Are you enjoying the calm after the storm? Many people are still trying to recover from the storm. The storm I am referring to is the turmoil that may have been caused by the surprise and unexpected results of last year’s tax returns. Maybe you actually enjoyed the results of your last tax return. Either way, with a little thought and planning during May and June, you can help to ensure that small adjustments now will have a compounded effect on the final results of this tax year.
With April 15 (Tax Day) in the rearview mirror, many people feel they can forget about income taxes until the end of the year. This is true. You can. But you may be well served to take a look at the current year now in order to avoid yet another year of surprises in the area of taxes next year.
A few key areas should be reviewed to achieve peace of mind for the summer:
Each year there is a chance for your payroll withholdings to change without you ever doing a thing. This can occur for a number of valid reasons including changes in the withholding tables designed to “put more money in taxpayer’s pockets now”. This can stimulate the economy and provide a false feeling that taxes have been reduced. This happened in 2018 and caught a large number of taxpayers by surprise. Taxpayers who had never “owed” before, found themselves paying a tax due with their tax returns. It was true that many, or even most, of these taxpayers had enjoyed a reduction in their annual income tax, but their reduced withholdings exceeded that tax cut. The result, tax due. Taking the time now to compare your year to date income and income tax withholdings to last years, can reveal an unintended change. A small adjustment now could salvage a favorable outcome at year end.
If you are self-employed, you likely already understand how small increases in your income can result in gut-wrenching results when talking about income taxes. The combination of regular income tax, self-employment tax and State/Local taxes can result in more than 40% of your net income being swallowed up by tax, even after the benefit of the Qualified Business Income Deduction. This means that if you have a “good year”, one to be proud of, you could easily find yourself in a desperate financial position after the close of the year.
By taking a look at your current income, compared to last year’s at this point, you can begin to predict the potentially higher tax consequences of having a good year. Planning, creating habits, setting tax funds aside and even making small increases to your estimated tax deposits during the balance of the year can ensure that you do not overspend personally and leave yourself with a tax dilemma at tax filing time.
Both of the above points work together to help avoid unwanted underpayment penalties. No one likes to pay a penalty. Truth is, in the world of income taxation, they really are not necessary. A basic strategy can be applied to ensure that you spend the entire year in a “Safe Harbor” when it comes to income taxes. The simplest of available strategies is to pay in, during the year, in equal installments, at least 100% of last year’s total tax. Seems simple enough. But somehow many taxpayers fail to live in such a safe harbor every year. If you will take a little time now, you can achieve the peace of mind of knowing that even if you do owe taxes at the end of the year, you will not owe a penalty.
Each of the above points should be included in any basic tax planning exercise. If you prefer the ease of small adjustments, financially, instead of lump sum corrections, consider asking your CPA or tax advisor for assistance with a Mid-Year Tax Planning exercise. Make this year better than last.