Intentionality in Reading Your Tax Return
Most tax returns have been filed and received, now that the hard work is done, we want to help you identify planning opportunities, as well as correct any potential issues that your tax return uncovered. Our goal is to work with you to identify a few scenarios. We find it most opportune to review your tax returns now, while there is still time to address issues before next year, and while you may have time to amend returns if necessary.
Reviewing tax returns can be daunting and difficult given the many state and federal complexities that are often changing. We will focus on a few key items to review each year after your filing is complete.
Paycheck Withholdings
Beginning with your paycheck withholdings – you likely received a refund or owed, I’m certain very few broke completely even. For those that owed taxes after filing, it’s likely in your best interest to file a new Form W-4 with your employer and increase the amount of federal income tax withheld by decreasing the number of allowances. Did you receive a hefty refund? Update your W-4 to increase the allowances, ultimately decreasing the federal income tax withheld.
If you’re in a household with two working spouses who report married filing jointly (MFJ) your W-4 requires more intentionality. This is often thought to be based on how many dependents are claimed, but this has less of a bearing on the withholding results. Pages 3 and 4 of Form W-4 provide a worksheet for those with a working spouse to ensure their withholdings are sufficient. This worksheet is crucial to ensuring enough taxes are taken out of each paycheck, preventing a sizeable tax payment from being due down the road.
Are you paying the appropriate amount of taxes?
Rather than spend our time examining how to shelter our income from taxes each year, let’s explore ways to use tax-advantaged tools alongside healthy management of your tax bracket. If you’re currently in the 24% tax bracket or lower, you should be employing ways to save money in after-tax vehicles, such as a Roth IRA or brokerage account. Utilizing after-tax savings options while in a tax bracket of 24% or lower will be significantly rewarding when considering the amount of taxes you’ll pay in the future at a higher tax bracket, either due to tax law changes or promotions throughout your career.
Let’s look at this concept further using a real example. Assume you contributed $10,000 to a traditional IRA while in the 22% tax bracket. You will receive a $2,200 tax deduction today. This same $10,000 withdrawn 30 years in the future while in the 28% tax bracket equates to that same $10,000 generating a tax bill of $2,800 in the future. With this philosophy, it would have been financially prudent to contribute up to the annual contribution limit ($6,500 for 2023 Roth and Traditional IRAs) to a Roth IRA and pay zero taxes 30 years later (based on 2017 tax rates before the TCJA acts reducing tax rates and brackets in 2018).
Deductions and Credits
Understanding your standard deduction and other life events can allow you to decrease your tax burden. Here are a few common deductions and credits to be on the lookout for.
If you utilize an HSA and have a child less than 17 at the end of the current tax year, you qualify for an HSA plus dependent deduction.
Remember, this kiddo also grants you the Child Tax Credit (phase-out limits starting at $200,000 single or $400,000 MFJ).
Purchasing a new, energy-efficient vehicle or appliances for your home can qualify you for more tax credits.
"Super-sized donations” involve taking the standard deduction one year, then bundling donations and deductions in the following year to exceed the standard deduction.
Contributions to a Traditional IRA are generally deducted immediately from your taxable income, so long as the phase-out contribution limits are not reached.
Since contributions to a 401(k) ($22,500 annual contribution limit for 2023) come directly from gross income, they reduce your overall tax liability.
There are numerous creative ways to receive tax deductions and credits, it’s important to locate the areas of your financial plan that could benefit from these actions and take advantage of the tax gains that inherently coincide.
Interest Income
With rising interest rates, both savings accounts and money market funds are paying more interest income than in previous years. Income from interest is included in your taxable income. While this might not pose a challenge to everyone, those in a high-income tax bracket (MFJ income exceeding $365,000, single income exceeding $182,000) have something to consider. It is worth reviewing whether investing in a tax-free municipal money market fund is advantageous as opposed to investing in taxable savings or other money market options.
For those in a high-income tax state, it’s a valuable consideration to examine state-specific municipal money market funds along with United States Treasury Securities, both of which are exempt from state taxes.
Bottom Line
There are countless ways to reduce your tax liability and just as many opportunities to lean into tax-advantaged practices. Pairing these tools with your financial plan will aid in your preparedness for next tax season along with overall success in financial goals.