Tax-deductible expenses (charitable contributions, mortgage interest)

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eric
Posts: 35
Joined: Wed Apr 20, 2016 6:06 pm

Tax-deductible expenses (charitable contributions, mortgage interest)

Post by eric »

Is there any way to model tax-deductible expenses?

For example:

- charitable contributions.

- mortgage interest, which is deductible, but varies over time as a mortgage is amortized and the principal is gradually paid off

- state property tax, which is deductible on the Federal return, but not on the state return

Thanks.

jimr
Posts: 634
Joined: Thu Feb 28, 2008 6:48 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by jimr »

The planner isn't really set up to handle taxes with that level of precision. There are only a few levers you can adjust, but usually with some tinkering those are enough to get you in the ballpark.

For charitable deductions, you could enter the after tax cost of the expense after manually calculating the value of the deduction.

For a mortgage, you could break the term into 3 or 4 parts (eg maybe three 5-year periods for a 15 year mortgage). Then you can use a different after-tax amount for mortgage payment for each of the periods, taking into account the different average deductions over the three periods.

Jim

eric
Posts: 35
Joined: Wed Apr 20, 2016 6:06 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by eric »

Thank you.

eric
Posts: 35
Joined: Wed Apr 20, 2016 6:06 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by eric »

Regarding deductibility, it would be very helpful to have a separate flag, as you suggest in a separate response today.

Most significant, I have two residences (principal residence and second home), both with big mortgages, and most of the mortgage payment represents interest. (I understand your suggestion to break it up into time periods.) So it's a factor that makes a significant difference in my projections, not just a marginal issue.

jimr
Posts: 634
Joined: Thu Feb 28, 2008 6:48 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by jimr »

Thanks for the extra info. You've made a compelling case to some sort of deductibility flag and I made a note to look into it when I'm in that area of the code again.

Many of the features of the planner resulted from comments like yours and it's much appreciated that you took the time to write up your comment.

Best,

Jim

eric
Posts: 35
Joined: Wed Apr 20, 2016 6:06 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by eric »

jimr wrote:Thanks for the extra info. You've made a compelling case to some sort of deductibility flag and I made a note to look into it when I'm in that area of the code again.
Thanks. That would be a great help.

To give you some sense of how it matters.... I've just started playing around with my mortgage numbers. I've discovered that my mortgage interest payments for my two properties total roughly $500,000 over 30 years, so assuming 30% tax rate, that makes a difference of $150,000, which is significant to my planning. Using your suggestion to break it up into periods is reasonable, but because the amortization is constantly reducing the principal, the interest is constantly diminishing so it would not be correct to break the $500,000 evenly into three periods. By my calculations, 50% of the interest falls into the first 10 years, 36% into the next 10 years, and 14% into the final 10 years. All of this is in nominal dollars, so the assumed inflation rate is significant. To model it accurately, I'll have to somehow factor in the inflation rate in my spreadsheet, and use the same inflation rate in FRP. Probably what I'll do is take the interest for each of the three periods and discount it based on the inflation discount factor at the midpoint of the period (5 years, 15 years, 25 years). If I'm doing sensitivity analysis with different inflation rates, I'll have to change the rate in both my spreadsheet and FRP, and re-enter the numbers.

I do understand that it's not reasonable to aim for precision in a planning process that is dominated by uncertainties, and it's OK to make some compromises and simplifications. But I don't want my results to be off in significant ways, so I can't oversimplify. For example, could I just represent the $150,000 as a one-time expense at 15 years, deflated at the assumed inflation rate? I can't know without crunching the numbers, and hoping I have the calculations right, and updating the results in FRP - all of which is time-consuming and error-prone.

It would be so much easier if those calculations could be done within FRP. :-)

trfrp
Posts: 13
Joined: Sat Apr 16, 2016 9:32 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by trfrp »

Eric, since you asked for my input, here is my quick reaction.

The deductability of mortgage interest is already very indirectly reflected in the FRP simulation through the income tax rates that you specify. If you estimate your income tax rate by dividing the taxes that you actually owe by your total gross income, then your mortgage deduction reduces your effective tax rate. If you use this lower rate in FRP, then you are implicitly assuming that you will have mortgage interest deductions or similar items in the future that will keep your effective tax rate down. The lower tax expense computed by FRP at this lower tax rate effectively already accounts (in a very rough sense) for the mortgage interest that you expect to deduct in the future. If you choose to model your actual mortgage interest deductions in the future, then you should adjust your FRP income tax rate upward to avoid double-counting the mortgage interest deduction.

For what it's worth, I have been modeling my housing costs by including my entire mortgage payment (interest and principal) as a cash flow expenditure. Because it is a level payment, it is easy to input (with a zero COLA). I haven't included my principal residence in my FRP plan yet, but if I do I will probably just add a "House" asset in the year after my last mortgage payment at today's after-tax market value with a COLA rate set to the expected market appreciation on the house. My sense is that this will get me in the ballpark.

eric
Posts: 35
Joined: Wed Apr 20, 2016 6:06 pm

Re: Tax-deductible expenses (charitable contributions, mortgage interest)

Post by eric »

Jim - Here's another reason why tax-deductible expenses would be helpful....

My husband is a psychotherapist, self-employed. He has a number of business expenses which are tax-deductible. I can show these expenses in FRP as a separate Misc Expense line, and adjust the amounts to account for taxes. (So if we're in the 30% tax bracket, I'd enter 70% of the expenses.) But that requires that I carefully document what I've done, and that I keep track of the calculations and the tax rate. It would a real convenience if FRP could provide a way to designate expenses as tax-deductible and to do the calculations at the specified tax rate.

Thanks.

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