to commit additional time and research to your investing process.

Final Word

Both gold and silver are great investment options for just about any diversified portfolio. These assets are known to be great stores of value, often experiencing price growth even in times of poor market conditions and economic uncertainty.

Whether you invest in gold, silver, or a mix of the two, it’s important to use safer assets to maintain balance in your investment portfolio and protect yourself from risk. Moreover, regardless of which direction you go, it’s important to do your research and get an understanding of the assets you’re investing in. After all, it’s never a good idea to blindly invest your money in any asset, even one that’s thought of as “safe.”

Source: moneycrashers.com

How to identify credit repair scams

family learning more about credit

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

If you have poor or damaged credit and want to repair it, you may have considered using a credit repair service to help. Unfortunately, there are many companies and individuals that want to take advantage of unsuspecting consumers needing help with their credit. 

While there are legitimate companies that can help you repair your credit, there are also credit repair scams that are only after your money and your information for identity theft purposes. To keep both safe, we created this guide to help you tell the difference between legitimate credit repair companies and credit repair scams.

Five signs of a credit repair scam

There are many things credit repair companies are not allowed to do or promise customers. If it sounds like it’s too good to be true, it probably is, and you should steer clear of that company. We’ve put together a list of signs you should watch out for when working with credit repair companies.

1. Guaranteed results

Under the Credit Repair Organizations Act (CROA), credit repair companies cannot guarantee results. Here are a few common examples of false promises unethical credit repair companies might make:

  • Improvement to your credit score
  • Results in a fixed time period
  • Removal of all of negative items, even if they are accurate

2. Up-front payment is requested

The CROA prohibits credit repair companies from asking for any payment before they render services. Many scammers know that most consumers don’t know this and, as a result, promise a quick turnaround on credit repair for a large upfront payment.

Some illegitimate credit repair companies may not allow you to cancel unless you pay a fee. All credit repair companies are required by law to give you at least three days to cancel services with them and there is no penalty for canceling.

3. Claims a new identity is needed 

A credit repair company can’t promise or offer you a new identity. Anyone offering you a new identity is a fraud. Besides guaranteeing results, scammers may try to promise you a clean slate with a new Employer Identification Number (EIN) or a Credit Privacy Number (CPN).

They tell you to use these numbers on your future credit applications instead of your Social Security Number. We explain more about common credit repair scams below.

4. Don’t explain your legal rights

Credit repair companies should explain your legal rights to you from the beginning. These are a few common things an unethical credit repair company might do.

  • Tells you not to contact the credit bureaus directly
  • Doesn’t give you a copy of the contract to review before signing
  • Fails to inform you that you can repair your credit yourself without the help of a credit repair company
  • Leaves out important information from the contract, like the date services will be executed or the amount you will pay

If you feel like the company isn’t telling you everything or refusing to answer your questions, you should seek services elsewhere.

5. Asks you to misrepresent information

Finally, an unlawful credit repair company might ask you to misrepresent your information. This can range from unlawfully using an EIN or CPN number in place of your social security number to claim you are a victim of identity theft when you’re not.

five signs of a credit repair scam

Common credit repair scams 

You’ll most likely see credit repair companies illegally promising results. However, it’s important to familiarize yourself with other scams so you understand what is and is not legal. We highlighted a few common ones below.

File segregation schemes 

A file segregation scheme is when a company or individual offers to give you an Employee Identification Number (EIN) to use in place of your Social Security Number when you apply for credit. It’s illegal for companies to do this, and it’s illegal for consumers to obtain one to use in place of their Social Security Number. 

Credit privacy numbers 

Like an EIN, a Credit Privacy Number (CPN) is created by scammers to use in place of your Social Security Number when applying for credit. Simply put, a CPN is a fake Social Security Number. Usually, these are created using somebody else’s identity, and using one can be considered identity theft. 

Tradeline renting 

Tradeline renting is when you pay for authorized user status so that the tradeline shows up on your credit reports to improve your score. This doesn’t repair any negative information on your credit, but adding a positive tradeline to your credit report can boost your score.

While this isn’t necessarily illegal, it can get you into trouble. There is nothing wrong with a loved one adding you as an authorized user. However, if you pay to “rent” a tradeline from a stranger, you don’t know how it will impact your credit and it may be a scam to get your money. 

credit repair scams to watch out for

What to do if you are scammed

There are a few things you can do if you realize you’ve fallen victim to a credit repair scam. Take a look at your options below.

who to report a credit repair scam to

Can credit repair companies fix your credit?

Yes, a legitimate credit repair company can help you work to remove inaccurate negative items from your record that may be damaging your credit score. Here are ways to recognize a legitimate, expert credit repair company. Although you can work to repair your credit yourself without a credit repair company, ideally a credit repair company would make the process much easier. Here are some signs of a legitimate, expert credit repair company:

  1. They create a repair strategy custom to your unique situation. A good credit repair company will customize their course of action only after evaluating your credit reports and credit history. Everyone’s credit history is different, and their approach to repairing your credit should reflect that. 
  2. Maintain communication with you during the process. A credit repair company that maintains scheduled calls, emails or any other form of communication with you will help you stay up-to-date with their progress. They shouldn’t keep you in the dark as they’re conducting their services. 
  3. Informs you of your rights from the beginning. At the time of signing, a credit repair company should provide two documents: a disclosure of your right to repair your credit yourself and a detailed contract of services.
  4. Make realistic claims about their services. Like we said above, credit repair companies cannot guarantee results. A legitimate credit repair company will not guarantee timeframes or point changes, but they can guarantee the delivery of services—access to credit monitoring tools, or letters delivered on your behalf. 

How to safely repair your credit

Making payments on time and disputing inaccurate information on your credit reports can help you repair your credit. While you can do this on your own, a professional credit repair firm like Lexington Law Firm will make the process easier and more efficient.

Lexington Law Firm proudly adheres to CROA to make sure we give our clients the best experience possible. For over a decade, we’ve helped clients challenge information that is unfair, inaccurate and unsubstantiated. Give us a call today for a free, personalized credit report consultation.


Reviewed by John Heath, Directing Attorney of Lexington Law Firm. Written by Lexington Law.

Born and raised in Salt Lake City, John Heath earned his BA from the University of Utah and his Juris Doctor from Ohio Northern University. John has been the Directing Attorney of Lexington Law Firm since 2004. The firm focuses primarily on consumer credit report repair, but also practices family law, criminal law, general consumer litigation and collection defense on behalf of consumer debtors. John is admitted to practice law in Utah, Colorado, Washington D. C., Georgia, Texas and New York.

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

Source: lexingtonlaw.com

16 Repurposing Ideas to Help You Waste Less and Save More

In this photo, a wine bottle is repurposed to be a vase.


You can repurpose a wine bottle as a vase to make your home more inviting. Chris Zuppa/The Penny Hoarder

An empty two-liter soda bottle can be converted into an easy, light watering can for the extra landscaping you put in during the first weekend of social distancing.
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Strawberries, blueberries and other produce come in plastic containers that have open slits on the sides. These can make great bath toys because water flows out of them like a sieve, which can create the perfect waterfall or rain forest.

To Entertain Your Kids (or Your Kids-at-Heart)

This photo shows cardboard toilet paper tubes repurposed as a necklace.
Kids can repurpose cardboard toilet paper tubes as a necklace. Chris Zuppa/The Penny Hoarder

1. Toilet Paper Tubes

Fill a wine bottle with water, wildflowers and greenery to make a deck, patio or the front steps a little more inviting.

