In a right world, every taxpayer would pay just enough in taxes so they don’t owe money to the IRS or get too much of a refund when they file their tax return. In other words, the sweet spot is kind of like Goldilocks...a small refund that’s just right! Of course, life gets in the way, and we often forget about how some life events can impact our taxes (for good or for bad). As a result, we can lose track of where we stand, and we get a big (often nasty) surprise at tax time.
Fortunately, it’s pretty easy (albeit not fun) to keep tabs on your taxes throughout the year. This article will outline:
- What can impact your tax liability
- Why tax planning is so important
- Why this year is a particularly important for keeping an eye on your tax liability
- How you can do this yourself
- Where to turn in case you don’t want to (or feel you can’t) do it yourself
What can impact your tax liability?
There are many things that can impact the amount of taxes that you owe. Changes in family status, changes in jobs, buying securities & real estate, selling securities & real estate, deaths, births—these are all but a few of the many things that can impact your tax liability. It can be daunting, and it can be easy to make a mistake, which can cost your money.
For the purposes of this article, we’re going to focus on two things that will have a direct impact on your taxes now, and in the future:
- The Tax Cuts & Jobs Act of 2017 (also known as TCJA)
- IRS withholding table changes
More on that in a second. Let’s talk about tax planning.
Why is tax planning so important?
First of all, what IS tax planning? Simply put, tax planning is taking time to estimate your tax liability throughout the year in the best way to account for these changes. That way, you can make adjustments like increasing withholdings, making estimated tax payments, or decreasing withholdings. Tax planning can go into very intricate (and complicated) detail, but let’s focus on this for a second.
Tax planning, when done properly, can help you avoid paying too much throughout the year (and avoid the dreaded ‘interest-free loan’ that you give to Uncle Sam). If you’re not familiar with that concept, just Google ‘interest free loan uncle sam’ and you’ll get about 160 articles. Use quotes, though, or else you’ll get about 6 million hits. My favorite article comes from my friend at Military Money Manual, which also happens to be the top search result. Good job, Spencer!
Conversely, not paying enough in taxes will lead to underwithholding penalties. Obviously, we don’t want to pay more in taxes than we should. However, Uncle Sam also has rules in place on paying taxes as we go, so WE don’t get the benefit of that interest free loan, either.
Tax planning helps us account for all those things that might happen throughout the year that would otherwise slip through the cracks. Taking out money from your IRA? Selling some stock? Selling a house? Getting married? Getting divorced? All of that counts when it comes to tax planning.
Why is this year particularly important?
So why does it matter this year? Here’s why:
TCJA lowered tax rates for virtually everybody. With the increased standard deductions & child tax credits, almost everyone will see a reduction in their tax liability in 2018. As a result, the IRS updated their employer withholding tables to reflect this.
Wait! What are employer withholding tables, and why does this matter? Simply put, when your employer takes taxes out of your paycheck, they don’t just guess at how much to take out. There are strict guidelines that every employer must follow to ensure the right amount is withheld and sent to the IRS. Assuming your employer follows the law, there are exactly two variables that affect how much is withheld from your paycheck:
- The information on your latest form W-4. This is information that YOU provide to your employer so they can follow the appropriate instructions in the withholding tables.
- The IRS withholding tables themselves.
Lower taxes, lower withholdings, right? Not necessarily.
After a summer of doing tax projections for clients, I’ve found that many of them have actually been paying less than they should. Not because of anything that the client has done, but because the amount that their employers have withheld isn’t enough to pay their projected tax bill.
The IRS has identified this concern and issued a number of news releases with a common theme:
- Taxpayers with children, other dependents should check their withholding soon
- Key tax change affects taxpayers with dependents; IRS urges workers to check withholding
- Taxpayers with high incomes, complex returns: Check withholding soon
- Tax bill this year? Check withholding soon, avoid another one next year
- June 15 tax filing deadline approaches for taxpayers living and working abroad; Check withholding for 2018
I think you get the point. So, how do you do this? Fortunately, it’s not as hard as you might think.
How you can do your own tax projections
You can check your withholdings yourself, or you can work with your tax professional or financial planner to do it.
For DIY-minded people, the IRS makes it fairly straightforward, with an online calculator. The online calculator is fairly easy to use, doesn’t require reams of information, and gives you recommendations on whether to change your withholdings or to send estimated payments. I’ve used it before with clients, particularly when taxes are a significant focus. There are some shortcomings, however.
First, it’s only a calculator. That means the projection is only as good as the information you’re putting into it. If you’re not organized, or don’t feel comfortable using the tool, you might not get an accurate picture of your tax liability.
Second, it’s not really detailed. If your tax situation is complicated, this calculator probably isn’t going to give you the information you need.
Finally, it doesn’t incorporate changes that you haven’t implemented yet. If you decide to ramp up your retirement savings, take Social Security, or any number of things...it’s hard to account for all that in the IRS calculator.
And if that’s the case, perhaps you should turn to your tax professional or financial planner.
Who can help you do your tax planning?
Your tax professional should be able to help you get a clearer picture of your tax situation. After all, unless you just hired them, they’ve already got last year’s information. They’ve got a good indication on whether you had a huge refund or a huge tax bill. All you have to do reach out to them to see if they can help give you a tax projection. With that said, if you work with a financial planner, you’ll want to make sure you get all of the appropriate information (such as capital gains, interest, dividends, Roth conversions, etc.) from your financial planner so your tax professional has the information they need.
Or, if you do your own taxes, you should be able to ask your financial planner to do a tax projection for you. In fact, your financial planner should incorporate & offer tax planning as part of their services. And if they don’t, fire them. Your taxes are too important to your financial situation to ignore. And if your financial adviser says, “I just do investments,” or “I only know insurance,” then fire them and find someone else who will help you with your tax planning needs.
Bottom line, TCJA will benefit the vast majority of taxpayers. However, it’s important to do some tax planning now so that you don’t get a nasty surprise at tax time. You can take a walk through the IRS’ website and calculate your own taxes, if they’re relatively straightforward. If not, you can consult with your tax professional or financial planner. And if you don’t have anyone to turn to, talk to us! We’d be more than happy to discuss your situation and see how we can help! Schedule your consultation now.