Insights

April 27, 2023

How to Avoid Surprises When Filing Your Tax Return

In Tax Planning, Wealth Strategy

When the hard part of filing your tax return is over, it often feels like cause for celebration, and a relief to put behind you until this time next year! But depending on your unique circumstances, you may have seen the result of your filing and found yourself wondering “How did I get here?”. Maybe you were surprised by a large tax liability or pleasantly relieved to receive a larger refund than expected. Let’s discuss the pros and cons of each scenario, and then review helpful tips to mitigate surprises on next year’s tax bill.

Pros and Cons of Tax Surprises

Scenario One: Large Refund

A large refund means that you had too much withheld from your paychecks or that you paid more than you should have for your quarterly estimates. Thus, at the end of the year, the IRS simply returns the excess money.

Pros:

  • The IRS saved your overpayments and now you can get it back instead of spending it all throughout the year.

Cons:

  • This is a large amount of money that you could have invested throughout the year, a potentially missed opportunity with this rising interest rate environment.
  • If your monthly budget is tight, sending an overpayment to Uncle Sam could cause some added stress to your financial needs on a day-to-day basis.

Scenario Two: Large Tax Liability

On the other hand, ending up with a large tax liability indicates that you underpaid your taxes throughout the year.

Pros:

  • You benefit from bigger paychecks throughout the year to use for your spending, savings, or investing.

Cons:

  • You may be penalized for underpayments.

To find out more on how this applies to your specific circumstances this year, read the Penalty for Underpayment of Estimated Tax information in the following IRS link.

How To Avoid Surprises Next Year

  • Consider whether you have one-time income items or deductions: Review your most recent tax return for items that caught you by surprise and determine if those items are a one-time occurrence, or if they will continue in the year ahead. For example, having LASIK eye-surgery is most likely a one-time expense, while changing your filing status to “married jointly” will presumably continue in subsequent years.
  • Look for one-time additional taxes or credits: Review the tax and credits section of your Form 1040 along with supplemental Schedules 2 and 3 to determine if there were any special circumstances that generated additional taxes or credits. For example, a credit for the purchase of an electric vehicle or installation of solar panels would create a credit in one year, but not repeat the following year.
  • Compare this year’s return to last year’s: Ask yourself what you have done differently this year compared to past years that might have created a large refund or debt.
    • Did you have additional income, significant capital gains or losses, deductions, credits, or other life events that impacted your tax situation?
      • Here is a helpful list to guide you through some other factors that may apply
  • Use withholdings and/or estimated payments to approximate your tax liability:  Adjust your withholding and/or quarterly estimates according to your new taxable events.
    • Consider all income sources and deductions that will be “same as last year “(SALY) and any new or different taxable events that will impact this year.
  • Adjust allowances claimed on your W-4 as needed: If you are an employee, check to ensure you are withholding the appropriate tax amount from your salary by using this Tax Withholding Estimator. If you want to adjust your withholding, you can ask your employer for a new Form W-4 .
  • Use estimated payments to avoid underpayment penalties: For business owners or anyone using quarterly estimates, make sure that you pay these estimates on time each quarter. Generally, you can avoid incurring penalties if you pay at least 90% of your current tax or 100% (or 110%) of the total tax shown in the prior year.
    • Quarterly deadlines for 2023:
      • 1st payment …………….. April 18, 2023
      • 2nd payment …………… June 15, 2023
      • 3rd payment ……………. Sept. 15, 2023
      • 4th payment ……………. Jan. 16, 2024

If you have additional questions on what to do in the event of a large tax refund or liability, please reach out to your Coldstream wealth management team for assistance and we would be happy to discuss the options available to you.

DISCLAIMER: THIS MATERIAL PROVIDES GENERAL INFORMATION ONLY. COLDSTREAM DOES NOT OFFER LEGAL OR TAX ADVICE. ONLY PRIVATE LEGAL COUNSEL OR YOUR TAX ADVISOR MAY RECOMMEND THE APPLICATION OF THIS GENERAL INFORMATION TO ANY PARTICULAR SITUATION OR PREPARE AN INSTRUMENT CHOSEN TO IMPLEMENT THE DESIGN DISCUSSED HEREIN. CIRCULAR 230 NOTICE: TO ENSURE COMPLIANCE WITH REQUIREMENTS IMPOSED BY THE IRS, THIS NOTICE IS TO INFORM YOU THAT ANY TAX ADVICE INCLUDED IN THIS COMMUNICATION, INCLUDING ANY ATTACHMENTS, IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, FOR THE PURPOSE OF AVOIDING ANY FEDERAL TAX PENALTY OR PROMOTING, MARKETING, OR RECOMMENDING TO ANOTHER PARTY ANY TRANSACTION OR MATTER.

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