There are many factors that can cause an unfavorable tax swing leaving you with a surprising tax bill in the spring. Here are six warning signs that you might have some unexpected taxes waiting for you.
You didn’t update your W-4
You may have noticed a change in your tax withholdings earlier this year. These changes are based on withholding tables rolled out by the IRS to employers in early February. Now, according to the U.S. Government Accountability Office (GAO), as many as 30 million taxpayers may not have adequate withholdings for 2018. If you have not already done so, review your withholdings in light of the new tax laws.
You withdraw funds from an IRA before you’re 59½
Situations arise where you need to dip into your retirement savings to address an immediate need. When this happens, it might have major tax implications. This includes:
The withdrawal may be subject to a 10 percent early withdrawal penalty.
The funds withdrawn will be taxed at your highest (marginal) tax rate.
The additional income may push you to a higher tax bracket or bump you over tax-benefit phaseout thresholds.
You receive a large raise early in the year
While the raise means more income for you, it also means more taxes due to the IRS. Depending on how much more income, it might be taxed at a higher rate than your income in previous years. The tax brackets are built-in to the IRS withholding tables, but they don’t take your entire situation into account.
You have a second job
Making some money on the side is a great thing, but can be a major tax problem if you don’t plan properly. In addition to being taxed as ordinary income, it might be subject to self-employment tax of 15.3 percent! Plus, withholding rules start over for each job and do not account for any other income you receive.
Your child turns 17
One of the biggest tax benefits that come by having dependent children is the Child Tax Credit. In the year your child turns 17, they are no longer eligible for this potential $2,000 credit. What’s more, personal exemptions are suspended for the next few years. So you may not only lose an exemption for this child, you now will not receive a Child Tax Credit.
Your standard or itemized deduction is lower
While the standard deduction is nearly double to $12,000 ($24,000 for married filing jointly) for 2018, personal exemptions are suspended. In addition, many itemized deductions are either limited or eliminated! This can create a vastly different amount of taxable income versus last year. While tax rates are generally lower, there will be more than one surprised taxpayer that sees an expected tax refund turn into a tax bill.
So what can you do? If any of these situations apply to you, now is the time forecast your income and deductions for the year and estimate your tax liability. If your withholdings are falling short, there is still a little time to update your paycheck allowances for a pay period or two or make an estimated tax payment.
For the first time since 2013, the IRS is raising the contributions limits for IRAs. The maximum contribution for 401(k) accounts and IRAs is increasing by $500 for 2019. If you have not already done so, now is the time to plan for contributions into your retirement accounts in 2019. Check out the tables below for the new contribution limits and Social Security increases:
Retirement Contribution Limits
Retirement Program
2019
2018
Change
Age 50 or older
catch up
401(k), 403(b), 457 plans
$19,000
$18,500
+$500
add: $6,000
IRA: Roth
$6,000
$5,500
+$500
add: $1,000
IRA: SIMPLE
$13,000
$12,500
+$500
add: $3,000
IRA: Traditional
$6,000
$5,500
+$500
add: $1,000
Social Security
Item
2019
2018
Change
Wages subject to Social Security
$132,900
$128,400
+$4,500
Annual Social Security
employee tax:
$8,239.80
Average estimated monthly
retirement benefit
$1,461
$1,422
+$39
Don’t forget to account for any matching programs offered by your employer as you determine your various funding levels for next year.
The IRS continues to focus their audit activities in key small business areas. The wise business owner is well advised to be able to defend the following five areas to keep the IRS at a comfortable distance:
Business or hobby? Be ready to provide proof your business is truly a business and not a hobby. Those who fail in the eyes of the IRS can have their expense deductions severely limited, while still required to report the income. Make sure you can answer and provide documentation for these four questions:
What is your profit motive?
Are you an active participant in the business?
Are you conducting the activity in a business-like manner?
What expertise do you have in the service or products your business provides?
Reasonable shareholder salary. S corporations are in the unique situation where some compensation is excluded from payroll taxes. Many businesses take this too far. The IRS is looking closely at businesses who avoid paying a reasonable salary in order to lower their Social Security and Medicare bills. When determining salaries for shareholders, consider their experience, duties, responsibilities and time devoted to the business. Once you have a picture of their ongoing contributions to the business, research comparable positions and salary ranges to pinpoint a fair salary. Save your findings and calculations as backup to provide in the event of an audit.
Contractors or employees? Make sure consultants and other suppliers are not employees in disguise. The IRS looks at how much control you have over the work being done – the more control you exert the higher likelihood you may have an employee versus a contractor. Penalties can be very steep if the IRS decides your consultant is really your employee. If in doubt, ask for a review.
Expenses for meals and entertainment. The IRS is now disallowing any entertainment deductions, even if there is business conducted before or after the event. That means business meal documentation is now more important than ever and should include receipts, who attended the meal, and the business purpose of the meal. Bringing food in for business lunches rather than going out is a safe way to show business intent. If you have an event with both entertainment and food included, get two receipts – one for the entertainment and one for the food.
File your Forms W-2 and Forms 1099. Don’t forget to file all required 1099s and W-2s. Most of them are due on or before Jan. 31. The IRS is penalty crazy in this area with up to $270 per missing or incorrect form.
