Understanding how our tax system works can be tricky for anyone. Whether you’re an adult who never paid much attention to the taxes being withheld from your paycheck or a kid who just got his or her first job, the starting point to reducing your tax is knowing when to ask a question. But that means having a basic understanding of what might be taxed.
Here are some pointers to help you or someone you know navigate our tax maze.
There are many types of taxes
When you think of taxes, the income tax usually comes to mind. This is a tax on personal and business income you earn from performing a job, or providing a product or service. But there are also other types of taxes besides income taxes. Here are some of the most common.
Payroll taxes. While income taxes can be used to pay for pretty much anything the government needs money for, payroll taxes are earmarked to pay for Social Security and Medicare benefits. This is 15.3% of most employee’s paycheck, but half of it is paid by your employer.
Property taxes. These are taxes levied on property you own. The most common example is the property tax on a home or vacation property.
Sales tax. These are taxes on goods and services you purchase. While most of this tax is applied at the state and local levels, there are also federal sales taxes on items like gasoline.
Capital gains taxes. If you sell an investment or an asset for a profit, you may owe capital gains taxes. The most common example of this is when you sell stock for a gain. Capital gains taxes could also come into play with other assets, such as selling your home or a rental property you sell for a profit.
Estate taxes. This tax is applied to assets in your estate after you pass away.
Not all income is subject to tax
Most, but not all, of your income is subject to tax.
While your paycheck is subject to taxes, interest earned from certain municipal bonds is not. And the government often excludes things like certain life insurance benefits.
Capital gains taxes have exclusions for gains on the sale of your home and donated stock.
Estate taxes have an exclusion, so only estates in excess of this exclusion amount are taxed.
Many employee benefits such as health care, Health Savings Account contributions, commuting benefits and small gifts from your employer are tax free.
The rules around these different types of taxes is complex. Having someone in your corner to help you navigate your tax obligation is often an essential element in minimizing how much tax you do have to pay. It is also helpful, though, for you to understand the basics so you know when to ask a question.
Working more than one job can help maximize income, but also potentially create a tax surprise. Here are several be aware of:
Social Security Surprise: As a full-time employee, the most you’ll have to pay in Social Security taxes in 2023 is $9,932. The problem is each employer you work for will withhold Social Security taxes up to this threshold.
Example: Jane Smith works two jobs. Employer #1 has withheld $6,000 in Social Security taxes so far in 2023, while Employer #2 has withheld $4,000. Jane has already paid more than the annual limit of $9,932 in Social Security taxes for 2023. Jane will get back the excess Social Security taxes, but she’ll need to wait until she files her 2023 tax return in 2024.
What you can do: Work as a contractor for your second job. You’ll be responsible for paying your own income, Social Security and Medicare taxes, but you’ll be able to manage Social Security taxes to avoid overpayment.
Phaseout Surprise: As your income increases, the number of deductions and tax credits available to you will get smaller as benefit phaseout limits are reached.
Example: The Child Tax Credit provides a $2,000 tax credit for each qualifying child. You don’t qualify for this credit, however, if you file a joint tax return with taxable income above $440,000, or are single and file a return with taxable income above $240,000.
What you can do: Certain deductions and adjustments can help decrease taxable income below a phaseout’s limit. This will potentially allow you to still take advantage of a tax break, such as the Child Tax Credit.
Benefits Surprise: Every retirement and medical account limits how much you can contribute annually. If you exceed these limits, you may have to pay taxes twice on the same income.
Example: The 401(k) contribution limit in 2023 is $22,500. You inadvertently contribute $27,500. The first $22,500 of contributions won’t be taxed until you start making withdrawals after you retire. The excess $5,000 contribution could be taxed twice – you must include the $5,000 as taxable income on your 2023 tax return; you’ll also pay taxes on that $5,000 when you withdraw it from your 401(k) after you retire.
What you can do: Correct any over-contribution before filing that year’s tax return. Up-to-date record keeping throughout the year can alert you to when you’re close to the annual contribution limit.
Estimated Tax Surprise: If your extra job is a contract position, you’ll receive a Form 1099 summarizing how much you billed a particular client in all of 2023. If this is the first time receiving a 1099, you may be surprised to learn that you’re responsible for making all tax payments to the IRS. If you are making a net profit, tax payments for 2023 will need to be made in September and January 2024.
What you can do: Estimated tax payments can sometimes be rather large, especially if you’re making a decent amount of money, so keep good bookkeeping records so you can budget for these payments.
Please call if you have questions about these or any other job-related tax topics.
Taxes can affect many areas of your life. Here are some common situations when you’ll want to schedule a tax review.
Something changed in your life. A change in your life could mean significant changes in your tax status. Some of these changes include:
How your taxes may be different: Tax deductions and credits can increase and decrease because of these and other life changes. You’ll want to know as soon as possible if your taxes will be going up so you can be prepared to pay the increased amount.
Getting married or divorced
Retirement
A child starting college or an adult going back to school
Moving to a new home
The birth of a child or an adoption
A family member passes away
A new job. You’ll have several decisions to make when starting a new job that will affect your tax situation:
How your taxes may be different: You can decrease your taxable income by contributing to qualified retirement and medical savings plans. A tax planning session can reveal how much you can contribute to each of these plans, and if you should consider adjusting your paycheck withholdings.
