With the recent passage of the 2008 tax stimulus package, many people have been asking what their adjusted gross income is and how that differs from their take home pay, their salary, and the other similarly named modified adjusted gross income. The differences are pretty simple once you understand the motivations behind it but it’s easy to confuse many of them together.

First off, you salary is the pre-tax amount your employer pays you to work for them. Next, your take home pay is your salary minus any deductions you may have for health insurance, retirement plan contributions such as a 401(k), taxes, and any other adjustments. Your take home pay is the dollar amount that gets written on the check (or is deposited into your bank account). Your salary is what you tell your parents when you get a job (it’s bigger).

Why is this important? The AGI and MAGI are often used to determine if you are eligible for certain benefits, deductions, etc. For example, the MAGI is used to determine contribution eligibility for IRAs such as the Roth IRA.

Adjusted Gross Income

According to the IRS, your AGI is all taxable income you earn including the following categories:

• wages,
• salaries,
• tips,
• taxable interest,
• ordinary dividends,
• taxable refunds, credits, or offsets of state and local income taxes,
• alimony received,
• business income or loss,
• capital gains or losses,
• other gains or losses,
• taxable IRA distributions,
• taxable pensions and annuities,
• rental real estate,
• royalties,
• farm income or losses,
• unemployment compensation,
• taxable social security benefits,
• and other income

minus

• specific deductions including educator expenses,
• the IRA deduction,
• student loan interest deduction,
• tuition and fees deduction,
• Archer MSA deduction,
• moving expenses,
• one-half of self-employment tax,
• self-employed health insurance deduction,
• self-employed SEP, SIMPLE, and qualified plans,
• penalty on early withdrawal of savings, and
• alimony paid by you.

Some argue that this is what appears on your 1099 or your W-2’s, but that’s not entirely accurate (self-employment tax isn’t even within scope for a 1099). The full list above is comprehensive and provided by the IRS so that’s the official story (source). Note one important item(s) missing from the “minus” list, the standard deduction or any other itemized deductions (like mortgage interest).

Modified AGI

How does the MAGI differ? You simply take your AGI and exclude the following (source):

• Any passive loss or passive income, or
• Any rental losses (whether or not allowed by IRC § 469(c)(7)), or
• IRA,
• taxable social security or
• One-half of self-employment tax (IRC § 469(i)(3)(E)) or
• Exclusion under 137 for adoption expenses or
• Student loan interest.
• Exclusion for income from US savings bonds (to pay higher education tuition and fees)
• Qualified tuition expenses (tax years 2002 and later)
• Tuition and fees deduction
• Any overall loss from a PTP (publicly traded partnership)

Relationships

So your MAGI will be higher than your AGI but smaller than your gross income. Your gross income will be your salary plus any other income, passive or active, and thus larger than MAGI or AGI (since they include subtractions for certain items).

Why is this important?

Knowing what makes up these numbers is important because those values will dictate what you are permitted to do, tax-wise. The best example is with a Roth IRA. If you file as a single and your MAGI is under $99,000 for 2007, you can contribute the maximum $5,000. If your MAGI is between $99,000 and $114,000 then your contribution is phased out (Roth IRA contribution phase outs). If your MAGI is over $114,000, then you can’t contribute to a Roth IRA.

So, if you know you’re within those phaseout ranges, you might want to contribute a little bit more into the 401(k) so you can take advantage of the Roth IRA. Since you know what makes up the MAGI calculation, you would be well informed and smart to do that (if you wanted to contribute to a Roth IRA).

There you have it, AGI and MAGI, all wrapped up in a pretty little (and somewhat complex) bow.

It’s been said that we Americans live in a world of instant gratification. We want the coolest gadgets and gizmos, the best food, the best cars, the best everything… right this very second. We are impulse, we are impatient, and most important of all, we are able to fund our impulsiveness and impatience with lots and lots of spending.

You know who else knows this? Stores. There’s a very good and profitable reason why there are tabloids and candy bars at the checkout aisles (one of the reasons why self-checkout kiosks haven’t become more ubiquitous is because you can’t sell someone high margin items like magazines and candy if they’re busy checking themselves out… plus the machines always break for some reason). Anywhere you go, you’ll likely see some small little item by the register like a trinket or a small votive candle or whatever. You’re impulsive and stores know it.

You know who else knows this? Salespeople. If you ever get a quote from someone to do work on your house, you’ll always get a special one day deal. You’ll always get an “awesome deal” that will only be good for the next three days. If you go into a store with salespeople, say furniture, you’ll always be offered six or twelve months of 0% financing if you buy today. One day offer!

Advertisers scare you by showing a burglar breaking into your home and then flashing a number for a security system company. They show you beer and snack commercials during football season and they show you pizza delivery commercials late in the evening. They know that they can take advantage of your need for instant gratification to bypass your normal decision making patterns. They’re smart… but you’re smarter.

