To IRS, We Are One; To Me, We Are Three - Figuring Taxes

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HappyPappy
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To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HappyPappy »

We are married and file jointly. I have a W-2 job, my wife has a sole proprietorship, and I manage an in-law's money (it is legally our money in our held in its own accounts under our names, but in fact it belongs to my in-law).

I have always used TurboTax to do our taxes. I probably should take more time to look at the actual forms, but I've always been too lazy or felt like I didn't have enough time to do so.

I'd like to figure out the tax burden for the W-2 job, the sole proprietorship, and our in-law's investments all separately.

My plan, is to enter the W-2 income into TurboTax, follow along as if we did not have the sole proprietorship and our in-law's investments, and see our total tax burden for 2023 - not just what we owe but everything we've paid already. Then I'll add in my in-law's investments, see how much the overall tax burden increases. I'll pay this out of my in-law's money. Then I'll go back and add the income and deductions from the sole proprietorship to see how that affects our total tax burden. The increase in the tax burden will be paid by the sole proprietorship.

Is that going to produce an equitable distribution of our total tax burden among all three of our "tax" entities?
sailaway
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by sailaway »

I would do the business income first and the other money last, myself, especially if any of it is subject to NIIT or additional Medicare surcharge.
MathWizard
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by MathWizard »

As you describe it, the in-law money would be taxed the highest, since the W-2 and the sole proprietorship would use up the standard deduction and the lowest tax brackets.

If you want an equitable split, I suggest just figuring with all the income combined and allocate the tax burden proportionately based on the various incomes.

If the money is legally yours, them the in-laws would be dependents. Since the TCJA, I haven't had dependents, so I'm not sure what effect that has on taxes.

Though I don't know if it is law yet, there was a proposal to have a tax credit for those with W2 income who are caregivers for parents. You might want to check that out if it has become law, and if it applies to you.

I'm not sure why the money is legally yours, but considered as your in-law's , but this would highlight a disadvantage of having money from parents going to children too early, due to the loss of a second standard deduction and low tax brackets.
Atgard
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by Atgard »

The hard part is if you figure out Source 1's income and tax burden first, then add in Source 2 and allocate the additional Tax to Person 2, then Person 1 gets all the benefits of the standard deduction and lower tax brackets vs. Person 2 who will pay at higher marginal rates.

One way is add up all the income, figure out the total taxes, and allocate them proportionally. So if Source 1 made 30% of the total income, they pay 30% of the total tax. This is simple and more fair, but the downside is it treats all income the same, whereas some income (capital gains & dividends for example) are taxed at different rates. Depending on your situation this may be a minor quibble (20% vs. 22%) or a bigger deal.
ccieemeritus
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by ccieemeritus »

I mostly agree with your plan. Calculate your taxes without the in-law money. Save the tax forms as a PDF. Then add in the in-law money. Save that tax form (which would be your submission) as a PDF. That's what adding their investments to yours adds to your tax burden. Pay that out of their account.

I wouldn't separate you and your wife's calculations. You are on the same team.
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mhadden1
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by mhadden1 »

HappyPappy wrote: Sat Feb 10, 2024 11:45 am it is legally our money in our held in its own accounts under our names, but in fact it belongs to my in-law
This sounds weird to me.
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HomeStretch
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HomeStretch »

+1 to ccieemeritus’s method of calculating the in-law’s share of the incremental tax liability per the as-filed tax return.

As far as allocating your/spouse’s share of the tax liability between business and personal, your method of entering the W-2 income as the baseline proforma tax return gives the W-2 tax liability share the advantage of the lower tax brackets. If you need to precisely allocate the joint tax liability accurately between the two, you need to run proforma returns for each to use to allocate the proforma joint business/W-2 return’s (used as the baseline when calculating the in-law share) tax liability.
toddthebod
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by toddthebod »

HappyPappy wrote: Sat Feb 10, 2024 11:45 am My plan, is to enter the W-2 income into TurboTax, follow along as if we did not have the sole proprietorship and our in-law's investments, and see our total tax burden for 2023 - not just what we owe but everything we've paid already. Then I'll add in my in-law's investments, see how much the overall tax burden increases. I'll pay this out of my in-law's money. Then I'll go back and add the income and deductions from the sole proprietorship to see how that affects our total tax burden. The increase in the tax burden will be paid by the sole proprietorship.

Is that going to produce an equitable distribution of our total tax burden among all three of our "tax" entities?
So if you make more at your W-2, your in-laws have to pay more taxes? How is that equitable?
Backtests without cash flows are meaningless. Returns without dividends are lies.
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ClevrChico
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by ClevrChico »

I have a somewhat similar situation and use Excel1040 (https://sites.google.com/view/incometaxspreadsheet/home) to calculate the individual tax burdens. The override feature built in comes in handy too.
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HappyPappy
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HappyPappy »

toddthebod wrote: Sat Feb 10, 2024 12:55 pm
HappyPappy wrote: Sat Feb 10, 2024 11:45 am My plan, is to enter the W-2 income into TurboTax, follow along as if we did not have the sole proprietorship and our in-law's investments, and see our total tax burden for 2023 - not just what we owe but everything we've paid already. Then I'll add in my in-law's investments, see how much the overall tax burden increases. I'll pay this out of my in-law's money. Then I'll go back and add the income and deductions from the sole proprietorship to see how that affects our total tax burden. The increase in the tax burden will be paid by the sole proprietorship.

Is that going to produce an equitable distribution of our total tax burden among all three of our "tax" entities?
So if you make more at your W-2, your in-laws have to pay more taxes? How is that equitable?
Management fee? :)
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HappyPappy
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HappyPappy »

ccieemeritus wrote: Sat Feb 10, 2024 12:08 pm I mostly agree with your plan. Calculate your taxes without the in-law money. Save the tax forms as a PDF. Then add in the in-law money. Save that tax form (which would be your submission) as a PDF. That's what adding their investments to yours adds to your tax burden. Pay that out of their account.