Retirement savings plans – Learn about the available retirement savings plans offered by the employer and any other tax-deferred savings options. Remember that some employers will match a certain percentage of contributions that an employee makes to a plan.
Medical savings accounts – Your employer may offer a Flexible Spending Account or a Health Savings Account to help with paying certain medical expenses with pre-tax funds.
Withholding – You’ll need to determine if you want additional federal (along with state and local income taxes if applicable) income taxes withheld from your paycheck beyond what your employer is obligated to withhold.
A new business or side hustle. A new business (hopefully!) means more money, but also more tax responsibilities. Here are some things to consider:
How your taxes may be different: Most small businesses are flow through entities. This means any business profits will add to your personal income. Because of this, your personal tax situation could vary dramatically! So tax planning becomes critical on two fronts: Your new taxable income level AND helping you stay in compliance at the federal, state and local business tax rules.
Separate accounts and credit cards – If you only remember one tip, it’s to keep separate accounts. Without this, it is easy for the IRS to deem expenses as personal and, therefore, not deductible.
Paying estimated taxes – As a business owner, you are responsible for making tax payments throughout the year to the IRS if your business is profitable.
Setting up a bookkeeping system – Having an accurate bookkeeping system is vital to making sure you don’t pay any more in taxes than you’re legally obligated to pay. Consider reconciling your bank accounts weekly (or even daily if possible) so they’re always current.
Other tax responsibilities – You may be required to submit a sales tax return depending on what types of products you sell or services you provide. You’ll also be required to submit various payroll tax returns if you have any employees.
Nobody likes a tax surprise and now is a great time to schedule a tax planning review.
During tax season, there are a number of areas that generate questions. Here are five of the most common and their answers. But like most things, there can be exceptions, so if in doubt always ask for help.
Are my miles earned on my credit card taxable? Taxation of any extras you earn with a credit card – including miles, discounts, even cash back – are not taxable if you had to pay to get them. Other rewards that you receive, for example a reward for signing up for a card or for referring a new cardholder, are considered taxable income per the IRS.
Does my employer contribution count towards the 401(k) limit? Your employer’s matching contributions do not count toward your maximum contribution limit, which for this year is $22,500. If you’re 50 or older, you can sock away an additional $7,500 (for a total of $30,000) this year.
What happens to loans from my retirement account if I change jobs? When you switch jobs, you must pay back any loans borrowed from your employer-sponsored retirement account within a short amount of time. If the loan isn’t paid back, the outstanding balance is considered a distribution that is subject to income taxes and an early withdrawal penalty.
Do I really need to report gifts given to people? Yes, but only if you give more than $17,000 ($34,000 if married) in 2023 to any one person. It must be reported to the IRS on a gift tax return. That’s because the IRS keeps track of gifts you’re allowed to make over the course of your lifetime, which in 2023 is $12,920,000 ($25,840,000 if married). Only after reaching this lifetime dollar amount will you need to actually make a gift tax payment.
Do I have to report a loss? You may think the IRS isn’t interested in losses you incur, such as when you sell a stock at a loss or if your business loses money. The reality is that you should always report losses on your tax return because you can use them to offset income under certain conditions. In addition, most losses can be carried forward to future years to offset income.
Have your own question? Reach out. The answer could surprise you.
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.
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 2023, 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.
The number of independent workers continues to soar in the U.S. According to MBO Partners, there were 64.6 million independent workers in 2022, an increase of 26% from 2021. The number of full-time independent workers increased to 21.6 million, up from 15.3 million in 2019.
Succeeding as an independent contractor, however, can be challenging because it requires understanding a different set of key success factors than being a full-time employee. Here are some tips on developing your skill set as an independent contractor and where to turn to if you need help.
Contract for companies with generous payment terms. The time required for companies to pay its bills to contract workers varies from business to business. Investigate a company’s policy for paying its contract workers to make sure it’s what you’re expecting. Remember, cash is king!
Market your services by creating an online portfolio. If being a contract worker is your full-time job, you’ll need to always be looking for your next gig. One great way to market yourself to prospective businesses is to create an online portfolio that showcases the work you can perform. You can choose to build a website using a do-it-yourself service or hire a developer to create a custom website.
Stick to a budget. As a full-time employee, you know the exact date you’ll receive your paycheck and usually the exact dollar amount. As a participant in the gig economy, however, you could earn a bunch of money in one month and hardly any money the following month. Prepare a financial budget so you can use income earned during your good months to cover costs during low income months.
Stay one step ahead of the IRS. Paying taxes is now your responsibility. Participating in the gig economy requires more knowledge about how to meet your tax obligations, so ask for professional help. You can also find more information by visiting the IRS Gig Economy Tax Center.
Get advice from others. Working primarily by yourself can leave you isolated from fellow workers. Join a local group of self-employed workers that meets on a regular basis to network and learn what other workers are doing to be successful.
Remember that you are not alone. The complex nature of tax obligations for contractors can be navigated with professional help.
