Our tax code contains plenty of opportunities to cut your taxes. There are also plenty of places in the tax code that could create a surprising tax bill. Here are some of the more common traps.
Home office tax surprise. If you deduct home office expenses on your tax return, you could end up with a tax bill when you sell your home in the future. When you sell a home you’ve been living in for at least 2 of the past 5 years, you may qualify to exclude from your taxable income up to $250,000 of profit from the sale of your home if you’re single or $500,000 if you’re married. But if you have a home office, you may be required to pay taxes on a proportionate share of the gain.
For example, let’s say you have a 100-square-foot home office located in a garage, cottage or guest house that’s on your property. Your main house is 2,000 square feet, making the size of your office 5% of your house’s overall area. When you sell your home, you may have to pay taxes on 5% of the gain. (TIP: If you move your office out of the detached structure and into your home the year you sell your home, you may not have to pay taxes on the gain associated with the home office.)
Even worse, if you claim depreciation on your home office, this could add even more to your tax surprise. This depreciation surprise could happen to either a home office located in a separate structure on your property or in a home office located within your primary home. This added tax hit courtesy of depreciation surprises many unwary users of home offices.
Kids getting older tax surprise. Your children are a wonderful tax deduction if they meet certain qualifications. But as they get older, many child-related deductions fall off and create an unexpected tax bill. And it does not happen all at once.
As an example, one of the largest tax deductions your children can provide you is via the child tax credit. If they are under age 17 on December 31st and meet several other qualifications, you could get up to $2,000 for that child on the following year’s tax return. But you’ll lose this deduction the year they turn 17. If their 17th birthday occurs in 2022, you can’t claim them for the child tax credit when you file your 2022 tax return in 2023, resulting in $2,000 more in taxes you’ll need to pay.
Limited losses tax surprise. If you sell stock, cryptocurrency or any other asset at a loss of $5,000, for example, you can match this up with another asset you sell at a $5,000 gain and – presto! You won’t have to pay taxes on that $5,000 gain because the $5,000 loss cancels it out. But what if you don’t have another asset that you sold at a gain? In this example, the most you can deduct on your tax return is $3,000 (the remaining loss can be carried forward to subsequent years).
Herein lies the tax trap. If you have more than $3,000 in losses from selling assets, and you don’t have a corresponding amount of gains from selling assets, you’re limited to the $3,000 loss.
So if you have a big loss from selling an asset in 2022, and no large gains from selling other assets to use as an offset, you can only deduct $3,000 of your loss on your 2022 tax return.
Planning next year’s tax obligation tax surprise. It’s always smart to start your tax planning for next year by looking at your prior year tax return. But you should then take into consideration any changes that have occurred in the current. Solely relying on last year’s tax return to plan next year’s tax obligation could lead to a tax surprise.
Please call to schedule a tax planning session so you can be prepared to navigate around any potential tax surprises you may encounter on your 2022 tax return.
Your cash is parked in a bank account. Do you know if it’s making or losing you money? Here are some ideas to help you make the most of your banked cash:
Understand your bank accounts. Not all bank accounts are created equal. Interest rates, monthly fees, minimum balances, direct deposit requirements, access to ATMs, other fees and customer service all vary from bank to bank and need to be considered. Start by digging into the details of your accounts. There may be some things you’ve been unnecessarily living with like ATM fees or monthly account charges. Once you have a handle on your current bank, conduct research on what other banks have to offer.
Know your interest rates. As a general rule, the more liquid an account, the lower the interest rate. Checking accounts offer the lowest rates, followed by savings accounts, which yield lower rates than Certificates of Deposits. Maximizing your earnings is as simple as keeping your cash in accounts with higher interest rates. The overall interest rate earned between all your accounts should usually be higher than the inflation rate, which is generally around 2 percent during normal times. But in the midst of high inflation like we are currently experiencing, your combined interest rate may have a difficult time beating the inflation rate.
Make smart moves. There are a couple of things to take into account when making transfers. First, federal law allows for only six transfers from savings and money market accounts per month. If you exceed this number, you’ll be hit with a penalty for each transaction that exceeds six transfers. Second, if you invest in longer-term investments like CDs or bonds, there are penalties for withdrawing funds before the maturity date. So make sure you can live without the funds for the duration of the term.
Stay diligent. Putting together a cash plan is just the start. The key to success is to be persistent. Besides losing out on potential earnings, mismanaging your cash can result in hefty overdraft fees. The more attention you devote to your cash, the more your money will grow.
As a busy working parent, you may be on the lookout for activities that are available for your kids this summer. There may be a solution that’s also a tax break: Summer camp!
Using the Child and Dependent Care Credit, you can be reimbursed for part of the cost of enrolling your child in a day camp this summer.
Am I eligible?
You, and your spouse if you are married, must both be working.
Your child must be under age 13, your legal dependent, and live in your residence for more than half the year.
Tip: If your spouse doesn’t work but is either a full-time student, or is disabled and incapable of self-care, you can still qualify for the credit.
How much can I save?
For 2022, you can claim a maximum credit of $1,050 on up to $3,000 in expenses for one child, or $2,100 on up to $6,000 in expenses for two or more children.
What kind of camps?
The only rule is: no overnight camps.
The credit is designed to help working people care for their kids during the work day, so summer camps where kids stay overnight aren’t eligible for this credit.
Other than that, it doesn’t matter what kind of camp: soccer camp, chess camp, summer school or even day care. All of these are eligible expenses for this credit.
Other ways to use this credit
While summer day camp costs are a common way to use this credit, any cost to provide care for your children while you are working may be eligible.