Remove the allure of instant gratification and you can save yourself big money.

You don’t need that tabloid and your stomach doesn’t need that Three Musketeers bar. You shouldn’t take that contractor’s awesome one day deal because you can probably do better shopping around. Finally, furniture will always have 0% financing. Always. So, remove instant gratification from your life and you can save yourself money; here are two reasons why:

Shopping Around

If you resign yourself to always get at least three quotes on something before you buy it, you’ll save yourself money even if you do nothing else. While this seems obvious for things like high dollar contracting work where there are plenty of differentiated suppliers, it works even for commodity type things like DVDs and books. There are two reasons why this is effective:

• You save money by finding the lowest cost among three similar vendors.
• By not buying immediately and waiting to see the price in at least two other places, you may re-evaluate how badly you need that item or the work. You could decide it’s not what you want.

Is Time A Factor?

Sometimes time is a factor and you need to buy something immediately, such as airline tickets. However, if time is not a factor, consider waiting for the sales to come to you. There are plenty of bargain airline ticket places that will send you their latest fare sales, just wait for a good deal before pulling the trigger on tickets if there isn’t a specific event you’re going to. This same rule applies for items. Amazon.com has rotating deals on all classes of items, just wait until your item goes on sale before you buy it.

So, the next time you want to buy something, take a step back and try to find three alternative stores (or three alternative items that may be cheaper but serve the same function) and think if time is a factor. These two alone will save you a bunch of money you can better spend on a trip to Europe! (just wait for the deals!)

I’m a fan of the casinos. I don’t know whether its the pumped in oxygen, the bright lights, the sounds of excitement and joy, or the free drinks flowing throughout… but I love going to casinos. Sometimes I win, sometimes I lose, but I almost always have a good time putting my hard earned money on a felt table and seeing if it’ll grow and multiply. When I go to casinos, I usually bring a set amount I’m willing to lose, say a few hundred bucks, and then I enjoy myself. I understand that when I go to a casino, I’m there to have a good time; I’m not there to make money.

Sadly, the stock market is nothing like that. It’s pressing a few keys on your keyboard or clicking a few buttons with your mouse. The transactions happen with no fanfare, there is often little anticipation, yet if you try to time the market or day-trade… you’re essentially gambling. Why would anyone gamble if you can’t at least get some free drinks out of it?

What always surprises me is that so many smart people try to play the stock market as if it were a game at a casino. People try to time the market by buying it on the way up and selling at the peak. People try to sell their shares when the market is going down so they can cut their losses or re-buy later. It’s not as if the vast majority of experts aren’t advising against it. The latest is the manager of Yale’s endowment, David F. Swensen, who says you should keep things simple by advising that you “use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.”

Who else has advised index funds? Vanguard’s John Bogle recommends them. Warren Buffett of Berkshire Hathaway, the Oracle of Omaha, has also advised them. With a panel like that, why do people choose to pick their own stocks?

It’s the thrill. It’s the excitement. How fun is it to say you made $500 this week on the stock market because you made a great trade? How fun is it to buy a stock prior to its earnings announcement and then see if you guessed right? If that sounds like you, then recognize that you’re gambling on the stock market.

It’s no different than if you put down $500 on black or put it all on a hand of three card poker… do the brokerages give you a free meal or a free room if you lose big? Probably not… if I were you, keep the gambling in the casinos where you get a little more enjoyment out of it!

(Photo by shalmaneser)

LendingClub is another player in the growing peer to peer lending marketplace and one that I signed up with despite my reservations with the whole peer to peer lending craze. I was tempted because online savings account interest rates have fallen sharply lately because the Fed lowered the target funds rate so quickly and because they have a signup bonus with very easy requirements. (If you get referred to LendingClub and become a borrower or lender, you get $25. If you deposit $1,000 and start lending, that bonus increases to $50; both referrer and referee get the same bonus)

Account Signup

The signup process was easy and I had an account up and running within minutes. Setting up my account so I could begin lending was also trivial, a four step process of entering my personal information, bank information, and some association information (school I went to, employer, etc. but these were optional). The account process proceeds with the typical bank account verification process of small deposits.

Default Rates

It appears that LendingClub’s default rate and other lending stats are rosier than the likes of Prosper and others, but that could be because they are much newer to the game. Techcrunch did a brief writeup on LendingClub and noted the same thing about the default rates, expecting them to rest close to what Prosper was seeing. Ultimately it appears that both should have similar statistics with regard to late payments, defaults, and other lending related statistics. If you think LendingClub borrowers are on the whole “better” than Prosper, I would take a step back and re-evaluate because they will be roughly the same.

Tax Headaches

I don’t know how LendingTree sends out tax forms but it sounds like dealing with taxes from Prosper loans is a huuuuuge pain.

