End Of Year Tax Planning
Written by Dan Pilla
With the end of the year fast approaching, you’re probably wondering what you can do to cut your taxes. Remember: if you wait until April to start thinking about this, it’s just too late. Here are some ideas to get you moving in the right direction now.
1. Consider paying state income taxes before December 31. Many people wait until April 15 to pay their state income taxes, since that’s when they file their state tax returns. However, if you pay your state income taxes in 2023, you can’t claim the deduction for those taxes until you file your 2023 tax return. That doesn’t happen until April 2024. Thus, you have to wait an entire year before getting the tax benefit of the expense.
By paying your state taxes now, you get a deduction for those taxes in 2022. That means you get the benefit of the expense more than one year sooner than you’d otherwise realize.
Keep in mind, however, that the standard deduction for 2022 is double what it was prior to the Tax Cuts and Jobs Act. That means you may get a larger tax benefit by not itemizing, depending on your situation. It is also true that there is a $10,000 cap on what you can deduct for state and local taxes in 2022. Thus, if you are already at the cap for 2022, it won’t help to pay more state taxes this year. You have to look at your situation carefully.
2. Review your wage withholding or estimated payments. About 85% of all taxpayers get a tax refund when they file their tax returns. The average refund in 2022 was about $3,500. If you get a tax refund, it doesn’t mean the government got religion and decided to give you free money. It means you paid more taxes than you owe. If you got a refund in 2022, you need to examine your withholding situation going into 2023 to make sure you don’t overpay.
Whether you’re an employee or you make quarterly estimated tax payments as a self-employed person, sit down now and do some preliminary calculations on your tax liability. Figure out if you overpaid. If so, consider adjusting Form W-4 (for wage earners) or your estimated tax payment pattern (for self-employed people).
Keep in mind that no law requires you to pay more taxes than you owe. For withholding purposes, you avoid under-withholding penalties if you pay either 100% of last year’s tax (2021) or 90% of this year’s tax (2022), whichever is less. Use that yardstick to guide you in adjusting your withholding going forward.
3. Count your money now. Each year, millions of people are blindsided come April 15 with surprise tax liabilities they can’t pay. Don’t wait until March or April to start figuring your tax, especially if 2022 was a particularly good year for you.
On the other hand, the Jobs Act cut taxes for about 80% of all taxpayers. And if you own a small business such as a sole proprietorship or S corporation, you get the benefit of the 20% deduction under §199A. That reduced taxes considerably for most small business owners.
It is important to sit down now and examine your 2022 financial situation. Substantial changes to your economic condition may increase your tax burden. If you don’t have the money to cover the tax, you’ll wind up as one of the 3-plus million taxpayers facing enforced tax collection actions.
Make sure you have a good handle on what you’re going to owe. If you figure it out now, you have four and a half months to put together a plan to pay the tax. If you don’t, you could be hit over the head in April. In my experience, it’s that kind of shock that causes people to start making critical mistakes in how they handle their tax burdens. Often, it leads to years of hassle and harassment from the IRS.
Simple Steps 4-9 Want to read more? PTT subscribers can get the entire article when they download their Nov – Dec 2022 issue of Pilla Talks Taxes.
How to Get More Help If you need more help with end-of-the-year tax planning, you must consult one of the professional members of my Taxpayer Defense Institute (formerly Tax Freedom Institute). Call our office for the latest list of the current consulting members.
Don’t wait to take this action. If you do, you’ll lose most of your opportunity to cut your taxes for this year.