With tax season over, one of two scenarios likely occurred: You either got a refund that’s currently greasing your wheels, or you had to dig into your pockets to pay what you owed.
Maybe this was by design, but then again, maybe it wasn’t.
Whether you owed money, didn’t get a big enough refund or don’t think you took enough deductions, there is likely a lesson that can be learned from this latest tax season.
Here are a few beastly tax tips you can bank on:
If you owed money on your taxes
If you had to pay Uncle Sam $1,000 or more, you most likely fell victim to one of two scenarios. While these are both very common, they’re also easy to correct when you plan ahead. Here’s how:
- If you had a single source of income
If you have one source of income and owed money at the end of the year, not enough money has been withheld from your paycheck or quarterly payment – plain and simple.If you’re a regular employee, that likely means that your W-4 includes too many allowances. Alternatively, if you’re a business owner or self-employed, you simply did not send in enough for your quarterly payments.
The solution here is obvious: Amend your W-4 with your employer, or remit more to the IRS quarterly. If you realize the error of your ways now, you won’t make the same mistake again with this year’s tax.
- If you have two or more sources of income
Clearly, having more than one source of income is a good problem to have – it probably means you’re making more money. However, two or more sources of income means that functionally one income is stacked on top of another. The income at the top of the heap begins, right off the bat, to be taxed at a rate that is much higher than the source at the bottom.You may be lulled into a false sense of security by assuming that higher marginal rates are for those richer than yourself. On the contrary, many people who consider themselves ordinary find themselves in a higher tax rate than expected.
The federal income tax is progressive and almost all sources of income are cumulative. In other words, for a given taxpayer or household all the money brought in “from whatever source derived” is put into a big pot and then the income tax laws are applied.
If you owed taxes at the end of the year, focus on greater withholding to improve your end-of-year situation. Think of it like this: There is no real risk to over-withholding, because you get back any overpayment in the form of a refund.
If you didn’t get a big enough refund
Most taxpayers strive for a tax refund. But the truth is, your refund is nothing more than getting back the excess money you paid that was beyond your legal liability. So really, by striving for a refund, you’re endeavoring to give the government an interest-free loan.
If you can accept this reality, your quest for a refund is great, in my humble opinion, because it keeps you out of trouble. What do I mean? The logic is simple – by trying to obtain a refund, you’re likely contributing more to your taxes than you otherwise would.
Now that we’ve balanced the good and bad, let’s get down to business: You didn’t get enough back this year. Understandably, you’re not cool with this.
Here’s what you can do to change things next go-round:
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Have more withheld from your paycheck
To have more taken out, amend your W-4 for less allowances. Having more withheld might be painful at first, but you’ll learn to live with less, and in the long run you’ll be a richer person for it. - Check your eligibility for tax credits and deductions
In the immediate term, you can look over your return or have a tax consultant look it over for credits and deductions that were missed. If you do happen to find a tax-reducing measure that you didn’t take, simply amend your return with a tax preparer (or by using Form 1040-X), and note your mistake so you don’t make it again next year. - Work with a tax planner
Tax planners make their living structuring your finances so that you pay the lowest taxes or receive the greatest refund allowed. Planning at the beginning of the tax year will keep you from finagling with your receipts as you file your taxes. You’ll already be organized by the time tax season hits.
If you didn’t have enough deductions
It’s easy to get seduced by the idea that you can itemize your deductions to the point where you owe nothing, or are entitled to an enormous refund.
However, the reality is you should only itemize your deductions if they are greater than $6,300 if you’re unmarried, or $12,600 if you’re married (based on 2014 tax laws).
If the sum of your deductions don’t add up, the standard deduction is where you’ll derive the greatest benefit. Essentially, it’s the “throw a dog a bone” category where the IRS allows most to reduce their taxable income.
With that in mind, here’s what you need to know about deductions to improve your tax situation next year:
- Understand that personal deductions are limited
Remember the episode of Seinfeld where Kramer insisted to Jerry that the post office was going to pay for his broken stereo “because of the write-off”? The show illustrated the confusion most have over what a write-off is and who can take one.The truth is that, if you’re like most, you’re a regular employee, and thus entitled to less deductions than a business or self-employed individual. With this classification, the law limits your allowable deductions related to business activity. The reasoning here appears to be that you aren’t assuming any financial risk, your company is. If a business deduction exists, therefore, your employer is most likely entitled to it, not you.
- Don’t miss the deductions that do apply to regular employees
Some deductions are allowed to encourage certain societal behavior, such as pursuing higher-level education or buying property in a certain area. If you’re a regular employee, the deductions carved out for you likely fall into this category.To find these deductions, you can begin by combing through the section called “Adjusted Gross Income” (look at bottom of the first page of Form 1040), or by working with a tax planner.
A few common deductions you may qualify for:
- Student loan interest deduction
- IRA deduction (if you don’t have an employer-sponsored plan)
- Moving expense deduction
- Consider medical expenses
While unlikely to occur without a major injury or illness, medical expenses can become a tax positive. When your medical bills eclipse 7.5 percent of your adjusted-gross income, that excess amount becomes deductible. - Beware of the Alternative Minimum Tax
Generally speaking, without going into the nitty-gritty details, you must have taxable household income around $250,000 for Alternative Minimum Tax (AMT) to apply to you.However, it’s important to note that the AMT disallows some deductions, while requiring a rework of others. It’s wildly complex, and forces you to pay a minimum tax (deductions-be-damned) when your income exceeds the threshold.
But there’s even a silver lining here. If you are subject to the AMT one year, but not the next, you can take a tax credit for that previous AMT year.
- Consider taking more risk if you’re high income
The majority of deductions are intended to soften the blow of loss, which is the case with capital losses. Net capital losses are deductible up to $3,000 for any year, with the remainder to carry forward for future years.The lesson here: As you make more money, take more risk in terms of investments. If your investments pay off and you make money, great. If you lose, you can write off the total of that loss over the years, soaking up prospective gains. This is a burden-offsetting deduction that comes with significant potential upshot, so it’s well worth the risk if you’re in a high-income household.
A final thought
Taxes are necessary to keeping our country functioning as a cohesive unit. They allow for the type of mass coordination that’s required for a country that is the third most populated on the planet. But that doesn’t mean you should pay more than the law mandates. Implementing some of these tactics can help you keep more of the money you’ve earned.
And remember, always think of Dino Tax Co when you need help with your taxes.
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