by Andrew D. Schwartz, CPA
In my last post, we looked at one of the main causes of the April 15th surprise: when your tax bill dwarfs the payments you made during the year.? Here’s more of the top causes:
Not All Breaks Are Equal:
Not all tax breaks are created equal?(my?previous article gives you a run down on the “winning”?tax breaks).
Certain changes to your financial or personal situation generally guarantee a big April 15th surprise. Get married or buy a home during the year, and chances are good that you have no idea how your taxes will end up that year.
Other tax breaks that seem to indicate a substantial savings don’t end up impacting your tax situation much at all. Believe it or not, having a baby or sending a child to college saves you very little in taxes unless your income is relatively modest.
What if you take full advantage of a retirement savings plan offered by your employer? While money contributed into the plan through salary deferrals saves you taxes, your employer reduces the taxes withheld from your pay by an equivalent amount since the withholding tables are based on your taxable earnings instead of your gross earnings. So even though maxing out your salary deferrals is one of the best tax shelters available to you during your working years, you will generally not see much of a change to your refund or balance due by doing so.
Delayed Reaction:
Another contributing factor to a big tax surprise is the fact that even though you make the bulk of your tax planning decisions during the year, you don’t see the impact of those decisions until you prepare your returns the following winter. When you finally work through your paperwork and realize there is an issue to address, the next year is already one-quarter done, leaving you just nine months to make any necessary adjustments. And then, if you forget to make a second set of adjustments the following January, you’ll find yourself with another April 15th surprise when you prepare your taxes for that year.
Besides setting the rates for your withholdings and estimates, another common example is paying for a child’s dependent care expenses with pre-tax dollars through your employer’s flexible spending account. While this strategy generally makes a lot of sense, it backfires if your spouse has no earned income during the year.
Lets say you paid for $5,000 of childcare expenses with pre-tax dollars through your employer’s FSA, but your spouse didn’t earn any income during the year. When you prepare your taxes, you’ll need to add that $5k back to your taxable wages, increasing your federal tax bill by up to $1,750, with no accompanying withholding. And then, since you most likely sign up for your benefits annually during November, once you realize this pitfall, it’s too late to undo the election for the current tax year.
Good Intentions + Complex Rules = April 15th Surprise:
Which of these goals did you set last month?
- Minimize your tax burden
- Adjust your withholdings
- Maximize your contributions to tax-advantaged savings ???? opportunities
With the April 15th deadline still a not-too-distant memory, invest some time now to make those adjustments necessary to avoid a big tax surprise next April.