Next Steps

I had talked about opening up a Prosper account and I went through the motions of opening a LendingClub account, but I’m not sure if I’m ready to lend any money (or do I want to deal with handling the taxes, considering I’d be lending so little). I went through Moolanomy’s affiliate link to he was able to score a $25 for the trouble (I did too), so all was not lost. It’s interesting they would pay out commissions even if you don’t actually lend any money (if you verify a bank account, they pay out a commission) but I’m not complaining.

I was reading an article the other day (I about the importance of paying attention to your asset allocation mix, rebalancing, the usual exciting investment stuff, when I stumbled upon this passage (third paragraph):

Not to scare you, but that’s a risky situation. If one of your largest asset classes should take a sudden fall - the way emerging markets plunged nearly 60 percent between 1997 and 1998 - your returns will go into a tailspin along with it. [link]

The “not to scare you” part is in reference to advice that you shouldn’t let an asset type, in this case emerging markets, get too large without rebalancing to reduce, or at least spread out, your investment risk.

While that in and of itself is sound financial advice, the most significant idea I got out of reading that article was that I don’t know much about the history of the markets. My investing history is exceptionally weak. By investing history, I mean all the swings, bubbles, bursts, run-ups, corrections, crashes, etc. in the stock market, bond market, housing market, and other various markets and as a result, I’m doomed to follow the “sky is falling” mentality of mainstream media. My investing history is limited to the big ones like Black Monday back in 1987 and the trivia ones like the tulip bulb craze in the 17th century, but I had no idea emerging markets crashed 60% between 97-98. Did you know that the peak of the dot com boom to the trough of the burst lasted 929 days?

Do yourself a favor and check out this great resource by Fortune in which you can view the performance of the markets over the last 50 years? Spanning the top are the Presidents and Fed Chairmen and the chart reflects the performance of the markets along with periods of bear markets and recessions. It’s a superficial look but it’s a jumping off point.

If you see any periods that look especially interesting, such as the 20% drop that started in the summer of 1990 and ended in the fall, start doing research to see what caused it, how people reacted, etc. What’s especially interesting is now you can read the archives of many popular newspapers such as the New York Times, you can read the sentiment of the writers and the public by scanning the archives. Panic and irrational reactions aren’t 21st century creations, they existed back then too (much like irrational exuberance!).

Last night I had a flat tire and drove my donut-riding self over to Costco where they were able to plug the leak. (I love buying tires at Costco, especially now that they opened a store right by my house!) While they were fixing the leak, I had 45 minutes to kill and wandered around the warehouse. I meandered over to the tax section and picked up a copy of Quicken 2007 Home & Business. I’ve been meaning to get some sort of tax software package (Nickel raves about it and his 2304982039 years of data) and wasn’t sure if I should go with Quicken 2008 or Quickbooks. I decided I would read reviews, install the Quickbooks Simple Start trial and then install Quicken 2007 to do a real comparison.

My Needs

A lot of people have sworn by personal finance management software like Quicken but I had never tried it for myself. The main reason is because I didn’t want to spend money on software that would manage a process I already had a good handle on. Part of it was learning curve, part of it was me being cheap, but that all came to a head as I felt I needed some sort of accounting software for my side business.

Quickbooks

Quickbooks is powerful. If you run a business with inventories, invoices, and the full “light” nine - Quickbooks blows Quicken away. Quickbooks has great reporting features and some niceties that Quicken simply wasn’t designed for. For example, with Quickbooks you itemize all of your invoices and then all of your collections separately. If you perform work, you send out an invoice. When you receive a check, you record the collection (and this was just with their simplest package, Quickbooks Simple Start!). There are also a lot of great features behind the scenes such as the ability to export accounting versions and have that data sync back up after your accountant has worked with the books. Ultimately, Quickbooks is for the serious business owner looking to have a little more control over their books. If you’re a serious serious business owner, you probably want to outsource your accounting (who knows, I’m not at that level in terms of accounting complexity so I’m not a good person to rely on for that recommendation).

Quicken

Quicken is a personal finance management application first and accounting package second, even with the “Business” label. For my business, which has few invoices, no inventory, and a simple accounting structure, it’s perfect. For our personal finances, it’s great in that it has integration with nearly ever bank, company, or brokerage we work with (I have yet to find one it doesn’t integrate with) so I no longer need to log into my accounts via the web, Quicken does it for me, downloads the data, and integrates it with all the other data.

Verdict: Quicken

With a simple business structure and a need for personal finance management, I felt that Quicken was the right version for me. It cost a mere $70 at Costco, which will be tax deductible, it was a discount compared to Amazon or Intuit.

Why Not Online Versions?