For example, you can use this credit to pay a qualified day care center, a housekeeper or a babysitter to take care of your child while you are working. You can even pay a relative to care for your child and claim the credit for that expense, as long as the relative isn’t your dependent, minor child or spouse.
This is just one of many possible tax breaks related to children and dependents. Please call if you have questions about this credit, or if you’d like to discuss any other tax savings ideas.
Couples consistently report finances as the leading cause of stress in their relationship. Here are a few tips to avoid conflict with your long-term partner or spouse.
Be transparent. Be honest with each other about your financial status. As you enter a committed relationship, each partner should learn about the status of the other person’s debts, income and assets. Any surprises down the road may feel like dishonesty and lead to conflict.
Frequently discuss future plans. The closer you are with your partner, the more you’ll want to know about the other person’s future plans. Kids, planned career changes, travel, hobbies, retirement expectations — all of these will depend upon money and shared resources. So discuss these plans and create the financial roadmap to go with them. Remember that even people in a long-term marriage may be caught unaware if they fail to keep up communication and find out their spouse’s priorities have changed over time.
Know your comfort levels. As you discuss your future plans, bring up hypotheticals: How much debt is too much? What level of spending versus savings is acceptable? How much would you spend on a car, home or vacation? You may be surprised to learn that your assumptions about these things fall outside your partner’s comfort zone.
Divide responsibilities, combine forces. Try to divide financial tasks such as paying certain bills, updating a budget, contributing to savings and making appointments with tax and financial advisors. Then periodically trade responsibilities over time. Even if one person tends to be better at numbers, it’s best to have both members participating. By having a hand in budgeting, planning and spending decisions, you will be constantly reminded how what you are doing financially contributes to the strength of your relationship.
Learn to love compromising. No two people have the same priorities or personalities, so differences of opinion are going to happen. One person is going to want to spend, while the other wants to save. Vacation may be on your spouse’s mind, while you want to put money aside for a new car. By acknowledging that these differences of opinion will happen, you’ll be less frustrated when they do. Treat any problems as opportunities to negotiate and compromise.
From supplementing their current income to replacing income that was lost because of layoffs, the pandemic or other reasons, many people have started side hustles over the past 2 years to help make ends meet.
If you currently have a side hustle, don’t forget about the tax implications from earning extra money. Here are several ideas to help you stay on top of your side hustle’s taxes:
All income must be reported. Income from side hustles can come from a variety of sources. Regardless of where the money comes from or how much it is, it is supposed to be reported on your tax return. If you do work for a company, expect to receive a 1099-NEC or 1099-MISC if you are an independent contractor, or a W-2 if you’re an employee.
Keep good records and save receipts. Being organized and having good records will do two things: ensure accurate tax reporting and provide backup in the event of an audit. Log each receipt of income and each expense. Save copies of receipts in an organized fashion for easy access. There are multiple programs and apps to help with this, but a simple spreadsheet may be all that you need.
Make estimated payments. If you are running a profitable side business, you will owe additional taxes. In addition to income tax, you might owe self-employment tax as well. Federal quarterly estimated tax payments are required if you will owe more than $1,000 in taxes for 2022. Even if you think you will owe less than that, it’s a good idea to set a percentage of your income aside for taxes to avoid a surprise when you file your 2022 return.
Don’t fall into the hobby trap. You won’t be allowed to deduct any expenses if the IRS determines that your side hustle is a hobby instead of a business. To make sure your side hustle is deemed a business by the IRS, you should show a profit during at least three of the previous five years.
Get professional tax help. There are many other tax factors that can arise from side income such as business entity selection, sales taxes, state taxes, and more. Please call to set up a time to work through your situation and determine the best course of action for your side hustle.
Keeping your taxes as low as possible requires paying attention to your financial situation throughout the year. Here are some tips for getting a head start on tax planning for your 2022 return:
Check your paycheck withholdings. Now is a good time to check your tax withholdings to make sure you haven’t been paying too much or too little. The IRS has an online tool that will help you calculate how much your current withholdings match what your final tax bill will be. Visit https://apps.irs.gov/app/tax-withholding-estimator.
Action step: To change how much is withheld from your paycheck in taxes, fill out a new Form W-4 and give it to your employer.
Defer earnings. You could potentially cut your tax liability by deferring your 2022 income to a future year via contributions to a retirement account. For 2022, the 401(k) contribution limit is $20,500 ($27,000 if 50 or older); $6,000 for both a traditional and Roth IRA ($7,000 if 50 and older); or $14,000 for a SIMPLE IRA ($17,000 if 50 and older).
Action step: Consider an automatic transfer from either your paycheck or checking account to your retirement account so you won’t have to think about manually making a transfer each month.
Plan withdrawals from retirement accounts to be tax efficient. Your retirement accounts could span multiple account types, such as traditional retirement accounts, Roth accounts, and taxable accounts like brokerage or savings accounts. Because of this you should plan for your withdrawals to be as tax efficient as possible.
Action step: One way to structure withdrawals is to pull from taxable accounts first, and leave Roth account withdrawals for last. Another approach would be to structure proportional withdrawals from all retirement accounts that would lead to a more predictable tax bill each year.
Net capital gains with capital losses. If you have appreciated investments you’re thinking about selling, take a look through the rest of your portfolio to see if you have other assets that you could sell for a loss and use to offset your gains. Using the tax strategy of tax-loss harvesting, you may be able to take advantage of stocks that have underperformed.
Action step: Make an appointment with your investment advisor to look over your portfolio to see if there are any securities you may want to sell by the end of 2022.
Tax planning can potentially result in a lower bill from the IRS if you start taking action now. Please call if you have questions about your tax situation for 2022.
