Many people rush to get in last-minute lucrative tax-planning moves before December 31, but few consider the opportunities that extend to January.
What tax moves should be on your mind before April?
1. Evaluate Your Compensation In The Form of Equity (aka Equity Compensation)
As we discussed in our previous post, the beginning of the year is a great time to evaluate what we call your compensation in the form of equity, including ISOs, RSUs, and other stock options.
- Do you have any shares vesting soon?
- Should you exercise your shares?
- How will you plan for taxes (both from your choices this year and the year prior)?
To answer these questions, you need to know precisely the type of equity compensation you have because they are all taxed differently. You can even influence how you are taxed for some forms of equity compensation, depending on what you do with it and when.
Your equity's type, timing, and treatment can all impact your tax bill, and the differences are often significant. You must think ahead when it comes to equity comp.
2. Make Sure You Pay Your Estimated Tax Payments
Are you earning a lot of extra income this year (stock options, side hustle, real estate, crypto, etc.)? You may need to make estimated quarterly tax payments by the required deadlines.
The payment for Q4 2021 earnings (Sep-Dec) is due January 18, 2022. Typically, your withholdings from W2 income satisfy that requirement for that income, but if you are receiving income that isn't from an employer, tracking your income and paying the respective taxes are your responsibility.
If you don't pay enough or pay late, you could be subject to an underpayment penalty (which accrues interest). How can you avoid that? The IRS has specified particular “safe harbor” estimated payment thresholds that, if paid, will protect you from an underpayment penalty regardless of what your actual tax bill ends up being for the year.
Those thresholds amounts are:
- At least 90% of taxes owed in the current tax year, or
- 100% of your actual tax bill on last year’s return if your AGI was $150,000 or less on that return, or
- 110% of your actual tax bill based on last year’s return if your AGI was more than $150,000
The first limit still requires that you estimate this year's tax bill ahead of time, so it’s often simpler to just pay 100 or 110% of your previous year's tax liability.
3. Adjust Your W-4 Withholdings (And Make A Plan for A Refund)
Planning to receive a refund or owe a big tax bill? Take another look at your withholdings. In a perfect world, your withholdings would be exactly enough to cover your tax bill—no more and no less.
In reality, that rarely happens. But, with some beginning-of-the-year planning, you can get reasonably close.
If you're withholding too much (and get a large refund), you are giving an interest-free loan to the government. That is money you could have put to work for you throughout the year via increased savings, extra investment, or paying off a loan. Consider reducing your withholdings so that you aren’t giving up that benefit.
If you're not withholding enough, you’ll end up needing to write a check to cover the difference on your tax bill. You should increase your holdings, so you don't owe as much each year.
Since last year is already behind us, though, you need a plan for your refund if you are expecting one. How can you make the most of it?
Since it will come in a lump sum that you probably didn’t include in your budget, consider investing it. You won’t feel the pinch on your budget since it wasn’t there to begin with, and it will help you make forward progress on your goals.
Something else you may want to consider is applying it toward your estimated quarterly payments for next year. That may be a good planning move, and convenient too. You can select that option right on your tax filing documents, and the IRS will handle it automatically for you.
4. Gather Your Tax Documents and File Early
Create a tax preparation checklist, so you're ahead of the crowd. What do you need? The list will be different depending on your income and expenses, but common items include:
- W-2. You should receive a W2 from every employer you have had throughout the year.
- 1099 for contract or investment payments.
- Last year's returns (federal + state). You may need this to calculate your safe harbor amount if you plan to pay it. Also, some items carry over from one year to the next. A prime example is net capital losses over $3,000. When you download your tax return from last year, ensure you get all the accompanying schedules and attachments since much of this information is there.
- Social Security number, so the IRS knows who you are.
- Planned deductions (+ proof) and credits. Deductions are probably the most commonly misunderstood aspect of tax filing. Some items are deducted from your gross income to arrive at your adjusted gross income, or AGI, while others are deducted from your AGI. For deductions from your AGI, you can claim either the total of those deductions or the standard deduction. It makes sense to claim whichever amount is higher.
Bonus: Make Extra Payments To Your Investments
While the deadline for 401(k) contributions has passed, the same isn’t true for other accounts.
One above-the-line deduction that you shouldn’t overlook at the beginning of the year is an IRA contribution. You can contribute for a prior year through the tax filing deadline for that year. In other words, you can still make an IRA contribution for 2021 and claim the deduction through April 15, 2022.
You can also fund your HSA for another month until May 17.
We Can Help You Sail Through Tax Season
The best part of all of this is you don’t have to do it by yourself.
Rivermark Wealth is a tax-focused financial planning firm. We monitor and manage our client's tax liability throughout the year to help them pay the lowest tax bill possible within the framework of the current tax code.Call us to see how we can help you.