The plastic tubs used for food like yogurt and hummus can make great storage containers. There’s really no need to ever pay for new plastic containers. By the time the lids are a little warped from the dishwasher, you can recycle them and start using the next round of empty food containers.

2. Produce Boxes

If you have the time and energy to reorganize, use empty shoe boxes or smaller shipping boxes to create drawer organizers. The boxes’ height can be cut to fit drawers if needed.

3. Holiday Cards

Fill empty water bottles with sand or rocks for hand weights. Plus here are more ideas for making homemade weights and other DIY fitness gear.

4. Cardboard Boxes

The netted bag that holds produce can be scrunched up to clean a really messy pot or two before you throw it away.
A cup from an old bra makes for a great mask. And here are three more ways to make a DIY mask with materials you already have.

To Use Around the House

5. Netted Produce Bags

When raking up piles of leaves, pile them onto an old sheet, pull the four corners together and take to the trash or mulch pile. The sheet can be used over and over so you won’t need to buy lawn and leaf bags, trash bags or even a wheelbarrow.

6. Broccoli Rubber Bands

One of the extra muffin tins that crowds your kitchen cabinet is perfect for organizing jewelry.

7. Plastic Food Containers

But that’s just the beginning of what you can do with your trash. We’ve gathered some other repurposing ideas that can save you trips to the store, save you some money and even save (some of) your sanity.

8. Old Towels and T-Shirts

Cucumber slices soothe eyes that are strained from binge-watching “Bridgerton.” Don’t stop there: We have even more inexpensive suggestions for a DIY spa day.
Here’s another option: Cut the bottoms out of boxes large enough to fit around your child. Help them decorate the boxes to look like a car, then use string or ribbon to create suspenders. Now you can hold speed-walking or running car races in the backyard or living room.

9. Empty Shoe Boxes

If you have old Christmas cards packed away, punch a hole in the corner of each one and loop them together with a string or metal ring. Now you’ve made a book for little ones who love to look at photos, especially of other children.

10. Muffin Tins

Privacy Policy

To Take Care of Your Yard

11. Wine Bottles

Ready to stop worrying about money?

12. Two-Liter Bottle

Cut decorated tubes into smaller sections to create beads to string on a piece of yard or twine for a necklace. The Internet has many more suggestions for crafty kids of all ages.

13. Old Sheets

In this photo, an old sheet is repurposed as a bag for yard leaves.
An old sheet is repurposed to collect yard leaves. Chris Zuppa/The Penny Hoarder

Those thick rubber bands that come around bunches of broccoli are great “chip clips” to close bags of food or a hair-tie in a pinch.

To Take Care of Yourself

14. Water Bottles

Old towels and T-shirts with stains can’t be donated, so use them as dish towels or rags.

15. Old Bras

Source: thepennyhoarder.com

16. Cucumbers

You can also cut them into strips and braid them to make a chew toy for your pooch.
Rolls of toilet paper have tubes that, once decorated with crayons and stickers, can become kazoos or a village of towers.



Katherine Snow Smith is a senior writer at The Penny Hoarder.

TaxAct Review 2021 – Free Online Tax Software

Millions of Americans rely on multiple streams of income: independent contractors, small-business owners, solopreneurs, freelance workers, hustlers stringing together side gigs, and folks who earn passive income through investing. Their tax situations are significantly more complicated than wage-earners with one or two jobs, especially if they’ve formally incorporated businesses to take advantage of valuable tax breaks and legal protections.

It’s frustrating but understandable that business owners and independent workers have to pay more to file their taxes with brand-name services like TurboTax or H&R Block. Or do they?

TaxAct Plans, Pricing, and Features

TaxAct is significantly cheaper than its two big-name competitors. However, its free version isn’t suitable for any but the most straightforward tax situations, and its support infrastructure inspires less confidence than nervous filers might like. But substantial improvements to usability make it a serious alternative to gold-plated DIY products and full-service CPAs.

TaxAct offers four main plans:

  • Free
  • Deluxe
  • Premier
  • Self Employed

Less common products include:

  • Estates & Trusts, a pricier option for taxpayers with income from trusts or estates
  • Distinct small-business tax products for various legal business structures, including sole proprietorships, partnerships, S-corporations, C-corporations, and tax-exempt organizations
  • Online tax prep and e-filing solutions for independent CPAs

TaxAct guarantees the accuracy of all returns prepared with its software.

TaxAct also has a maximum refund guarantee that’s technically distinct from its accuracy guarantee. If you receive less than the maximum refund you’re otherwise entitled to or get audited due to an error in TaxAct’s software, TaxAct will pay the refund difference or cover any audit-related liability, up to $100,000.

Each plan’s pricing is subject to change and may increase as the filing deadline approaches, so it’s in your best interest to file as soon as you have all the necessary documentation in hand. Once you’ve collected all your documents, the only thing left to do is decide which plan is right for you.

Free

TaxAct’s most basic plan is free. It costs nothing to file your federal and state returns. This plan caters to individual filers with straightforward tax situations.

But its functionality and features, such as prior-year return importing and phone support, are somewhat limited.

Key features of the Free plan include:

  • Simple Filing. The free version supports simple tax situations. If you earn all or the vast majority of your income from regular employment and don’t need to itemize your deductions, this version is probably all you’ll need. Importantly, it covers the earned income tax credit and child tax credits but not dependent care credits. If you have a more complicated situation that includes investment income, itemized deductions, or self-employment tax, you need to upgrade.
  • W-2 Importing. You can import W-2s from your employers, saving you the time necessary for manual entry.
  • At-a-Glance Help During the Filing Process. TaxAct’s filing system boasts a useful support panel on the right sidebar next to the fields you use to complete your return. The panel’s search feature can help you find answers to quick questions. But it’s worth noting that clicking on individual results to get more detail takes you to TaxAct’s dedicated support system (and temporarily away from your return), making it less user-friendly than other tax software’s help features.
  • Unlimited Tax and Technical Support. TaxAct’s email and phone support system includes unlimited help with tax-related questions and technical platform issues. TaxAct’s support staffers aren’t necessarily licensed accountants and may not be able to answer complicated tax questions, but they’re nevertheless authorized to handle general tax issues and provide basic advice and guidance for uncertain filers.
  • Personalized Financial Analysis. Known as BluPrint, this complimentary, automatically generated report uses your tax return (including deductions, investment earnings, and business activities) to recommend opportunities to save on taxes and make changes that may improve your financial situation in the future.

Deluxe

This plan costs $24.95 to file your federal return early in the tax season, then around $40 to $45 as the filing deadline approaches, depending on timing. It costs $54.95 per state return.

It’s a much more robust program that can handle moderately complicated tax situations, including itemized deductions and investments. But it’s not sufficient for small-business owners and others with very complex taxes. It includes everything in the Free plan, plus:

  • Itemized Deductions. If you choose to itemize your deductions, which is a common practice for those with more complicated tax situations, such as homeowners and parents, you need to file a tax form known as Schedule A.
  • Form 1040 Schedules 1 Through 6. This plan supports IRS Schedules 1 through 6, which cover various types of income, credits, and tax.
  • Donation Assistant. This useful mobile app lets you track charitable contributions throughout the tax year. It also helps track the fair market value of noncash donations, such as clothing, vehicles, and furniture. If you’ve kept paper records of these donations instead, you can also access Donation Assistant through your desktop TaxAct account. You can add to your Donation Assistant list throughout the year following your filing date.

