Even though you’ve filed your taxes for 2021 (unless you’re on extension), there are still tax-related items to tick off your list before the end of the year.
Know your tax payment game plan for the current year. While a tax refund can feel like a welcome surprise, it’s a sign you’ve been giving the government an interest-free loan. It’s important to check that you’re not over-paying. If you are still working, you’re most likely paying taxes through withholdings, and it’s a fairly simple matter to establish whether you need to make changes. But if you’re self-employed, in retirement, or receiving substantial income from other sources, you may need to make estimated quarterly tax payments. If you are making estimated payments, you’re most likely paying just the right amount. However, it is important that you make sure to properly budget and have the cash set aside for these payments. In particular, keep an eye on investment income—it can vary from year to year quite a bit.
To more effectively manage tax obligations, many people take advantage of the safe harbor rule that allows you to pay 90% of your tax liability for this year, or 110% of last year’s tax liability (100% if AGI was below $150,000), to avoid underpayment penalties and interest. But these only satisfy the required safe harbor amount and not necessarily the entire tax liability; you’ll need to be prepared to hand over the remaining lump sum next April.
Having a good understanding of what your tax liability is likely to be, makes it easier to smooth out your cashflow needs over the course of the year. And remember, circumstances can change midyear, causing a need to adjust your tax plan. For example, the tax liability from a home sale could be significant, and you would want to consult your accountant ahead of time to be better prepared come tax time. Sadly, it’s not uncommon to see clients forget their game plan and then, in April, suddenly realize they still have a meaningful tax bill waiting for them. Having a good understanding of your plan, and revisiting it throughout the year is essential. If you need to set aside a large amount, it might be a good idea to earmark a separate account for tax money.
Stay up to date with expanded limits. Ensure that you’re maximizing the amount you can put into your employer-sponsored 401(k) retirement plans. The maximum employee contributions went from $19,500 in 2021 to $20,500 for 2022. Make sure you’re taking advantage of that increase, and budget accordingly.
The same goes for annual gifts. The government increased the annual limit for tax-free gifts in 2022 by $1,000. You can now gift up to $16,000 per year to anyone without having to file a gift tax return.
Keep records in one place. It’s absolutely critical to keep a record of all substantial financial transactions. This includes real estate settlement statements, charitable donations, large purchase receipts, business expenses (if you are a business owner), capital improvements to your home or rental property, medical or dental expenses, and that is just to name a few. If you’ve maintained proper records, it will be easier to calculate your tax basis if you go to sell your home, business, artwork, etc.
Also note, that the statute of limitations for an audit is 3 years, so it is imperative that records be kept for at least that time range. Create a file where you can store documents and records you may receive throughout the year, so you’re not hunting around for them next year. If in doubt, add it to your file. Good record-keeping is a staple of any tax year, and can save you quite a bit of hassle down the line.
Share your tax return with us. Tax years are like snowflakes; no two are ever quite the same. And where there’s change, there’s opportunity for both planning and for checking errors. So, don’t be surprised if we request a copy of your tax return. It’s always worth getting a second set of eyes on it, to ensure nothing’s been missed or listed inaccurately. For example, commonly unreported items we’ve caught in the past include contributions to your Health Savings Account (HSA), 529 college-savings plan contributions, and Qualified Charitable Distributions from IRAs.
Even better, we can pull a lot of useful information from your tax return to use for financial planning purposes. For example, if we see you had significant capital losses that can be carried forward, we can rebalance your portfolio to take profits off the table while avoiding a tax liability. For a high net-worth individual, the benefits can reach significant dollar amounts.
On the other end of the spectrum, if we see substantial realized gains each year, there are tax-loss harvesting strategies we can put in place to offset these gains, year over year. There are several different strategies that can alleviate tax liabilities. Tax-loss harvesting strategies are often most effective when started earlier in the year, especially if a large capital gain is anticipated.
At Bridgewater, we know tax matters are complex, but where there are opportunities to be had, we want to make sure they’re up for discussion and implementation. Alongside your portfolio, tax is another essential area of your financial picture, and we want to give it the attention it deserves.