By now you have most likely either filed your tax return for last year or you have filed an extension. In either case it’s not too early to start planning for this year. Planning can both reduce your tax liability and avoid an unpleasant surprise when you discover the balance due on this year’s tax return. The following are a few areas to consider when planning for this year.
Adjust Withholding (if applicable)
If your prior year tax return has been filed and you expect this year to be comparable to last year, you may want to review your withholding. If you received a big refund last year and would prefer to receive a bigger paycheck each pay period instead, reduce the withholding. However, if you owed additional tax, you may want to increase the withholding to lower the tax due with the return and avoid any underpayment penalties.
Verify All Estimated Tax Payments Have Been Made
If you don’t receive a paycheck, retirement plan distributions or any other type of payment from which taxes can be withheld, you may be required to pay estimated tax payments to avoid paying penalties. Verify these payments were made and total at least 100% of the tax shown on the prior year return. If your prior year return has been filed, your tax preparer should have calculated the amount of the payments for you. If you have not yet filed your return, the amount can be estimated and the remaining payments can be adjusted when the return is finished.
Consider Life Events and How They Will Affect Your Taxes
If you got married, divorced or had a child during the year, it will affect the tax due on this year’s tax return. Other events that may affect your taxes include retirement, loss or change in jobs or your spouse getting a job, your children or you going to college, or your child graduating from college and the loss of him or her as a dependent. These events may increase or decrease gross income, deductions and tax credits available.
Determine the Tax Consequences of Other Significant Events
The purchase or sale of any rental or business property, or the sale of stocks or bonds may have a significant effect on your tax liability. Other significant items to consider are the withdrawal of large amounts of money from an IRA or retirement plan, or receiving a large inheritance during the year. Will you be reporting a large amount of income, gains, losses or deductions from these items or events which will affect the current year tax liability, but had no effect on last year’s return?
Compare Farm and/or Business Income to Last Year
If there is a substantial increase or decrease in income with a minimal change in expenses, it will affect the tax liability for the current year. If at least two-thirds of your gross income is from farming, you aren’t required to pay estimated tax payments if you file by March 1st of the following year. If you are not a qualified farmer, you will want to estimate how the change in income for the year will affect your tax liability and adjust estimated tax payments accordingly.
Be Familiar with Changes to the Tax Law
These changes may have been included in current year tax legislation or prior year tax legislation that references future year changes. Also, be aware of any proposed tax changes that may affect the current year or next year’s taxes.
If you have experienced any significant changes to income or any life events that will affect your tax return this year, you should consider contacting a tax professional. It would be preferable to consult with your tax advisor before making any changes, if possible, but definitely before year-end. There may be other options available such as spreading the income over multiple years to be taxed at lower tax rates or deferring the income to future years and avoiding any additional tax in the current year.
Your tax advisor will be able to estimate any additional tax liability that the event could incur compared to last year or; if the event caused a major reduction in income, how much less tax would be due. This knowledge would assist you in adjusting your withholding or estimated tax payments to avoid a huge tax bill at year end or an overpayment of taxes that could have been used for other purposes.
Remember it is never too early to start planning for the next tax year. It will make the tax deadline much easier. Be sure to contact your Ketel Thorstenson tax advisor if you have any concerns.