Premier

This plan costs $34.95 to file your federal return early in the tax season, then around $60 to $70 as the filing deadline approaches, depending on timing. It costs $54.95 per state return.

Premier is designed for those with complex tax situations not adequately addressed by lower-priced plans, such as investors and rental property owners. Premier includes everything in the Deluxe plan, plus:

  • Interest and Dividend Income. If you earned more than $1,500 from interest or ordinary dividends during the tax year, you need to file a tax form known as Schedule B.
  • Capital Gains. If you earned capital gains income from the sale of an asset, such as a publicly traded security, you need to file Schedule D.
  • Rental Property Income. If you earned rental or royalty income from owned real estate, you need to file Schedule E.
  • Foreign Bank and Financial Accounts. This plan accommodates income from foreign deposit and investment accounts.
  • Priority Support. This plan comes with priority support from TaxAct’s in-house tax experts. Features include a dedicated phone line with screen-share capabilities and in-app chat functionality.

Self Employed

This plan costs $64.95 for the federal return early in the tax season, then around $85 to $95 as the filing deadline approaches, depending on timing. It costs $54.95 per state return.

It’s more comprehensive than Premier, making it ideal for those with complex or unusual tax situations, such as solopreneurs and small-business owners. Virtually all IRS tax forms and schedules are available. In addition to all the features and functions of the Premier plan, Self Employed includes:

  • Small-Business and Self-Employment Income. If you earn the bulk of your income from contract or consulting work or are the proprietor of a small business, you need to file Schedule C and pay self-employment tax.
  • Farm Income. If you earn income from farming activities, you need to file Schedule F. (If you earn rental income from farmland you own but don’t materially participate in farming activities, you can file Form 4835 with Schedule E.)
  • Year-Round Tax Planning Guidance. TaxAct’s team is available year-round for help with tax planning, a valuable perk for self-employed people who need to pay quarterly estimated taxes or make contributions to retirement plans like solo 401(k)s or individual retirement accounts.
  • Deduction Maximizer. This step-by-step guide helps self-employed filers claim every tax deduction they’re entitled to. It’s built into the prep interface, so you might not even notice it’s running.

Estates & Trusts

This plan costs $109.95 for your federal return and $49.95 per state return. It’s designed to provide additional support for customers who need to file IRS Form 1041 and related forms, so it may not be necessary if your tax situation doesn’t involve income from a trust or estate.

There’s a separate set of interview questions devoted to trusts and estates, so you don’t have to worry about completely winging it.


Small-Business and Tax-Exempt Organization Packages

TaxAct has four additional packages designed for small-business filers with complex tax situations and one for tax-exempt organizations.

The Sole Proprietor plan costs $64.95 for federal returns early in tax season, then $85 to $95 as the filing deadline approaches, depending on timing. State returns cost $54.95 apiece. The three other small-business plans and tax-exempt organization plan, which correspond to different legal business structures, cost $109.95 for the federal return and $54.95 per state.

That’s several hundred dollars cheaper than hiring a human CPA. The plans available for small businesses and tax-exempt organizations are:

  • Sole Proprietor. This plan includes support for IRS Form 1040 and Schedule C and is ideal for those who are self-employed as well as freelancers and contractors. This package is similar to Self Employed, and the two can be used interchangeably by sole proprietors without employees.
  • Partnership. This plan includes support for IRS Form 1065 (U.S. Return of Partnership Income) and a host of associated forms commonly used by partnerships.
  • C Corporation. This plan includes support for IRS Form 1120 (U.S. Corporation Income Tax Return) and associated forms.
  • S Corporation. This plan includes support for IRS Form 1120-S (Income Tax Return for S Corporations) and associated forms.
  • Tax-Exempt Organization. This plan includes all the support necessary to file an informational return under federal income tax exemptions outlined in Sections 501(a), 527, and 4947(a)(1) of the tax code.

Additional Features

In addition to its free and paid tax filing packages, TaxAct’s most notable features include free ways to access your information and special protections against tax problems.

Tax Return Status App

TaxAct offers a slick iOS and Android app that provides status updates on your federal and state taxes (including whether the IRS and your state treasury have accepted them) and helps you estimate how long it should take to get your refund.

It’s free for anyone to download and use (even if you don’t use TaxAct to file). The federal government also provides online updates to your return’s status and estimated refund arrival dates. But TaxAct’s app is far more mobile-friendly than the IRS’s website.

Prior Year Returns

If you want access to your TaxAct returns from the past three years, you can do so for free through your account dashboard. That’s useful for filers who need to amend a previously filed return due to an issue such as an IRS audit and folks who simply need to access accurate completed returns.

Guaranteed Pricing With Auto-Enroll

TaxAct’s Auto-Enroll service lets you lock in your return’s price once you create your account and begin your return — even if you don’t complete your return in a single sitting. That’s useful if TaxAct decides to raise its prices before or partway through the current tax season.

Audit Defense (Protection Plus)

TaxAct offers this benefit in partnership with Protection Plus, a third-party provider. You must purchase Protection Plus when you file, but you can cancel for a full refund within 30 days of purchase as long as you haven’t already received an audit notice. Pricing is subject to change, but the line-item cost for Protection Plus has never exceeded the cost of a Self Employed plan.

Protection Plus covers you for as long as the IRS can audit your state and federal returns. It connects you with tax professionals who handle all correspondence and discovery, helping to interpret IRS notices and requests and direct negotiation of penalties and potential settlements with the IRS or state treasuries.


Advantages

TaxAct has several core advantages for taxpayers looking to save time and money.

1. Affordable at All Service Levels

TaxAct is very affordable. Its most expensive federal package for individual filers, Self Employed, costs less than $100 for the federal return and less than $55 for each state return.

Some of TaxAct’s better-known competitors charge double or triple what TaxAct Premium costs for similar levels of service. The cumulative cost of TurboTax’s highest-priced federal plan approaches $300, for instance.

2. Not as Promotional as Competing Platforms

Though it does offer different price points, TaxAct is only minimally promotional. It doesn’t push you to upgrade to a higher-cost plan or hound you to purchase add-on services.

TaxAct’s website has a laid-back layout and tone. If you try to do something your current plan doesn’t support, the system politely prompts you to upgrade. TaxAct doesn’t constantly remind you of value-added services via jarring pop-ups or ad screens. If you’re interested in them, you can simply find them on each plan page.

By contrast, both H&R Block and TurboTax actively encourage customers to sign up for higher-cost plans or add-ons with varying degrees of pushiness.

3. Auto-Enroll Grants You Time

If you’re self-employed or otherwise have multiple sources of income, you may not be ready to file your taxes until mid-March after all the necessary forms and statements trickle in. Weeks may pass between the first time you sign in to your tax preparation account and the day you complete your state and federal returns.

TaxAct’s price guarantee is useful for people in that situation. No matter how long you procrastinate before filing, you get the best available price on your returns.

Many online tax filing services, including TurboTax and H&R Block, don’t automatically offer price-lock guarantees. If they raise prices before you finish your return, you could be stuck paying the higher price.

4. Helpful Editing Functions During the Import Process

TaxAct’s import feature lets you edit information on the previous year’s return before overlaying it onto the current year’s. That’s very helpful if you’ve recently experienced a life event that results in changes to your basic information, such as moving, getting married, or buying a new house.