Knowing what the IRS is looking for helps you prepare should it turn its focus to your business.
The more things change the more they stay the same. This is especially true when it comes to reviewing your tax situation. Mark your calendar to review these essential items each year to ensure you are not missing something that could cause tax trouble when you file your tax return:
Required minimum distributions
If you are 70½ or older, you may need to take required minimum distributions (RMDs) from your retirement accounts. RMDs need to be completed by Dec. 31 every year after you turn the required age. Don’t forget to make all RMDs because the fines are extremely hefty if you don’t – 50 percent of the amount you should have withdrawn.
Your IRS PIN
If you are a victim of IRS identity theft you will be mailed a one-time use personal identification number (PIN) as added security. You can expect to receive your PIN in the mail sometime in December. Save the PIN as it is required to file your Form 1040. If you would like to sign up for the PIN program, you can do so on the IRS website. Note that once you are enrolled in the program, there is no opt out. A PIN will be required for all future filings with the IRS.
Retirement Contributions
You may wish to make some last-minute contributions to qualified retirement accounts like an IRA. This can be $5,500 for traditional or Roth IRAs plus an additional $1,000 if you are 50 or older. Contributions to traditional IRAs need to happen by April 15, 2019 to be deducted on your 2018 tax return.
Harvest Gains and Losses
Profits and losses on investments have their own tax rates from 0 percent to as high as 37 percent. Knowing this, make plans to conduct an annual tax review of investment moves you wish to make. This includes:
Understanding investments held longer than one year have lower tax rates as long-term capital gains.
Trying to net ordinary income tax investment sales with long-term investment losses.
Making full use of the annual $3,000 loss limit on investment sales
Timing matters with investment sales and income taxes, so having a year-end strategy can help lower your tax bill.
Last-Minute Tax Moves
While your last-minute tax move opportunities may be limited, here are a few ideas worth considering:
Make donations to your favorite charities to maximize your itemized deductions.
Consider contributions of up to $100,000 from retirement accounts to qualified charities if you are older than 70½.
Make tax efficient withdrawals from retirement accounts if you are over 59½.
Delay receipt of income or accelerate expenses if you are a small business.
Take advantage of the annual $15,000 gift-giving limit.
Understanding your current situation and having a plan will make for a smooth tax filing process and maximize your tax savings.
The Social Security Administration (SSA) announced that the maximum amount of wages subject to the old age, survivors, and disability insurance (OASDI) tax will increase to $132,900 for 2019. The OASDI tax rate is 6.2%, so an employee with wages up to or above the maximum in 2019 would pay $8,239.80 in tax and the employer would pay an equal amount. Self-employed individuals pay tax at a 12.4% rate up to the limit. The 2018 wage base is $128,400, for a $7,960.80 maximum amount of OASDI tax.
The Medicare hospital insurance tax of 1.45% each for employees and employers, or 2.9% for the self-employed, has no wage limit.
The SSA also announced that recipients of Social Security benefits would get a 2.8% cost-of-living adjustment and that the earnings test for the amount of income that benefit recipients can receive without their benefits being reduced each year is $17,640 before full retirement age, and the limit taxpayers can earn in the year they reach full retirement age is $46,920.
Consider conducting a final tax planning review now to see if you can still take actions to minimize your taxes this year. Here are some ideas to get you started.
Assess your income. Begin by determining how your income this year will compare to last year. Then apply any tax implications this income change may cause. Be sure to account for the lower tax rates and the elimination of exemptions. Remember, if your income is rising, more of your income could be subject to a higher tax rate. Your higher income could also trigger a phase out that will prevent you from taking advantage of a deduction or tax credit formerly available to you.
Examine life changes. Review any key events over the past year that may have potential tax implications. Here are some examples:
Purchasing or selling a new home
Refinancing or adding a new mortgage
Getting married or divorced
Incurring large medical expenses
Changing jobs
Having a baby
Identify what tax changes may impact you. Tax changes for the current year are expected to be more impactful than we’ve seen in 30 years. Determine which of these changes will affect you. With these changes in mind, review your past income tax return to estimate what the impact may be on your upcoming tax bill. Please keep in mind that Congress has a habit of making last-minute changes, so you will want to plan accordingly.
Manage your retirement. One of the best ways to reduce your taxable income is to use tax beneficial retirement programs. Now is a good time to review your retirement account funding. Are you taking full advantage of your employer’s retirement plans? Are you saving money to invest in your future through various retirement savings options?
Look into credits. There are a variety of tax credits available to most taxpayers. Spend some time reviewing the most common ones to ensure your tax plan takes advantage of them. Here are some worth reviewing:
Child Tax Credit
Earned Income Tax Credit
Premium Tax Credit
Adoption Credit
Elderly and Disabled Credit
Educational Credits (Lifetime Learning Credit and American Opportunity Tax Credit)
Avoid surprises. Conducting a final tax planning review now allows you time to try to reduce your tax obligation. This is especially true if you are unsure of the specific changes made to the tax code. Remember some tax-saving ideas may require funding on your part. It is best to identify them now so you can save cash to take advantage of them prior to the end of the year.
