The holiday season is a busy time of year for many of us, both at work and in our personal lives, and it also happens to overlap with open enrollment for the health insurance marketplace. We understand that getting ready for tax season is probably one of the last things on your mind right now! But every year around the end of March/beginning of April, I talk with at least one or two people who end up owing more than they expected on their tax return—and unfortunately, there’s not much we can do to change circumstances at that point. If you own a business, you have some wiggle room to do your tax planning and make changes early in the new year. But if you’re a full-time employee, it’s important to make sure you are using your benefits and withholding options strategically before December 31.
The choices you make will vary based on your situation, so there’s no advice I can give that really applies to everyone. That said, here’s a rundown of some of the big variables that might affect your tax balance come April 15:
Where are You Right Now?
There are plenty of tried and true methods for cutting your tax bill out there, for example, saving for retirement or overpaying on student loans. However, none of these strategies are necessarily helpful without an in-depth understanding of your family’s life circumstances, goals, financial situation and values. For example, I had a client a while back who wanted to buy an engagement ring for his girlfriend and start looking at homes in the next year. He hoped that limiting his tax bill might help him make faster progress on these financial goals. As it turned out, contributing to his IRA would in fact lower the amount owed in taxes, but it would also take up the cash flow he needed to begin those other investments. He decided to wait on making that IRA contribution, but other people might have handled the situation differently.
In order to make educated, strategic tax planning decisions with your CPA, make sure you discuss these four elements:
Values: What are your philosophies on how you save and spend money, and how do you make financial decisions? What things are always a priority for you, such as giving to a church or charity, taking a vacation once a year or sending your kids to private school?
Cash flow: How much money do you have coming in every month, and where does it go? How much do you spend and save, and why?
Tax savings: How much are you setting aside for tax time, and is it enough?
Life goals: What do you want your life to look like in one year, five years and beyond? When will you need to start preparing for the goals and lifestyle you want to achieve?
All four of these elements are interconnected; you can’t look at one without considering the other three, and just a snapshot is usually not enough to take decisive action. The best options for you may or may not be beneficial tax-wise, but if you also share all of the above information with your CPA, we can get a bit more creative with your plan. So how well does your CPA know your values?
How Much are You Withholding?
This one is a really common issue for people who have changed jobs within the last year. The withholding form (W-4) that you fill out when you’re hired dictates what percentage of your income will be set aside for taxes. One little mistake on this form can make a big difference at tax time! This form has gotten a lot more complicated in the past ten years or so—it has grown to a whopping four pages long. Most of the full-time employees we work with are in a 25% federal tax bracket, so you can use the “gross pay” and the amount withheld on your last pay stub to do some quick math and see if you’re in the right ballpark. If you’re not entirely sure what you entered on your W-4, now is the time to take a look! Get in touch with your HR department and ask for a copy of the form they have on file.
Are You Using Your Benefits Wisely?
Depending on what your employer offers, there may be some opportunities to receive credits on your 2021 taxes for investments as long as you take action before the end of this year. Most flexible spending accounts (FSAs) and dependent care accounts (DCFSAs) require funds to be used up by the end of the year or you risk losing them, so if you have one of these, you probably want to get the balance to zero before December 31. FSAs cover minor health costs that aren’t covered by your insurance but may be tax-deductible, such as chiropractic services or acupuncture, and DCFSAs may cover anything from having children as dependents to providing for an elderly relative or caring for a family member with a chronic health condition. An FSA may be the best choice for you if you don’t qualify to itemize your deductions, or if there are copays and out-of-pocket costs you’d like to write off. If there are benefits that you’d like to use in 2022, you will likely need to sign up and determine how much you want to invest before the end of the year.
There are a few more ways to spend money now for savings on this year’s tax bill. Depending on what state you live in, the money you invest in a retirement fund, donate to charity and prepay on college tuition by contributing to a 529 plan may all qualify for deductions. Like the employee benefits in the section above, these decisions need to be made before December 31 to apply to this year’s taxes.
I don’t want you to be that person with a huge surprise tax bill this year! If you’ve owed a lot last year or if your circumstances have majorly changed, I encourage you to reach out and get in touch now. Even if that’s not the case for you, December is a great time to check in with your CPA to review your tax planning strategy, explore your options and get reacquainted before tax season kicks off. We’d love to hear from you!