I wouldn't separate you and your wife's calculations. You are on the same team.
I want to have a clear view of how the business impacts our taxes, and how taxes impact the business. We have separate books entirely for the business (which by the way is super small, contributing about 10% to our net income each year).
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HappyPappy
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HappyPappy »

HomeStretch wrote: Sat Feb 10, 2024 12:35 pm +1 to ccieemeritus’s method of calculating the in-law’s share of the incremental tax liability per the as-filed tax return.

As far as allocating your/spouse’s share of the tax liability between business and personal, your method of entering the W-2 income as the baseline proforma tax return gives the W-2 tax liability share the advantage of the lower tax brackets. If you need to precisely allocate the joint tax liability accurately between the two, you need to run proforma returns for each to use to allocate the proforma joint business/W-2 return’s (used as the baseline when calculating the in-law share) tax liability.
So complete an entirely separate tax filing for each "entity". I think that might result in the business not owing any tax when it files on its own, but adding a significant amount to our tax burden when we in fact file and the business income is added, in the IRS's view, with the W-2 income.

I guess I am using the W-2 income as the baseline because that is in fact the only we survive. Then by adding in the business, I see the tax implications of running that business. I guess if the business were larger we'd make an LLC then file separately or else we'd be artificially inflating the sole proprietorship's tax burden by putting its income on top of the W-2.

To be more specific:
W-2 gross income is about 125k.

Business gross income is about 12k.

In-law's money is about 100k with about 60k in Vanguard's S&P 500 index and 40k in a CD ladder.
HomeStretch
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HomeStretch »

HappyPappy wrote: Sat Feb 10, 2024 1:48 pm … So complete an entirely separate tax filing for each "entity". I think that might result in the business not owing any tax when it files on its own, but adding a significant amount to our tax burden when we in fact file and the business income is added, in the IRS's view, with the W-2 income. …
Bottom line is use the method that works best for your and spouse’s needs.
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HappyPappy
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by HappyPappy »

I appreciate all the replies. It forces me to think a little more critically about what I'm doing.
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grabiner
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by grabiner »

I would apportion the various types of taxes according to the income for each tax.

Thus, the self-employment tax for the sole proprietorship belongs entirely to that person (and it should, since it will count towards her SS earnings and future benefit). The income tax should be proportional to the income, reduced by any deductions related to a particular source of income (such as the deduction for half the self-employment tax); you can prorate income taxed at lower rates. (For example, if you are in the 24% tax bracket, $24,000 in qualified dividends is equivalent to $15,000 in ordinary income for tax purposes.)

The process I suggest for allocating income is analogous to how Form 1116 works for the foreign tax credit. If your total income was $103K including $10K of foreign income, and you have $3K of deductions directly related to your US income, then 10% of your income is foreign, and thus 10% of your tax was imposed on the foreign income. Form 1116 then uses 10% of your tax as a limit for the foreign tax credit.
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epoche
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by epoche »

Does the in-law have other income and also have to file a separate income tax form?

If not, I would also do the reverse - enter the in-law's portion first and calculate their tax burden, if any.
If they do have other income, I would do a dummy tax form adding in the portion you hold for them onto their other income to see how that affects their picture.

This will give you an idea of what they would pay if you weren't holding the money, and is likely to inform your view of what is equitable.

We have a similar situation and have looked at various arrangements.
The recommended options are typically to keep the money in the in-laws name with you as Power of Attorney for access to the accounts, or have them fund a trust with you as trustees. The trust income passes through to the owner/beneficiary (the in-law) of the trust and is taxed at their personal rate.

In our case, the person we are helping owes no tax with separate/trust accounts, but would owe at a high rate if we held the money for them and had to pay tax on their income too.
Your situation could be different depending on specifics.

Hope that helps.
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by mkc »

[Topic is now in Personal Finance (Not Investing) - taxes. mod mkc]
humblecoder
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by humblecoder »

At first, I did not like your approach for some of the reasons stated by others. The income source you add first will get the benefit of filling up your standard deduction and lower tax brackets. Whereas the income sources you add last would not.

However, the more I think about it, the more your approach makes more sense. Here's why...

Presumably, you would have your W2 job regardless of whether your wife has a sole proprietorship and regardless of whether you held your in-laws assets. This is the money that you and your family are living on. You would want your W2 income to get the advantage of the standard deduction and lower tax brackets because those are dollars that go towards paying for your basic needs.

What you are trying to do is determine the impact of adding each incremental layer of income on top of what you would already be earning to sustain the household. Looking at it that way, what you are doing makes sense.

The only thing I might do differently is apply your wife's sole proprietorship earnings before your in-law's income. Because her income is relatively low, it might not make any practical difference. However, theoretically, it should be prioritized in the tax brackets since it is a component of YOUR household income. Also, this way, you can measure the true impact of managing your in-laws finances in the way that you do. You can say "because I manage your money, it costs me this much more in taxes"

At the end of the day, there is no true right answer. Do whatever you think works best for you.
humblecoder
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Re: To IRS, We Are One; To Me, We Are Three - Figuring Taxes

Post by humblecoder »

As an aside, you might be able to reduce your total taxes by keeping your in-laws money in their name. That way, they can fill up their own standard deduction and lower tax brackets. Of course, you didn't share their entire financial picture (nor are you obligated to), so hard to say for sure.

There might be other disadvantages to this arrangement.. specifically losing the step-up in basis.

If there is a non-financial reason for this arrangement (ex: they can't manage their own money), perhaps there is another solution, such as putting the money back in their name and getting power of attorney. Just offering some food for thought there.
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