Other online tax filing programs, including TurboTax, import your return as is and then walk you through the editing process step by step, asking if each detail is still accurate. That’s much more time-consuming.

5. Human Support Is Better Than Some Competitors

The quality of TaxAct’s human support team has improved markedly since the early 2010s. Today, most paying customers have access to complimentary in-app chat or live phone support. And those willing to spring for higher-priced plans enjoy dedicated lines to credentialed tax experts.

6. Direct Access to Prior-Year Returns Comes Standard

In years past, TaxAct hasn’t always offered free access to prior-year tax returns. To see filed and partially completed returns from the past three years, you had to pay a one-time fee of $13.99 per return. These days, prior-year access is included in your filing fee.


Disadvantages

TaxAct has several disadvantages, including not always being the most user-friendly tax software.

1. Text Support System Can Be Confusing

TaxAct’s customer support apparatus provides a lot of detail, almost to the point of being overwhelming. The help section is a hodgepodge of semi-related topics, and the search feature doesn’t always return relevant results.

It’s easy to get bogged down in irrelevant help topics on your way to content that addresses your questions. That’s not optimal for busy filers squeezing in tax prep between everything else they’ve got going on.

2. Short Timeout Window

TaxAct has a very short timeout window, which can be problematic for filers who need to step away from the computer during the prep process. While data loss is unlikely, having to sign back in is annoying and disruptive, particularly for those with just a few minutes to spare before the next obligation.

3. No Hands-Off Prep Option

TaxAct remains a DIY tax prep aid, even as competitors like TurboTax move toward hybrid models that see (at least at higher price points) certified tax preparers or CPAs doing much of the grunt work.

If you can’t devote several hours during tax season to prepping your return by yourself, you may be willing to pay more for hands-on help.


Final Word

In the car business, there’s an old saying: “Only suckers pay sticker price.” The sticker price is the dealer’s opening offer, and they expect you to counter with a lower offer.

With all the add-ons, upgrades, and processing fees, filing your taxes online can feel like the reverse. Your chosen plan’s sticker price is the bare minimum, an amount you’d be lucky to pay in the final reckoning.

That’s not the case with TaxAct, which remains cheaper than its better-known competitors. TaxAct requires some sacrifices and assumes a basic level of tax-filing familiarity, but at least it won’t leave you much lighter in the wallet.

If you’re looking to save even more money, check out our top options for free online tax preparation software and services.

Source: moneycrashers.com

10 Hidden Benefits of Pursuing Financial Independence (FIRE)

Upon learning about the concept of financial independence and retiring early (FIRE), most people envision sitting on a tropical beach somewhere for the rest of their lives, sipping drinks with little umbrellas in them.

That sounds like it would be fun for a month or so, but the reality of financial independence is both more mundane and infinitely more interesting.

Once your investments generate enough passive income to cover your living expenses, you no longer need to work to pay your bills. Your day job becomes optional. At that point, you gain complete freedom over your time.

But both financial independence and your pursuit of it open other doors in your life as well. In many cases, a higher savings rate creates new opportunities for saving more money. Savings beget more savings, and wealth begets more wealth.

Hidden Benefits of FIRE

As you explore the notion of your own financial independence plan, look past the visions of pina coladas on the beach to consider the deeper implications and hidden benefits that the FIRE lifestyle can realize for you.

1. Lower Borrowing Costs

They say lending money is the world’s second-oldest profession. And for the millennia that people have been borrowing, they’ve been making the same lament: The people who most “need” loans are the ones least likely to receive them. When they do get approved, they typically pay high interest and fees.

Are lenders evil? No, of course not. They simply price their loans based on risk, and desperate borrowers make risky borrowers.

The greater your wealth, income, and credit score, the less you pay in loan interest and loan fees when you borrow money. You make a low-risk borrower because you have plenty of financial assets and demonstrate financial stability.

Wealthy people also tend not to carry expensive, unsecured debts like credit card debt and personal loans. They typically carry only low-interest secured debts like mortgages or auto loans, given the relatively low interest.

As you pursue financial independence, one of your first financial goals will likely be paying off high-interest debts. Beyond eliminating the high interest and monthly payments, your ever-decreasing debt and increasing net worth will position you to borrow money at the lowest possible interest rate and fees.

2. Optionally Forgo Life Insurance

Consider for a moment the purpose of life insurance. In a traditional family with one breadwinner, 2.4 children, a dog named Fido, and a white picket fence, the family’s ability to survive hinges on the breadwinner’s earnings. If the breadwinner gets struck by lightning, suddenly the family loses its only source of income.

Enter: life insurance. If your family depends on your income to survive, you need life insurance for sure.

I don’t own a life insurance policy, however, despite being married with an infant child. Our FIRE lifestyle renders life insurance unnecessary for two reasons.

First, we live entirely on my wife’s income, funneling all of mine into income-producing investments. If I die unexpectedly, my family would (hopefully) mourn, but they could continue living the same lifestyle without my income.

Second, because we’ve lived a frugal, high-savings lifestyle for a few years now, we’ve built substantial assets and passive income sources. Even if my widowed wife never contributed another penny, our existing assets would compound into a more-than-adequate nest egg over the next decade or two.

The upside: We can put the money we would otherwise spend on life insurance premiums into investments, to grow our net worth and passive income even more.

3. Optionally Forgo Disability Insurance

The exact same logic applies to long-term disability insurance. When you don’t rely on a single source of income to survive, you don’t necessarily need to protect that source of income with insurance.

Keep in mind that once you near or reach financial independence, you don’t need a cent of income from work to survive. The closer you get to FIRE, the less important your job becomes for your financial well-being.

Neither my wife nor I carry long-term disability insurance for the same reason we don’t carry life insurance. If one of us ceases to be able to work, we’ll be just fine between our existing passive income streams and the other partner’s active income.

So, we put the money we would have spent on disability insurance toward our investments to build wealth faster. Once again, savings begets more savings.

4. Better Negotiating Power for Salary & Benefits

If you don’t need a job to survive, you start from a powerful negotiating position.

You can ask for a dramatically higher salary, or far greater benefits, all without fear of losing your job offer or current position. In the overwhelming majority of cases, employers don’t retract offers out of personal offense taken to bold job offer negotiations by the employee.

But even if you’re negotiating with the world’s pettiest employer and they withdraw their job offer because of your negotiating stance, you can shrug your shoulders and keep living on your passive income and savings when you lead the low-expense, high-savings FIRE lifestyle.

Lowering your living expenses and boosting your savings rate positions you to demand more from your day job — while you still choose to work one.

5. Ability to Live Anywhere

Once financially independent, you can live anywhere in the world because you don’t rely on a job to bring in money.

But even before reaching financial independence, you can still negotiate with your employer to let you start telecommuting.

Or, for that matter, you can become a digital nomad by starting your own online business, taking freelance work, or taking a new job that lets you work from anywhere.

When you can live anywhere in the world, you can take advantage of geoarbitrage: The combination of a low cost of living and strong income from elsewhere.

You can, for example, move to a state with a much lower tax burden, or even move to a country where $2,000 a month buys you a good life.

I earn money in U.S. dollars but I live in Brazil, where I can live a luxurious life on a relatively low monthly budget. A full-time nanny here costs only around $500 per month, whereas we’d pay many times that in the U.S.

