How to Know What You Owe
In the wake of tax day, many of us might be feeling a bit like a deflated balloon.
Tax preparation is never easy, and the more complicated your financial life becomes as you grow through life, the more of a headache your prep might be.
As we assess the aftermath of filing season, it’s tempting to put everything out of our minds and worry about it next year. Instead, I encourage you to use this moment to reflect on how taxes are impacting your finances. With a little extra focus now, next year’s filing season will be easier both mentally and financially.
Did You Get a Refund?
Many people love getting a tax refund check. I hear conversations constantly this time of year about what people plan to do with theirs. Some people rely on their tax refund to make big purchases, while others plan to use theirs to boost savings or pay down a large chunk of their debt.
Any time you receive a financial windfall, you’re going to have a positive emotional response. After all, who doesn’t love receiving unexpected money - especially if it’s a significant amount? Unfortunately, getting a large tax refund isn’t always a good thing.
When you receive a tax refund, you’re only getting back your money. The money was never the government’s in the first place because somewhere along the line you overpaid on your taxes. While it’s nice to receive a large amount of money, a tax refund is the equivalent of giving the government an interest-free loan for an entire year and then being repaid. Having that money as part of your cash flow year-round could help you build savings, pay down debt, or reach other financial goals faster - rather than receiving it in a lump-sum after you file.
Did You Owe Taxes?
Nobody likes having to owe more taxes than you’ve already paid but sometimes it happens. In some cases, you may owe taxes on a large amount of money you were gifted, your income increased without taking any additional deductions or exemptions, or you made a large profit on a one-time event (like a property sale) without paying estimated taxes.
However, it’s more likely that you owe taxes for one simple reason: you’re not paying in enough taxes to the IRS each year out of your income. If you’re a salaried employee, this means adjusting the allowances claimed on your W-4.
Adjusting Allowances on Your W-4
How many allowances you claim on your W-4 impacts how much money is withheld from your paycheck and paid to the federal government to cover your tax payments. If you claim many allowances, the government withholds less from your paychecks. If you claim fewer allowances, the government withholds more - meaning you have a smaller take-home salary and you’ll likely get a tax refund during filing season.
It’s important that you’re claiming the correct number of allowances to make sure you don’t over or underpay your taxes each year. Major life events, like getting married or having children, signals that you should consider claiming an additional allowance. However, you can check the IRS’s withholding calculator to estimate how many allowances you should claim on your W-4 form through your employer.
Many people think that they can only adjust their W-4 information once a year, in the same way that they can adjust their health insurance elections. This isn’t accurate! If you want to adjust your W-4 claims, you can do it at any time. In fact, waiting might make it more difficult to zero in on paying the exact right amount in taxes.
What if you’re Self-Employed?
If you’re self-employed, you’re playing a bit of a different ball game when it comes to taxes. Rather than paying the with each check, you’re likely paying taxes using estimated quarterly payments throughout the year and then filing a return before Tax Day.
Although you won’t be able to adjust the withholdings on your W-4 like a salaried employee does, you can double check your estimated tax payment calculation to make sure you’re setting aside the right amount each quarter.
It’s important that you remember to pay on time and in full each quarter to avoid any penalties or fees, and to make sure you don’t owe more money than you’d budgeted for after you file.
Can You Pay Less in Taxes?
Taxes are an unavoidable part of life. At some point, we all need to pay our due. However, with a comprehensive financial plan, you can develop a strategy that helps you to mitigate the negative impact taxes can have on growing your wealth. Whether you contribute pre-tax funds to a retirement plan or you pre-tax money aside in an HSA for qualified medical costs you have many options available to you.
As a financial planner, I help clients who are both salaried employees and business owners build financial plans that maximizes their wealth. That includes coming up with a tax strategy that works for their unique financial needs and goals!
Want to learn more? Contact Allegiant Financial Planning today. I’d love to hear from you!