Insights

March 30, 2022

What Issues Should I Consider When Reviewing My Tax Return?

In Tax Planning, Wealth Strategy

Vince Lee
Contributions from: Vince Lee, CFP®, CPA

Whether you have a tax refund heading your way or you owe additional taxes with your return, you may be wondering “what can I do next year to reduce my taxes?” While the subject of taxes is fresh on your mind, this is a great time to review your income, deductions, and potential for savings before the end of this tax year. We will explore several areas of your tax return that illuminate tax planning opportunities.

Earned Income/Self-Employment Income

Earned Income – If you are an employee, you should review your Form W-2 or your year-end paystub to see if you are taking advantage of various tax benefits offered by your employer. If your company offers a retirement plan, such as a 401(k) or a Simple IRA, determine whether you are contributing as much as you could to take advantage of the tax savings. Similarly, if you have a high-deductible healthcare plan, consider whether you can defer more funds into a Health Savings Account (HSA).

Other tax saving vehicles your employer may offer include healthcare and daycare Flexible Spending Accounts (FSA). These accounts allow you to save money for your retirement, healthcare, or childcare needs, while reducing your tax liability.

Self-Employed Income – If you are self-employed, consider whether you are claiming all eligible deductions related to your business activity. If you are unsure of whether an expense is deductible, IRS Publication 535 is a resource to use. Like an employee, a self-employed person can also have their own retirement plan. The most common retirement plans for the self-employed are solo 401(k) plans and SEP-IRAs. A solo 401(k) plan (self-employed 401(k) plan) can have advantages over a SEP-IRA, so it’s important to understand the differences. You can learn more about the differences on the IRS website.

Capital Gains and Losses

If you sold investments this year, the net gains or losses are categorized as short-term or long-term. For investments held a year or less, you will have short-term gains/losses and on investments held for more than a year, you will have long-term gains/losses.

Short-term capital losses (including short-term capital loss carryovers) are applied first to reduce short-term capital gains. If you have a net short-term capital loss, it can be applied against net long-term capital gains. However, if you have a net short-term capital gain, it is taxed at ordinary rates with a top rate of 37%.

Long-term capital gains and losses are netted similarly to short-term gains and losses. If you have a net long-term capital gain, it will be taxed at 0%, 15%, or 20%, depending on your income bracket. If you have a net long-term loss, it can be applied against your net short-term capital gain, and any excess can be carried forward to subsequent years.

In a nutshell, if you have a gain from the sale of your investments, it is preferable the gain be long-term, as long-term gains are taxed at lower rates. If you find you are in a net gain situation, you may be able to offset those gains by intentionally selling investments that have declined in value — thus, booking a loss that can be used to offset your gains. This strategy is known as “tax loss harvesting.” It can result in meaningful tax savings not only in the current year but if you have excess capital losses, these losses can be carried forward indefinitely to offset gains in subsequent years.

Standard Deduction vs. Itemized Deductions

The Tax Cuts and Jobs Act (TCJA) enacted in 2017 impacted many taxpayers’ ability to itemize their tax deductions. The TCJA essentially doubled the standard deduction while eliminating certain itemized deductions and limiting the deduction for state and local taxes to a total of $10,000.

If you regularly make charitable gifts but are unable to itemize your deductions because of the high standard deduction, considering “bunching” your charitable gifts every 2 or 3 years. This will allow you to claim your higher itemized deductions in those “giving years,” while taking advantage of the standard deduction in the “non-giving years.” To ensure your favorite charities continue to receive support on a regular basis, consider setting up a Donor Advised Fund. This structure will enable you to take a larger charitable deduction in one year while making grants to your favorite charities from your Donor Advised Fund at your desired frequency.

Investment Income Surtax

Enacted in 2013, a 3.8% tax on net investment income (i.e., interest, dividends, and capital gains) applies to taxpayers with a Modified Adjusted Gross Income that exceeds $250,000 for joint returns and $200,000 for single taxpayers and heads of households.

If you are subject to this surtax, review your investments and consider “smoothing” out your gains over several years with this surtax in mind.

Large Tax Refund/Payment Owed

Large Tax Refund – While it is nice to have a large tax refund, it also means you have made an interest-free loan to the IRS. If you have a large tax refund, consider adjusting your withholdings by submitting a revised Form W-4 to your employer or adjusting the amount you pay in with your quarterly estimated tax payments. This means more money in your pocket throughout the year instead of receiving a lump-sum tax refund.

Payment Owed – Having a large payment owed with your tax return can make sense, especially if you had planned for it and appropriately reserved funds for the payment due. The IRS rules state that in order to avoid penalties, high-income taxpayers must pay in the lower of the following two amounts:  110% of your prior year’s taxes, or 90% of your current year’s estimated taxes. For example, your 2021 tax liability was $50,000 but because of a sale of your business this year, your tax liability for 2022 is expected to be $2 million. In this example, your requirement is to pay in at least $55,000 in taxes during the year with the balance of about $1.95 million due in April 2023. This allows you to hang on to your money a little bit longer.

Reviewing your prior year tax return can help uncover areas where you can financially benefit from proactive tax planning. It’s important to note that tax planning must be done before year-end to be effective. The earlier in the year you can think about this, the more opportunities you will have to reduce your taxes. If you’d like to discuss how any of these ideas may apply to your particular tax situation, please reach out to your Coldstream wealth management team.

DISCLAIMER: THIS ARTICLE HAS BEEN PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSIDERED AS INVESTMENT ADVICE OR AS A RECOMMENDATION. 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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