6. Eliminate Work-Related Expenses

When you no longer have to work, or at least no longer have to physically commute to an office, you can save a surprising amount of money on work-related expenses.

Take commuting itself for example. According to JobAlign.com, the average American commutes 19.7 miles each way. If they commute to work 21 days per month and incur an average cost to own and operate a car, that comes to an appalling $5,848 per year, based on CommuterConnections.org’s free calculator.

For years, my wife and I each owned our own cars. Then we got rid of one and shared. Then we got rid of the other, going completely carless.

We can do it because we intentionally chose my wife’s employer and city as conducive to walking and biking everywhere, and because I work remotely as a digital nomad.

Work-related costs don’t end at commuting. Consider clothes — white-collar workers routinely blow several thousand dollars each year on suits, shoes, accessories, and other symbols of their professionalism, taste, and success.

I wear the same athletic clothes to work every week. Although I own a few suits, I only wear them to weddings, funerals, and the occasional upscale social outing. The last time I spent money on professional clothing was — actually, I can’t remember.

The money I don’t spend on work-related expenses, I funnel right back into investments, further ensuring I never need to spend money on work clothes again.

7. Follow Your Passions

Most people work to earn a paycheck to cover their living expenses. When they get a raise and start earning more, they immediately go out and start spending more, in an endless cycle of lifestyle inflation.

The closer you get to FIRE, the less your work revolves around that paycheck. You don’t need it the same way most people do. Instead, your work increasingly becomes about spending your time meaningfully, allowing you to pursue passion projects that don’t necessarily pay huge salaries.

Want to work for a nonprofit helping to prevent tropical rainforest deforestation? Or perhaps you’ve always wanted to do more creative work as an artist or writer or designer? Go for it.

The FIRE lifestyle involves low living expenses, a high savings rate, and increasing passive income from investments, all of which combine to offer you more freedom from the “golden handcuffs” that bind so many people to their high-stress jobs.

8. More Flexibility to Stay Home with Kids or Aging Parents

With lower living expenses and higher passive income also comes more flexibility for one partner to stay home with kids or aging parents, if desired. Or, for that matter, for both partners to eventually stay home.

As part of your financial independence plan, you can opt to switch to a single-income household as a milestone along your journey to FIRE. But you don’t have to.

My wife and I both enjoy our work and plan to continue working indefinitely. Once again, you create that freedom to do what you like with your time by building more passive income at a younger age.

And long before you actually reach financial independence, you can create far more flexibility to support your kids as needed by negotiating a flexible or remote work schedule while you continue working full-time.

9. Lower Effective Tax Rate

With a higher savings rate, you can better take advantage of tax-sheltered accounts like IRAs, 401(k)s, ESAs, and HSAs. These accounts can both help you reduce your taxable income this year, and lower your taxes in retirement.

But the tax benefits of the FIRE lifestyle don’t stop there. The IRS often taxes income from investments differently than salary income — to begin with, you don’t have to worry about payroll taxes (FICA taxes).

When derived from capital gains, you also pay the lower capital gains tax rate on investment income, rather than the higher rate for regular income. And you can use strategies to reduce your capital gains tax even further, such as 1031 exchanges to defer taxes after selling large assets like real estate.

Some income-producing assets also come with their own unique tax advantages. Take rental properties, for example. Real estate investors can lower their taxes through a wide range of tax deductions and rules designed to promote investment.

The more of your income that you generate from investments, the more flexibility you have to slash your income taxes.

10. Ability to Capitalize on Cost-Saving Investments

Sometimes savings require an upfront investment that then pays for itself after a few years.

Take energy-saving home improvements for example. Homeowners can invest in a one-time cost to radically reduce their home energy usage, but it often costs thousands of dollars initially.

Over time, however, you can save massive money on utility bills once these improvements are in place. And, for that matter, you can save even more money on taxes through green energy tax credits.

Or take electric vehicles versus traditional gas cars. In some cases, electric cars cost more money to purchase but cost less to operate and maintain, saving money in the long run. One study by the University of Michigan found an average annual savings of $632 for electric vehicles compared to their gas-fueled counterparts.

It cost my wife and me time and money to move overseas initially. From paying for the recruiting network to help my wife find a placement, to setting up a mailbox with a scanning service, to the initial banking headaches, to moving my cellphone number to operate 100% digitally, it all took labor and money.

But today we enjoy a 65% savings rate, largely because we live overseas.


Final Word

Everyone’s financial independence plan looks different because everyone’s ideal life looks different. That’s the beauty of lifestyle design: You create the exact personalized life you want.

My wife and I happen to use our marriage and dual incomes to our advantage and to enjoy the expat lifestyle path to FIRE. But being married can be just as much hindrance as help if your partner doesn’t share your goals, and living overseas is only one strategy among infinite options.

I know others who worked high-income jobs for a few years, saving and investing most of their income to then quit in a blaze of glory.

Still others use leveraged real estate investing as their FIRE strategy, start a lifestyle business on the side of their full-time job, or forge some other unique path to FIRE.

Regardless of how you get there, both the journey and the destination of FIRE bring plenty of benefits besides the ability to storm out of your cubicle, never to return.

With every dollar of passive income you add, you become less dependent on your job. And in doing so, you can negotiate more flexibility, more income, and more benefits, all while reducing the need to shell out costs like life insurance, disability insurance, work clothes, commuting costs, and taxes.

All of which only accelerate your progress to financial independence, wealth, and complete freedom to spend your life however you like.

Source: moneycrashers.com

Taxhub Review 2021 – Online Tax Prep by a CPA

Taxhub is a relatively new online tax filing service that blends the user-friendly interface of online DIY services like TurboTax with the expertise of professional (often in-person) preparation services. It clearly aims to disrupt the tax prep industry.

This mobile-friendly cloud software platform offers CPA-prepared tax returns for individuals and businesses. Taxhub requires a fraction of the time commitment of DIY online options and may be cheaper than some full-service independent CPAs.

Taxhub isn’t the only online, hands-off, CPA-run tax prep platform out there. Imitators come and go, and big-name providers like H&R Block now offer hands-off or hybrid filing options of their own. But it does have a lot going for it.

Taxhub Plans, Pricing, and Features

Taxhub is more expensive than most DIY-friendly online tax software and at or above the cost of many independent CPAs. Whether its in-house expertise and hands-on service justify the high price is open to interpretation.

But the company’s approach to tax preparation is easy and convenient. No matter how simple or complicated your tax situation, a licensed CPA prepares your return, and the preparation experience is uniform for all filers. It consists of three steps:

  1. Upload Your Documents. After finalizing your plan, you upload your tax documents, including any relevant income and expense statements. You can upload files directly to Taxhub’s secure server or take a picture of each document and text (SMS) it to a particular phone number.
  2. Conduct a Phone Interview. The next step is a brief phone interview with a licensed CPA (usually the person who prepares your taxes) to go over the particulars of your tax situation. You can schedule the consultation from your account dashboard. There’s no questionnaire.
  3. Approve Your Return and Pay. After the interview, Taxhub prepares your return. After they finish — typically within 48 hours — you must review and approve your return. If you approve, you pay. The price may be higher than the estimate if your situation is complicated and requires a plan upgrade. In rare instances involving a very complicated return, your final price may be higher than the highest advertised price.