I know the online versions are secure and I know sites like Mint.com and Yodlee.com are free, but I don’t like the idea of having my data stored elsewhere. (Mint doesn’t store anything, they leverage Yodlee, but the data is still floating around out there) Is this irrational? Perhaps, but I surrender little by leaving it locally on my hard drive.

I have yet to fully play with all the features Quicken provides but I hope to in the coming weeks (after the honeymoon). I know there are a lot of Quicken guru’s out there so please share any tips or hacks you may have (like this one by Nickel on how he manages his various CDs), thanks!

There are plenty of reasons you should use a credit card instead of a debit card (if both are available) but here’s one that is especially compelling. A debit card is directly linked to your checking account, whereas a credit card is linked to an ephemeral credit limit. When Burger King accidentally bills you $2,243 instead of $22.43 or when they bill you $8,648 instead of $86.48, you aren’t suddenly emptied of all your funds.

Debit cards used to suffer from weaker fraud protection, that’s no longer the case. Debit cards used to be less widely accepted because they used a network that differed from credit cards, that’s less and less the case. However, debit cards will always be linked to your bank account (that’s by definition) so when someone accidentally enters in $2000 instead of $20, you’ll be out that money until someone is around to resolve it.

In the meanwhile, any checks you’ve written or any future debit transactions will result in NSF (not sufficient funds) and overdraft fees - which will likely put a smile on your bank’s face and a huge frown on yours.

So, if you want yet another reason not to use debit cards, this is a big one. Don’t underestimate the power of carelessness and stupidity.

Earlier this year I discussed how I was going to follow Flexo’s lead and open up a Fidelity Charitable Gift Fund. The idea behind the Fidelity Charitable Gift Fund is that you can make a charitable donation now, have the assets appreciate, and then decide where donations will go later on. Much like how a mutual fund is actually an organization, the Fidelity Charitable Gift Fund is an organization. When you donate money, you are donating to the Fidelity Charitable Gift Fund and you have two options as to where the money goes. You can either open up a Giving Account under your name (or any name you wish) or open up a Pooled Income Fund.

Giving Account

This is the type of account Flexo talked about and one that I was seriously considering. What you do is open a Giving Account, contribute funds, direct how the funds are to be invested, and then recommend grants. You will notice that all the documents say that you will “recommend” which organizations will be the beneficiary of your funds, but they aren’t legally bound to honor your wishes. I think that specific language is used for legal purposes but they honor most recommendations.

Pooled Income Fund

This is the second option and one I hadn’t considered. It’s part charitable fund and half income generation, akin to an annuity, though the final payout goes to a charitable organization (up to 10). So let’s say you contribute $10,000. You direct where the contributions will be invested and you can select up to two beneficiaries. Each quarter, the proceeds from your investments will be paid out to the beneficiaries. Upon the death of the final beneficiary, the value of the account goes towards charities. It’s different than the Giving Account and less desirable for what I’d like to accomplish.

Considerations

So, it sounds pretty easy right? Why wouldn’t everyone do this? (these concerns cover only the Giving Account)

• Initial limits and fees: The initial contribution has to be greater than $5,000 and each additional contribute has to be greater than $1,000. The fees include the expenses of the investments plus an Annual Administrative Fee. The administrative fee is the greater of 0.60% of the total fund value or $100 for the first half million, 0.3% for the second half million, 0.2% for the next million and a half, and 0.15% for the rest up to five million. Beyond that and the fees are different. If you were to contribute $5,000, you’d be talking an administrative fee of 2% plus the underlying investment fees. If you don’t have $5,000 or you don’t want to pay any of these fees, you might want to just donate directly to a charity.
• Time horizon: Since you do select investments for your contributions, there is the potential that your investments will lose value. So, if you plan on doing this, contribute funds you think you might want to use next year or the year after (or, ideally, in five years). Increasing the time horizon will smooth out the random walk of the stock market.
• Tax benefit: As much fun as it would be to have the Jim Charitable Trust, the tax benefits are better if you contribute appreciated stock. When you donate appreciated stock that you’ve held for over a year, you can deduct the entire value of the stock from your income, including the appreciation. (For more on that, read this article about reducing your capital gains by donating stock) With the Giving Account, you deduct your initial contribution and not the amount actually granted, so you never actually benefit from the appreciation (but you can donate appreciated stock).
• Grant exclusions: Almost any recommendation you give will be accepted with the exception of several groups, though there are very good reasons. For example, you cannot recommend any donation that would result in you receiving any sort of gift or preferential treatment. The list is available here.

I’ll be honest, the idea of opening a small charitable gift fund in our name does sound like fun and it would be great to be able to leverage the market to help further our philanthropic goals but with a $5,000 start price and those annual fees, I may wait a little while before opening one up. The uncertainty of the market (and a short time horizon) are also serious considerations as well… what do you all think? Good idea? Bad idea? Wait? Go now?