The only certainties in life are death and taxes – and only one makes you pay a penalty if you're late!
Tax Day is officially in the rearview mirror. Show of hands – who breathes a sigh of relief after finishing those dang tax returns? For nearly everyone, filing your annual income tax return is one of the most dreaded & stressful activities of the year. (Even CPAs are stressed out at tax time!)
Don't let next year's return sneak up on you, though! Instead of treating Tax Day as the finish line of a year-long race, we can flip the script and look at it as a chance to reflect, recalibrate – and take action now to reduce stress next year.
Reflect & Recalibrate
Going through a whole year's worth of receipts & account statements might sound like a bore, but it can also be a chance to reflect and recalibrate! You can treat the experience like reading your diary from last year – where you ate, what you bought, the trips you took, and experiences you had. Remember that nice dinner with your best friend? Or the vacation with your family? How about that deluxe Taschen art book? You can create a personal highlight reel of your year while also recording your deductible expenses.
This is also a great opportunity to recalibrate your spending. See a few online shopping purchases in last year's statements than you expected? Or maybe you start to notice how those "little" expenses – parking fees, streaming subscriptions, a drink or snack at the baseball game – start to add up once you see them all in one place. No need to feel bad about it (spilt milk, and all); treat this as a money mindfulness moment and adjust your current year spending as needed.
Prepare for Next Year
Filing your taxes may never be "fun", but there are a lot of ways to make it more manageable and help you avoid paying too much in taxes going forward. Here are a few actions you can take throughout the year to help reduce stress – and your tax bill.
Do a little bookkeeping each month. Instead of wading through a whole year's worth of receipts and bank & credit card statements all at once, give yourself a break by doing a little bit each month throughout the year. Just an hour or two per month should be enough to sort through & record deductible expenses. Even if you do nothing else, keeping a running tally of your deductible expenses each month will save time & stress when filing your taxes next year.
Contribute to employer-sponsored retirement plans. Traditional (i.e., not Roth) retirement accounts allow workers to use contributions to reduce taxable income. Most employer-sponsored retirement plans also offer some kind of contribution match for participating employees, so you can literally receive free money (with no current-year tax impact!) by contributing up to the full match. Even if your employer does not match contributions, many workplace retirement plans – like 401(k)s and SEP IRAs – allow workers to contribute more tax-deferred money each year than they could with Individual Retirement Accounts (IRAs).
Contribute to IRAs. For people without workplace retirement plans, tax-deferred IRAs are a great way to save for the future while also reducing current-year taxable income. (Even people who contribute to a workplace account may be eligible to deduct IRA contributions, depending on total household income.) And, unlike regular brokerage accounts, money invested in an IRA grows tax-deferred: no current year taxes are due on capital gains, dividends, or interest. That means your money can grow faster than in a brokerage account!
Contribute to an HSA. If you have a High Deductible Health Plan (HDHP), you are eligible to contribute to a Health Savings Account (HSA). HSAs have a unique triple tax advantage: contributions reduce current year taxable income, no taxes are due on any growth, dividends, or interest while your money is in the account, and no taxes are due for withdrawals to pay for qualified medical expenses. Although the annual maximum contribution is lower than for an IRA, contributing to an HSA is one of the best ways to reduce taxes while saving for the future.
Adjust your withholding based on taxes owed or refunded for 2022. Did you receive a W-2 from your employer this year? That means you previously filled out a W-4 stating how much you want withheld from each paycheck for taxes. If you owed taxes for 2022, you can choose to have more withheld from each paycheck to avoid owing again next April. If you received a refund, on the other hand, that means you had been withholding more than necessary. You can adjust down to put more of that money in your pocket throughout the year.
Pay your quarterly estimated taxes (self-employed). Nearly every self-employed person receives at least some income with no taxes taken out. Sole proprietors (including freelancers), partners, and LLC members are not allowed to pay themselves as W-2 employees, which means that compensation is received pre-tax. S-Corporation shareholders – who are typically required to pay themselves a W-2 salary – will still owe taxes on their portion of profits each year. The IRS requires this income to be reported and taxes paid using quarterly estimated tax payments. And, since the IRS charges penalties on taxes owed but not received, paying your quarterly estimated tax can help you reduce your tax burden by avoiding those penalties.
Next Level Tax-Planning Options to Consider
Looking for even more ways to potentially lower your tax bill? Here are a few higher-complexity tactics for avoiding unnecessary taxes.
Do you anticipate making more income in the current year?
Recognize capital losses. You can sell underperforming stocks, funds, or ETFs in a taxable investment account at a loss to offset up to $3,000 of ordinary income. That's right – getting rid of a few stinkers in your portfolio could actually save you on income taxes. You can also sell losing positions to offset capital gains from other investments.
Bundle charitable donations. You can deduct charitable cash contributions up to 60% of your adjusted gross income – but only if your contributions exceed your standard deduction. To make sure your itemized deductions exceed that threshold (2023 standard deductions are $13,850 for Single filers and $27,700 for Married Filing Jointly), consider bundling several years' worth of anticipated charitable contributions into one higher-income year. For example, if you normally give $5,000 per year to charity, consider bumping that up to $15,000 – more than the standard deduction for Single filers – to get the largest tax advantage.
Do you anticipate making less income in the current year?
Recognize capital gains. If you are likely to make less money this year, consider selling some outperforming investments that have grown too large in your portfolio. While everyone loves to see those high-flyers grow to many times the original price, there is a risk that too much of your net worth will become concentrated in a handful of positions – known as concentration risk. You can reduce that risk by recognizing capital gains in a year with lower overall income, which will allow you to pay less in taxes than you would in a "normal" year. You can reduce your capital gains taxes even further by only selling investments that you have owned for more than a year and a day. Long-term capital gains are always taxed at a lower rate than ordinary income!
Consider a Roth IRA conversion. Traditional retirement accounts like 401(k)s and IRAs give you a tax break when you contribute, with the trade-off that you will have to pay ordinary income on everything when you take that money out in retirement. (There are also penalties for withdrawing money before age 59 1/2.) Roth accounts do not have a tax benefit when you contribute, but instead they offer tax-free withdrawals of all contributions and growth in retirement. If your current year income will be lower than average – perhaps because of a job change or recent retirement – this could be a great time to roll some of those Traditional retirement investments into a Roth IRA. This will create a taxable event. However, you can choose the exact amount to rollover (for example, enough to fill up your current tax bracket), after which that money can continue to grow tax-free!
And finally, always, always, always file your annual return. Yes, there is a penalty if you owe taxes but cannot pay them – but it is a fraction of the penalty you could face for not filing at all. Even if you know you will owe the IRS money that you cannot pay, filing your taxes on time will save you a lot of money and headache compared to owing and not filing. The IRS may also agree to terms that let you repay your tax bill over time to make it more manageable.
I'm not saying you need to love paying your taxes. But, if you can't avoid that certainty in life, you might as well do your best to keep it easy!
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial futures. As both advisor and accountability partner, we help identify current strengths and weaknesses, clarify and refine your long-term goals, and prioritize understandable, manageable, and repeatable actions to bring long-term financial well-being. Reach out today to take the first step.
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