Tax preparation fees vary based on your needs. Individual Taxhub clients have access to a fully customizable prep and filing plan. Small-business clients have a fully customizable business prep and filing plan as well. Both businesses and individuals can schedule one-on-one CPA consultations for $29 per 15-minute interval, with fees credited back to the client if they later prepare and file with Taxhub.

Taxhub also offers a range of business services, such as S-corporation conversions and business incorporation, for independent professionals and small-business owners.

Individual Plan

Taxhub has one off-the-shelf plan for individual income tax filers. Starting at $159 per federal return, it includes:

  • One free state return
  • Wage income
  • Single or married filing
  • Common credits for filers with dependents
  • Common scenarios related to homeownership
  • Itemized deductions
  • Interest and dividend income

If Taxhub’s individual plan isn’t adequate for your needs, you can customize it by adding services on an a la carte basis, including rental property income, stock and crypto sales, and business income. Your estimated price updates automatically as you go, and at no point do you have to walk through a lengthy online questionnaire.

But adding a la carte services increases your return’s cost quickly. For example, you can expect to pay $100 to add business income or self-employment income and $100 to add equities sales, though pricing is subject to change. The first state return is included, but additional state returns cost $75 each.

Business Plan

Taxhub’s customizable business plan is appropriate for C-corporations, S-corporations, partnerships, and trusts. Pricing starts at $459 per business but can quickly rise for larger enterprises. As part of the customization process, you must answer basic questions about your business, including:

  • Number of fixed assets
  • Number of partners or shareholders
  • Annual revenues

For an additional fee, Taxhub can provide basic ongoing bookkeeping services as well.


Additional Features

Overall, Taxhub’s hands-off filing process is its most significant draw. But it has some additional features worth noting.

Maximum Refund Guarantee

Like most competitors, Taxhub has a maximum refund guarantee for state and federal returns. If you find another tax prep service that earns you a larger tax refund or lower tax liability, Taxhub promises to refund your preparation fees.

Pay With Your Refund

Taxhub allows you to pay your preparation fees with your IRS tax refund. Taxhub doesn’t directly charge for this option, but you do have to accept a bank charge the company can’t control.

Prior Year Returns

You can use Taxhub to file a previous year’s return, even if you didn’t previously prepare with Taxhub.

Tax Return Copies

You can obtain copies of your current year and prior-year tax returns by contacting Taxhub directly.

Audit Defense

All Taxhub customers are automatically enrolled in the company’s Audit Defense service at no additional charge. Under this plan, Taxhub corresponds and negotiates with the IRS on your behalf during the audit process while providing clear explanations and interpretations along the way.

Free LifeLock Trial Membership

Every Taxhub user gets a free trial membership with LifeLock, an identity theft protection provider. The trial runs for 30 days after you create your account, after which you can opt into a paid membership of your choice.

Messaging System

If you have any questions before or during the tax preparation process, you can use Taxhub’s internal messaging system (accessible through your account) to ask them. This system functions like email and usually takes a few hours to a business day to produce a response. Whenever possible, you’re connected with the CPA tasked with preparing your return.


Advantages

Taxhub has many filer-friendly features that justify paying CPA prices.

1. Incredibly Simple Process

Taxhub’s tax preparation process is incredibly simple: You provide some basic information about your life situation, sign up for the plan that suits your needs, upload your tax documents, conduct a brief consultation with a Taxhub CPA, and approve your completed return.

You don’t have to pore over your documents, interpret IRS jargon, or sit through tedious questionnaires. That’s a massive advantage over DIY tax prep services, which either hold your hand through every step of the process or require you to take ownership of the involved risks.

2. May Be Cheaper Than Some Other Full-Service Options

Although Taxhub is unquestionably more expensive than cut-rate DIY options like FreeTaxUSA and TaxAct, it might be a better deal than full-service, in-office tax prep options like Jackson Hewitt and Liberty Tax Service.

For example, depending on the complexity of your tax situation, it can cost you anywhere from $300 to $500 to file with Liberty Tax Service. Compare that with $200 to $400 for similar returns prepared by Taxhub.

Taxhub also has no hidden fees, a significant advantage over some office-based preparers. And it may be cheaper than independent CPAs and smaller firms that specialize in complex situations, though the gap has all but disappeared in recent years.

3. Can Upload Documents by Text Message

Taxhub lets you upload your tax documents via text message (SMS) rather than email attachment or fax. That’s a handy little perk that’s virtually unique among American tax prep companies — and one that’s hugely advantageous to customers who dislike breaking out their laptop or desktop computers.

4. Low Time Investment Relative to DIY Options

With no questionnaires or self-filled forms, Taxhub is a breeze compared to DIY competitors. Though the amount of time filers need to devote to the initial consultation and document upload processes lengthens as their situations grow more complex, the same applies to DIY returns. The more information your return contains, the longer it takes to answer all those interview questions and fill in all those form fields.

Once you finish your initial consultation with your Taxhub preparer, you’re pretty much done with your end of the bargain. Unless there’s an unexpected snag, Taxhub will file your return within 48 hours, and you’ll get your tax refund (if eligible) within a couple of weeks.

Accordingly, the amount of time required to complete a Taxhub return is almost always less than the amount of time needed to complete a comparable DIY return with TurboTax, TaxAct, or H&R Block.

5. Mobile-First Website

Unlike competitors like TurboTax and H&R Block that began as desktop software programs, the much newer Taxhub started as a mobile-friendly, cloud-based service. Every part of its website is a pleasure to use on small-screened devices. There aren’t any sections that feel like they haven’t been updated since the first iPhone’s release, as is the case with Jackson Hewitt Online and some other online tax prep services.

6. Audit Defense Included at No Extra Charge

All Taxhub customers get Taxhub’s Audit Defense product, which provides guidance and representation throughout IRS audits, at no extra charge. Many competing tax prep services charge for such services. TurboTax and TaxAct both charge up to $50 for comparable products, for instance.

7. Personalized Service

As a boutique shop, Taxhub offers a degree of personalized service larger competitors can’t match. Don’t let the all-online filing process fool you: When you do your taxes with Taxhub, you’re keenly aware of your value as a customer.

This differentiator is crucial now that H&R Block and TurboTax offer CPA-assisted packages clearly designed with competitors like Taxhub in mind.


Disadvantages

As convenient and easy as Taxhub is, it’s not without its drawbacks.

1. Not a Good Value for Simple Tax Situations

Taxhub’s off-the-shelf plan costs more than $150 per return but accommodates only relatively simple situations. By contrast, the lowest-priced plans offered by competitors like TurboTax and H&R Block also have limited functionality.

But they cost far less. Many offer federal returns for free, and some (including TurboTax) provide state returns for free as well, for a total cost of $0. If you have a straightforward tax situation one of those discount plans can accommodate, there’s absolutely no reason to spend so much money with Taxhub.

2. Limited Staff

Taxhub is a young company that has grown considerably since its founding but remains very much in startup mode. In the past, I’ve interacted professionally with Taxhub’s founder, something that would never happen at major incumbents like TaxSlayer or H&R Block (and probably wouldn’t happen at Taxhub these days, given the company’s growth).

Lean staffing cuts both ways. Compared with clock-punchers at major tax prep companies, Taxhub’s staff is more likely to be fully invested in making the product the best it can be and providing top-notch customer service.

