Now that tax season is over, it’s time to plan for next year. Too often, tax filing is done passively with no proactive planning. We are waiting for the government to tell us how much we need to pay and hoping it all works out. This is especially true for people with variable income and business owners!
My challenge to you is to take a mid-year check-up to attack your taxes. This can be done in three simple steps:
- Review last year’s tax returns.
- Anticipate any changes in income and deductions.
- Adjust tax withholding from your paycheck.
A mid-year check-up is the ideal time for tax planning. This is because you have last year’s taxes completed, you have several paychecks already with taxes withheld, and you still have half of the year to make any necessary adjustments!
Ready to attack? Let’s dive in.
Review last year’s tax returns
Take out your completed Form 1040 and review what happened last year. Lines 1 through 10 capture all your income for the year, including wages (line 1), interest and dividends (lines 2 and 3), IRA and pension income (lines 4 and 5), Social Security (line 6), capital gains (line 7), and “other income” (line 8…this could be rental income or business income). Your adjusted gross income (line 11) is the sum of all these lines.
Line 12 is your standard deduction or itemized deductions. This is simply an amount the IRS allows you to subtract from your adjusted gross income to give you a smaller “taxable income” (line 15).
Your taxable income is the amount of income on which you are taxed. Line 16 shows your total Federal income tax, while lines 25 add up how much Federal income tax you’ve already paid throughout the year.
The next several lines allow for any credits like the Earned Income Credit and Child Tax Credit. Once those are included, line 34 tells you if you’ve overpaid and how much you’ll get back (a refund), while line 37 tells you if you didn’t withhold enough throughout the year and you owe money.
While every taxpayer files a 1040, you might have additional forms to review:
- Schedule A: if you itemized deductions instead of taking the standard deduction
- Schedule B: captures things like taxable interest and dividends
- Schedule C: reports business income or losses
- Schedule D: adds up capital gains or losses
- Schedule E: reports income from rental properties, S corporations, etc.
Again, the goal with this step is to become more familiar with your tax situation. Let’s say you have a number on Line 7 of your 1040. This means you have a capital gain or loss. You can refer to Schedule D to see where this came from.
Anticipate any changes for this year
After reviewing last year’s tax return, the second step is to anticipate any changes for this year. Obviously, a change in income will influence your taxes. Are you anticipating higher income, or new income from a spouse or a side job?
Adjust tax withholdings from your paychecks
The last step is to use the IRS online calculator to determine how much you should be withholding from your paychecks. This is especially important if you:
- Owed a large amount last year or received a large refund
- Have multiple jobs or both you and your spouse work
- Have other anticipated taxable income not from your primary job (e.g., side jobs, self-employment income, or a Roth conversion)
Your income tax withholding is one of the best ways to attack your taxes. Instead of waiting around and letting your taxes control you, let’s be in control of our taxes so we can know exactly how much we need to pay.
To use the IRS calculator, you need:
- Most recent pay stub from all jobs (including your spouse)
- Amount of other income (side jobs, self-employment, or a special situation like a Roth conversion)
- Last year’s tax return
The calculator will ask you how you file taxes, if you have dependents, and how many total jobs you (and your spouse) are expected to have.
Next, it will have you refer to your most recent pay stubs to input your total wages, wages year-to-date, amount of Federal tax withheld for that paycheck, and total amount of Federal tax withheld year-to-date. You will do this for each job.
On the same screen, it will also ask if you or your spouse have any other sources of income. This can be sources reported on Schedule E (like rental income), distributions from an S-Corporation, or money you plan to convert from a Traditional IRA to a Roth IRA. Because these sources of income don’t have tax withheld like employment income, this can cause a surprise tax penalty if you don’t account for them throughout the year.
As you progress, the calculator can get detailed. The adjustments, deductions, and tax credit sections ask for a lot of information, but most of these can be skipped. When I go through this, I simply type in the amount of itemized deductions I took the prior year instead of listing them out individually:
Of course, it’s easier if you take the standard deduction. If you have children, be sure to enter their ages at year-end in the proper child tax credit section.
When you finish these components, the results tab will tell you how much you are anticipated to owe or have refunded based on the information you provided. Not only that, it also tells you how to adjust your withholding for the rest of the year.
As I went through this calculator with hypothetical numbers, I learned that I am projected to owe $8,709 in Federal income tax. Yikes! It recommends that I withhold an additional $945 per paycheck for the rest of this year. It also completed a Form W-4 for me with the $945 on the proper line. I can just write in my personal information and hand this to my payroll department!
What’s better, learning I owe $8700 when I file my taxes, or breaking it up in smaller amounts through the year?
This is why a mid-year check-up is vital. If you did this in December, you might only have one or two paychecks left. You might not have enough time to make the necessary adjustments.
A tip for Arizona residents…
Arizona has some of the best opportunities for state tax credits. This means you can donate money to certain organizations and get a dollar-for-dollar credit on your state taxes. Here are a few of them with the 2022 maximums for single taxpayers and married taxpayers filing jointly:
- Public School Tax Credit: $200/$400
- Qualifying Charitable Organizations: $400/$800
- Qualifying Foster Care Charitable Organizations: $500/$1,000
- Certified School Tuition Organizations: $1,243/$2,483
To get the tax credit, you must have a state tax liability that matches or exceeds the credit, so work with a tax professional to determine if you are eligible for the full credit.
By planning ahead, I’m freeing up money each paycheck and I don’t have to scramble at the tax deadline to make these donations.
Prepare now for your best tax filing yet!
Most people don’t enjoy filing taxes, but taking the time to perform a mid-year checkup can remove most of the unknown from filing your taxes. You can be equipped with a better understanding of your tax situation and the amount you should be withholding throughout the year.