Plan Taxes Early in the Year
Chances are that you are now preparing for taxes. Making sure to get your W2(s), 1099(s) or Self-Employment information and those forms that show those scary amounts you paid in student loan interests to file your 2019 taxes. However, January and February are the right time to start planning for taxes for the new year.
In my experience as a tax preparer, I have noticed a few key elections missed during the previous year that by the time it’s time to file taxes, are irreparable mistakes. Here are some choices to watch for at the beginning of the current year:
1. Change your W-4 Allowances accordingly. Life changes, - such as an income increase in the household, unemployment, marriage or divorce, or a new member in the family - may require you to revisit your W-4.
Your employer deducts taxes based on what you claim on your W-4. The more allowances you claim, the less is withheld from your paychecks. If the numbers match when you file taxes, you may end up even or paying/owing a small amount to Uncle Sam. The problem arises when your claim is higher than the number of your dependents when you file taxes. This could become an unexpected tax bill, including a penalty for underpayment. On the other hand, if you claim too few allowances, there are more taxes withheld, which may result in a tax refund. Though it may make you happy to receive a refund rather than having to pay, any funds you withheld from your paychecks is just an interest-free loan to Uncle Sam. A bit of discipline can make your money work harder for you by investing the proceeds you take home.
You can estimate your tax allowances with the help of the IRS Tax Withholding Estimator. I may suggest, if last year you ended up paying by claiming one allowance and that generated a tax liability and made you unhappy, you may want to claim zero this year to minimize your chances of tax payment when you file.
2. If you are Self-Employed, make sure to send your quarterly Prepayments to the IRS. The United States has a “Pay as You Go” system. Independent Contractors, Sole Proprietors, Partners, Limited Liability Companies, and S Corporation Shareholders may all be responsible for paying quarterly tax payments if they expect to owe $1,000 or more in taxes when filing taxes. In our current sharing economy – also known as access economy-, it is not uncommon to receive 1099s forms informing us of earned income but with no Federal Income tax withheld, leaving the taxpayer with all the responsibility to send their own prepayments during the year. The IRS sets the interest rate for underpayment. It was 6% for individual taxpayers for the 2019 tax year.
The IRS requires you to pay 100% of the tax liability shown on prior year’s return or 90% of the current year, if expected to be smaller. However, if your Adjusted Gross Income last year was more than $150,000 ($75,000 for married persons filing separately), the prior-year percentage increases to 110%.
The 2020 Quarterly Due Dates are:
· Q1: April 15 due date for income from January 1 to March 31
· Q2: June 15 due date for income from April 1 to May 31
· Q3: September 15 due date for income from June 1 to August 31
· Q4: January 15, 2021 due date for income from September 1 to December 31
Consider setting aside about 25-30% of your income for Income, Social Security and Medicare taxes. The actual amount will depend on your personal circumstances and tax rates.
You can figure out your estimated quarterly tax payments using Form 1040-ES.
3. Contribution to your Retirement Accounts. Yes, you have until April 15th to contribute to your last year’s Traditional or Roth IRA. A Keogh or SEP can wait until October 15th if you get a filing extension. But if you are contributing to your 401k, 403b, or 457b, January is a good time to plan your pre-tax contributions to your retirement plan with your employer. Any contribution you did not make in an employer account for the previous year, is irreversible. You may still be able to put some pretax funds into a Traditional IRA for the previous year (if done by April 15), but this comes with some rules. For instance, in order to receive a full deduction of your contribution when you are covered by a plan at work, you must have a Modified Adjusted Gross Income (MAGI) of $65,000 or less. In order to receive a full deduction, you and your spouse (if married) must not be covered by a plan at work. Both the Traditional and the Roth IRA have guidelines on how much you can deduct and your MAGI. Roth IRAS have limitations on whether you can contribute, depending on your MAGI and filing status. For example, a Single or HOH can contribute up to the max ($6,000, or $7,000 if you are 50 or older) if their MAGI is less than $124,000. Then it phases out until $138,999. An individual whose MAGI is $139,000 or more is not eligible to contribute to a Roth IRA. There is a back-door IRA that your Financial Adviser will be able to explain if your MAGI goes over the limitations.
As you prepare to file your previous year’s taxes, take a look at what kind of forms you have at hand and request a meeting with your tax advisor to plan for the current year.