That said, its small team is likely unable to provide the same breadth of service or overall responsiveness its larger competitors can, particularly during crunch times. It’s easy to imagine a scenario in which Taxhub’s small team becomes overwhelmed with customer questions or problems in the week or two before the filing deadline.

3. No Military Discount

Taxhub doesn’t advertise any discounts or deals for military filers. That’s a significant disadvantage relative to other options, which may offer deals for active-duty military.

4. Questionable Security Practices

Taxhub is a secure website with a lengthy privacy and security policy. I never felt like my information was at risk here, nor do I have any reason to believe that Taxhub is any more likely to experience a hack or breach than any of its better-known competitors.

That said, Taxhub has a laid-back approach to front-door security that could give some users pause. For instance, it doesn’t require you to set up any security questions, and its password requirements are pretty lax — they just need to be eight characters.

Taxhub’s timeout fuse is pretty long too. The website takes longer to time out than TaxAct and TurboTax. Though you should never do your taxes on a public Wi-Fi network, this long fuse can be a problem even in semiprivate situations, such as an apartment with nosy roommates or a shared Wi-Fi network.

At a minimum, use a virtual private network (VPN) and make sure your computer’s anti-malware software is operational and up to date.

5. Higher Prices Than DIY Competitors and Many Human CPAs

Taxhub was once cheaper than most mom-and-pop CPAs. That’s no longer the case for individual filers and businesses with complex situations. It’s now possible to spend well over $400 at Taxhub for a return that would cost $250 with an independent mom-and-pop CPA or less than $200 with TurboTax or H&R Block.


Final Word

For a scrappy tax prep startup, Taxhub is pretty impressive. It’s among the most hands-off tax services I’ve encountered, requiring far less time from its customers than DIY competitors.

It’s cheaper than most in-person tax prep services and other CPA-run online services, though recent price increases have blunted this advantage somewhat. And it offers some inclusions, such as text message document uploading and no-charge audit defense, that aren’t common elsewhere.

On the other hand, Taxhub doesn’t have instant name recognition or an established reputation. It’s not at all clear Taxhub has what it takes to grow into a company that could challenge the tax prep industry’s status quo. But disruption doesn’t happen without early adopters who buy into the cause.

For more options, check out our full list of top-rated free online tax preparation services.

Source: moneycrashers.com

Pandemic Side Gig Skills Useful After COVID

Online tutoring is another essential pandemic side gig that we really can’t imagine disappearing anytime soon. “Online tutoring is a huge and growing need,” says Greene. “Many parents (and students) remain wary of returning to conventional school due to concern over Covid exposure and safety concerns. Now that the door for online education has been ‘kicked open’ it won’t be closing— there will always be an online academic option going forward.”
Much like homeschool assistance, elder assistance was and is another critical role, even in our post-pandemic world. “Isolation in the senior community has been prevalent well before Covid,” says Hoskins. “Now the benefits have been seen and reaped, so the service will continue, and it will be such a relief for their children or neighbors who are unable to give the full assistance that’s needed.”
Ready to stop worrying about money?

Grocery & Food Delivery

Don’t wait for another election or census to flaunt your new work experience. Consider applying for an administrative role in one of your local government offices.
While this particular gig might not be around again for a while (we hope), that doesn’t mean you can’t take that skillset with you into your next endeavor. Founder and hiring manager Rick Hoskins of Filter King says that contact tracers likely developed an impressive array of skills when it came to research, handling customer data, and discretion.

What To Do Next

Privacy Policy

Contact Tracing

Given this type of experience, obvious next stepping stones seem to include data entry or analysis positions as well as any sort of medical receptionist position.

What To Do Next

Enjoyed watching Spot and his pad during the pandemic? As things open back up and more people venture out into the world for work and vacation, this side gig seems like an obvious one to stick around. “As people return to their workplaces, the need for someone to watch their pets, walk their dogs, take in the mail, and water their plants will increase, as will the demand for people to perform these tasks,” says Greene.

Homeschool Assistance

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What To Do Next

If you were one of the many drivers braving the pandemic to help people get around, we see you — and the good news is, your gig isn’t going anywhere. “Rideshare, and other services such as food delivery, will continue to expand and the number of drivers needed to perform these deliveries will continue to grow as well,” predicts Greene. “Driving is something almost anyone can do part-time to make extra, or in many cases, full-time money.” But the other great thing about being a rideshare driver? You’ve got people skills like no one else.

Poll Work

If you want to move past the driver’s seat, consider finding a job in customer service, sales, or even public relations. And be sure to bring that 5-star rating mentality with you.

What To Do Next

COVID-19 has changed a lot of things about the way we live, and the way we work is one of them. Whether you held a steady job throughout the pandemic, took some time off, or even joined the 55 million people working the gig economy, you’ve probably witnessed many of these changes first hand.

Elder Assistance

Did you make money contact tracing for a government agency in the last year? If so, the pandemic side gig skills you learned there might morph into another job, post-pandemic. Data entry, for one.

What To Do Next

Having acquired experience working with children in an educational environment, you might consider becoming a teacher’s assistant or even a childcare professional at a daycare facility. There are many types of daycare facilities including private and public school programs and those associated with large employers such as hospitals and universities.

Online Tutoring

If you spent part of the pandemic delivering food, Greene says you probably developed the ability to expertly manage your time and keep things organized, all of which lends itself well to any sort of administrative office job.

What To Do Next

This side gig is a great one to continue, but don’t forget you have other options as well. If animals are your thing, consider finding work in a local animal rescue organization or pet store. If you enjoyed watching the houses more than their inhabitants, consider upping your game and becoming a luxury house sitter.

Driving for Rideshare Companies

If you want to continue developing the helping skills you obtained during the pandemic, you might consider working in a senior center, senior living facility, or even in an administrative role in a doctor’s office.

What To Do Next

Parents couldn’t have done it without you, and fortunately this side gig is another important one that seems like it might stick around for a while. “This will be critical for parents who wish to continue to homeschool their children,” says Hoskins. “They might have discovered that their children thrive with a more personalized approach to their studies.” As the country continues the transition back into in-person learning and parents resume their normal day-to-day roles, their kids might still need your support with their schoolwork. Just remember, this won’t be the only thing you can do with your new hard-earned skills.

Pet-Sitting or House-Sitting

It’s easy to feel like time spent during the pandemic was wasted, but don’t. However you got through these past few months should be seen as an accomplishment, and as we head into a season of the “new normal” — remember to take your hard-earned experiences with you and wear them proudly in whatever venture you choose to embark on next.

What To Do Next

Because side hustles have become such an integral part of life as we know it, we thought we’d ask the career experts to tell us which gigs they think will survive the pandemic, and provide some advice for people looking to transition out of their side hustles and into full-time jobs. Here’s everything you need to know about these eight major pandemic gigs — and how you can use that side hustle experience in your next venture.

The Final Word

Whether it was takeout from Dumpling, groceries for Instacart, or something else entirely — food delivery services were huge during the pandemic, and author and career educator Dr. Steven Greene thinks they’re here to stay. “This is all about convenience first and safety second,” says Greene. “Families are always strapped for time and they want simplicity— and the time saved going to the market, shopping, and bringing the food home is precious.”
Not only has grocery and food delivery become a staple in our post-COVID lives, but it’s also a great way to rack up some seriously helpful transferable skills. Just like many other service jobs, delivering food provides valuable experiences you can take with you on your next career moves. Here are some ideas.



