So tax season has come to an end, but the memories of the last minute filers still burn brightly in our dreams. The filers who waited because they KNEW they owed. The taxpayers who had to go on extension because of missing documentation. The people who cried because there was nothing we could do to help their situation. Well, this post is for all of YOU!
Next tax season doesn’t have to be like this year. Nothing pains us more than not being to help someone out of their situation. To that end, here is our list of the top things you should do right now so that next year is less painful and hopefully easier on your pocketbook:
Start a filing system. Ask any attorney what the golden rule is and they will tell you “he who has the most paper wins.” This is the rule that the IRS goes by as well. Most taxpayers pay more in taxes than they should because of inadequate documentation. If you give donations to charity, drive your personal vehicle in connection with work, real estate, a medical condition or charity; it’s important for you to log these items. Unreimbursed business expenses are another area where documenting expenses is crucial. To ensure nothing is missed come next year, start a filing system to keep all of your paperwork. This can be as simple as a drawer where you dump everything until January 2013 or as elaborate as a spreadsheet. The point is make sure you keep all your documentation in one place that is easy for your to find.
If you owed, adjust your withholdings NOW. The amount of the refund you receive or balance due to the government is simple arithmetic. Withhold enough and you’ll get money back; fail to do so and be prepared to write Uncle Sam a check. If you owed last year, talk to the fine folks in your HR or payroll department now and have your withholdings adjusted on your W4. It’s already April, which means you’ve missed out on four months of withholding at the correct rate. The longer you delay, the greater the probability will be that you’ll owe again next year.
If you recently got married, change your withholdings. Newlyweds often forget to adjust their withholdings, but doing so can sometimes be detrimental to your bank account. Married couples sometimes find that their combined income pushes them into a higher income bracket. However, if you fail to make the necessary adjustments, you’ll quickly learn that you didn’t have enough withheld to cover your tax obligation. Follow the steps listed above to avoid this painful lesson.
Manage your pre-tax benefits. The easiest way to pay less in taxes is to reduce your taxable income. The best way to achieve this is to take advantage of all the pre-tax benefits that your company offers. This includes 401(k) contributions AND associated match, utilizing pre-tax transit and parking benefits as well as contributing to a Flexible Savings Account (FSA) or Health Savings Account (HSAs). Money is contributed to these items before your take home pay is calculated. As your pay will be reduced by these items, so will the corresponding amount for which the associated taxes are calculated upon. The result? A reduced tax base and less money paid to Uncle Sam.
Begin contributing to a retirement plan. If you’re not contributing to a 401(k) or other retirement plan, you’re passing up some of the best tax savings available. Contributions to 401(k) plans are not subject to federal or most state income taxes. Your contributions and employer match will grow tax-deferred until you withdraw them during retirement. You could save between 20 and 40% of your contribution in taxes. If you’re already contributing to a 401(k) or other employer-sponsored plan, increasing your contributions early in the year will increase your tax savings and your earnings over time.
Start contributing to an IRA. If your employer doesn’t offer a retirement plan, contributing to an IRA each year can get you some of the same tax savings. For instance, if you make eligible contributions to a qualified IRA, 401(k) and certain other retirement plans, you may be able to take a credit of up to $1,000 or up to $2,000 if filing jointly. The credit is a percentage of the qualifying contribution amount, with the highest rate for taxpayers with the least income. For increased earnings on your IRA, don’t wait until April 15th to open it. The earlier in the year you make your contribution(s), the faster it will grow.
Schedule a midyear evaluation. There is nothing that your tax preparer can do for you regarding your tax liability once December 31st rolls around. June will be here before you know it which means that half the year will already have passed. Schedule some time with your preparer to discuss your situation and any changes that you think may impact your tax bill next year (e.g. marriage, new child, job change or loss, etc). That way you all can begin to plan accordingly and make the necessary adjustments so that neither of you are get surprised with a big tax bill.
Run a tax projection. Once you’ve had a chance to get your tax situation reviewed, have your tax preparer run a tax projection. Make sure that you incorporate things such as capital gains from stock sales, mutual fund trades, execution of stock options, bond redemptions, unemployment compensation, medical expenses, etc. It’s easy for taxpayers to make a few decisions (such as pulling out money early from a 401(k)) and not realize that there are multiple tax consequences (like the 10% early withdrawal penalty). By having a tax projection run, you can see what those consequences are and prepare for any unintended ramifications.
Shift income if you make over $70K. If you are single and make over $70K, consider shifting your income via some of the following strategies to reduce the amount of taxes you pay:
- Rearrange your investments to reduce taxable income. You want investments that generate interest income inside retirement accounts, and investments that generate capital gains and losses outside of retirement accounts.
- Realize capital losses to offset capital gains.
- Bundle expenses to maximize itemized deductions.
- Increase retirement plan contributions as limits rise. Each October the IRS announces the new contribution limits for 401ks, IRAs, and other retirement plans. Check the 2012 contribution limits, and be sure to adjust your payroll contributions to put the maximum amount into your plans.
If nearing retirement, check to see if your retirement income will be taxable. The downfall for most retirees is that they begin to start receiving income from their investment vehicles but aren’t necessarily having taxes withheld (due to how the accounts work). If you are nearing retirement, be aware that the following income is typically taxable:
- Withdrawals from Traditional IRAs, 401ks, or other retirement plans. If a plan was funded with pre-tax dollars, whether by you or your employer, it will result in taxable retirement income when withdrawn.
- Pension income. Most pensions are a source of taxable retirement income.
- Interest income, dividend income and capital gains inside of after-tax accounts. Interest, dividends and capital gains that occur within tax-deferred accounts, such as IRAs, 401k plans or variable annuities, are not taxable in the year they occur. Instead, all gains are deferred and you only pay tax when you take a withdrawal.
- Withdrawals from an annuity. When you take withdrawals from a fixed or variable annuity (one that is not owned by an IRA or retirement account) the IRS rules say any gain must be withdrawn first, and this gain is taxed as ordinary income. Once all gain has been withdrawn, you would be withdrawing your basis, or principal. Withdrawals of basis are not counted as taxable retirement income.