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Acing the Tax Preseason

My niece requested for her birthday a gift certificate from a certain clothing store she “frequents”. The quote marks are because she probably does most of her shopping online, as I did when I purchased her “certificate” which was really just a pdf document attached to an email. Not being familiar with the website, I accidentally sent her three $50 certificates instead of one, which I originally intended. She was thrilled, to say the least, but we agreed that some of that can be considered a forward-looking gift to cover Christmas. This marks the first time I have ever purchased a Christmas gift four months in advance. I’m usually one of the frantic shoppers, rushing among websites and malls up to December 24.

In a similar way, I never used to think about income taxes until late-March. As I built my financial planning practice though, I realized that it was important to stay on top of tax changes to best serve my clients—particularly those with disabilities, who might face less typical tax situations. Now that I act as a seasonal tax preparer for a large firm, I realize that although clients cannot actually file their previous year’s tax return until January of the next year, tax professionals have a pre-season the length of which puts professional sports leagues to shame. Several of the truly organized among us have been accumulating continuing-education credits,since April 16th of last year. The rest of us are staring down the barrel at the four months of tax-regulation update classes and software practice. While I will admit that I am usually in the latter category for collecting official credits as a financial planner, I do think about and talk to my clients about taxes throughout the year. Here are a few situations in which it pays to talk taxes long before the general filing deadline:

If you owed last year and don’t want to again. From a financial planning standpoint, the goal when filing is to have as close to a $0 balance on your return as possible. If you have paid on time an amount of income tax equal to the 90% of the amount, you will end up owing for the current year OR 100% of the total amount you paid last year, you won’t have to pay a penalty and you won’t have given the US government or your state government an interest-free loan from your hard-earned money. Last year, though, many people ended up owing who never had before, despite the fact that rates went down for most tax brackets.

This is because the Tax Cuts and Jobs Act (TCJA) rules, which first applied to 2018 income, doubled the standard deductions for all filing statuses. For households with only one income, this did not require any adjustment in withholding, but it did cause two-income households to be underwithheld in some cases. Here’s why. Although the IRS knows that you are married, it doesn’t know that both you and your spouse work. So if each of you fills out the W-4 to indicate “married” as your withholding status, the IRS tables will calculate each of your withholding as if the entire deduction would be applied only against your one salary. In this situation, you are better off ticking the box on the W-4 that says “Married but withhold at lower single rate”. If you are married filing singly for any reason, you will also use “Married but withhold at higher single rate”. You also want to minimize the allowances you claim on the W-4, unless you have reason to believe you will be eligible for a large credit of some kind. Note that allowances as on the W-4 are NOT equivalent to exemptions, which are no longer part of the calculation post-TCJA.

If you changed jobs during the year or took on a second W-2 job. Even if you are not half of a two-career married couple, but you file as single and you have two W-2 jobs, you will want to make sure you are not underwithheld. You will list your filing status at “single” on both W-4s, but if you claim any allowances on one W-4, you may want to claim “0” on the other. If you change jobs during the tax year, you will likely set up your withholding the same on the new job as on the old one, but if your new position has a higher salary than your old one—which is to be hoped, of course—you may again want to make sure that the combination of filing status and allowances that populate your W-4 will not result in you having underpaid, come tax time.

If you started a business or took on a self-employment status side hustle. When you have self-employment income either because you have started a business or because you have taken on any work that pays via a 1099 rather than a W-2, you will not have ANY withholding on that inflow. Instead, you will need to judge at the end of each calendar quarter whether or not you owe the IRS. If your revenue, less your expenses yields a positive net income, you do owe the IRS both for income tax AND for self-employment tax. Unless your self-employment income is very modest, relative to your W-2 income, you cannot assume that the amount withheld from your W-2 income will be sufficient to ensure that you’ve paid the requisite 90% of the total on time.

If you added or subtracted a “qualifying child” or “qualifying relative”. Post-TCJA, taxpayers no longer get exemptions that reduce their income tax at the Federal level, but they do get a child-tax credit that maxes out at $2,000, which is double the pre-TCJA Level. Families can claim the credit for almost any child that meets the requirements to be your “qualifying child” . I say “almost” because although the qualifying child status only requires that the child be younger than 19; however, the child must be younger than 17 at the end of the tax year to get the child tax credit. The child must also be a US citizen, a US national or a US resident alien. So, if you give birth to or adopt a child during the tax year, you may be eligible for one more credit this year than last year. As a result, despite the same filing status, you will owe less taxes this year, all else equal. On the other hand, if you had a child that was 16 by the end of the previous tax year, clearly s/he will be too old to qualify for the credit this year. In this case, you will owe more. Many states that collect income taxes continue to employ exemptions in their calculations, so you will want to adjust your state W-4 if the number or status of children in your family changes. The TCJA also introduced a credit for other dependents, which may be available for children in the family who are over 17 or for parents or others claimed as “qualifying relatives.”.

If your itemized deductions will be much larger or much smaller than the previous year. Post-TCJA, far less people will itemize, because the standard deductions are so much more generous that it will be harder to have enough itemized deductions to make it worth it. On the other hand, you may have a large amount of deductible medical expenses in one year that makes it worth your while to itemize in that year. Or, you could be following one of the oft-mentioned strategies to maximize your charitable deduction by “bunching” your donations, so that you have one year of large donations such that it is worth your while to itemize, followed by a couple of years of small-scale donations, when you revert to the standard deduction. If you are alternating between standard and itemized deductions, or if your itemized deductions vary greatly from year to year, you will want to check your withholding yearly to make sure you won’t end up owing enough at filing time to generate a penalty.

Paying for holiday gifts (including gift certificates) and paying taxes have this in common. Failure to check your running balance and failure to pace your contributions to the total may result in a bill, far larger than you had anticipated, or even result in having to undergo a delinquent payment penalty. My niece was quite willing to broker a deal. The IRS may be less inclined. The Service does, however, try to help you by providing this calculator:. That said, working with a financial professional is the best way to get the whole picture and avoid an unpleasant surprise on tax day.

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