Source: thepennyhoarder.com

Capital Gains vs. Income Tax — Why Investors Pay Less Than Employees

In 2011, American businessman and investor Warren Buffett wrote an op-ed for the New York Times in which he famously claimed he pays a lower tax rate than any of the other 20 people in his office — including his secretary.

He said his prior year’s federal tax bill was only 17.4% of his taxable income that year, compared to tax burdens ranging from 33% to 41% for the rest of his team.

With Buffett’s estimated net worth topping more than $80 billion, how is that possible? The answer lies in the difference between how capital gains and income from employment are taxed.

Capital Gains vs. Ordinary Income

Few people take the time to analyze their tax returns. However, if you did, you might notice that different income types get taxed at different rates.

Ordinary Income

The IRS taxes most income at the ordinary income tax rates — these are the familiar tax brackets that determine the tax rate you pay on income from wages and salaries, income from a business or rental property, most interest income, and some dividends.

For the 2020 tax year, the ordinary income tax brackets are:

Rate Single Married Filing Jointly Head of Household Married Filing Separately
10% Up to $9,875 Up to $19,750 Up to $14,100 Up to $9,875
12% $9,876 – $40,125 $19,751 – $80,250 $14,101 – $53,700 $9,876 to $40,125
22% $40,126 – $85,525 $80,251 – $171,050 $53,701 – $85,500 $40,126 – $85,525
24% $85,526 – $163,300 $171,051 – $326,600 $85,501 – $163,300 $85,526 – $163,300
32% $163,301 – $207,350 $326,601 – $414,700 $163,301 – $207,350 $163,301 – $207,350
35% $207,351 – $518,400 $414,701 – $622,050 $207,351 – $518,400 $207,351 – $311,025
37% Over $518,400 Over $622,050 Over $518,400 Over $311,025

Capital Gains

Capital gains income results from selling a “capital asset” for a price that is greater than its “basis.”

The IRS considers almost everything you own, including your home, personal effects, and investments to be capital assets.

Each capital asset has a basis. Basis is the price you paid for the asset, plus any money you put into improvements.

For example, say you own a vacation home. You paid $250,000 for the property, and after you purchased it, you spent $10,000 renovating the kitchen. Your basis in the vacation home would be $260,000. If you later sold the house for $300,000, you would have a capital gain of $40,000.

We calculate capital gains on investments like stocks and mutual funds in much the same way.

If you purchase 100 shares of Apple stock (AAPL) at $100 per share, your basis in the shares is $10,000. If you later sell the stock when the price per share is $120, your capital gain would be $2,000 — that’s the $12,000 selling price minus your $10,000 basis in the investment.

On the other hand, if you decided to sell your shares after the price falls to $80 per share, you would have a $2,000 capital loss.

Short-Term vs. Long-Term Capital Gains

Capital gains and losses are categorized as either short-term or long-term, depending on how long you owned the asset.

Generally, if you owned the asset for more than one year, it’s a long-term capital gain or loss. If you held it for one year or less, it’s a short-term gain or loss.

The IRS taxes short-term gains at the same rate as ordinary income. But long-term capital gains have their own lower tax brackets. Here they are for 2020:

Rate Single Married Filing Jointly Head of Household Married Filing Separately
0% Up to $40,000 Up to $80,000 Up to $53,600 Up to $40,000
15% $40,001 – $441,450 $80,001 – $496,600 $53,601 – $469,050 $40,001 – $248,300
20% Over $441,450 Over $496,600 Over $469,050 Over $248,300

You can use capital losses to offset capital gains.

For example, say you had that $2,000 gain on Apple stock mentioned above, but you also sold 100 shares of Facebook (FB) at a $1,000 loss. You would net the two together and pay taxes on a net capital gain of $1,000.


Capital Gains vs. Ordinary Income: An Example

Now that we’ve explained the different tax brackets that apply to ordinary income and capital gains, let’s return to the question of why an investor like Warren Buffet pays a lower tax rate than his secretary. We’ll do this with a hypothetical example.

Let’s say Iris is a single taxpayer who has $70,000 in wages from her full-time job. Iris is in the 22% tax bracket, but that doesn’t mean she pays 22% on all $70,000 of income.

Instead, the first $9,875 of her income is taxed at 10%, the next $30,250 at 12%, and the final $29,875 at 22%. That works out to a total federal income tax bill of $11,190 ($987.50 + $3,630 + $6,572.50).

Iris is in the 22% tax bracket, but her effective tax rate is 16% — she pays $11,190 out of her $70,000 income.

But wait. If you’ve ever looked at a pay stub, you know that federal income taxes aren’t the only taxes deducted from your paycheck.

In addition to Iris’ federal income tax bill, she also pays Social Security tax at a rate of 6.2% and Medicare tax of 1.45% on her earnings. That’s another $5,355 out of her pocket.

Between federal income taxes and payroll tax, Iris is giving 24% of her income to the federal government.

Now let’s compare Iris’ tax rate to Keith’s. Keith is also a single taxpayer with $70,000 of income. But thanks to Keith’s grandparents, who left him a pile of money, Keith doesn’t work.

Instead, all of his income comes from long-term capital gains. The first $40,000 of Keith’s income isn’t taxed at all, because it falls into the 0% capital gains tax bracket. He pays just 15% on the next $30,000, for a total tax bill of $4,500.

Keith’s effective tax rate is just 6%. Plus, Keith doesn’t have any Social Security or Medicare taxes deducted from his capital gains. As a result, Investor Keith pays a much lower effective tax rate than Worker Iris.

Note: Iris’ and Keith’s tax bills might actually be lower due to deductions and credits that would reduce their taxable income and offset their tax liability. To keep this illustration simple, we’ve ignored the potential impact of tax deductions and credits.


Why Capital Gains Tax Rates Are Lower

In looking at the example above or reading Buffett’s op-ed, you might wonder why there’s such a big difference in how the U.S. Tax Code treats ordinary income and capital gains. Well, it depends on who you ask.

According to the Tax Foundation, a low capital gains tax rate encourages people to save and invest in the U.S. economy, and low capital gains tax rates have historically raised more in tax revenues than higher capital gains rates.

The Tax Policy Center, on the other hand, argues that tax rates on capital gains aren’t a major factor in economic growth, and the benefits of lower capital gains rates disproportionately benefit the wealthy.

That’s why some lawmakers have proposed higher taxes on investment income over the past several years. One example, the so-called “Buffett Rule,” would apply a minimum tax rate of 30 percent on all taxpayers with income greater than $1 million, no matter where their money came from.

Although that initiative didn’t pass, the Health Care and Education Reconciliation Act of 2010 created the Net Investment Income Tax (NIIT). The NIIT applies a 3.8% surtax on investment income, including interest, dividends, capital gains, and rent and royalty income for high-income taxpayers.

For these purposes, “high income” means single taxpayers with income greater than $200,000 or married couples filing a joint tax return who make more than $250,000.


Final Word

Capital gains tax rates are a highly debated topic. Advocates for lowering capital gains tax rates argue that it would increase economic growth and promote entrepreneurship. Their opponents believe raising the tax rates on capital gains would raise additional revenues and promote a more equitable tax system.

Whatever happens to capital gains tax rates in the future, it helps to understand how our tax laws treat different types of income. You can use that knowledge in your own tax planning, or simply have a better understanding of what it means when politicians and lawmakers debate the issue.

Source: moneycrashers.com