Avoid the Taxman's Pinch
Have you had an income bump this year, something other than a bonus? If you weren’t careful, you could end up with a whopper of a tax bill, as has already happened to several new clients this year. If I had known them last year, I could have warned them. Instead I am warning them, and you, to beware of this problem in 2020, as it is easy to anticipate and avoid.
If you have a six-figure income, or high five figures, and take a one-time income bump on top of it, the bump could push you into a higher tax bracket. Even if it does not, failure to withhold for federal income taxes could blindside you at tax time.
Let me give you an example, a composite of several clients so I won’t inadvertently disclose someone’s info. You are 70 years old and make $150,000 a year in salary, but only 9% was withheld. You have a few thousand dollars in side income, no withholding made. Then you get a one-time $100,000 pension distribution, which also has no withholding.
You are going to owe many thousands of dollars to Uncle Sam, perhaps tens of thousands – so many that you may have to choose between that down payment on a new home, or a payment plan. On top of the tax debt, there will probably be a penalty for not prepaying your taxes.
You can avoid most or all of that tax debt by anticipating it, and acting in advance. The most important action is, when you get a one-time income bump, you make a tax payment immediately through www.IRS.gov. Some folks say it needs to be 10% or 15% or even 20%, but if your income is at $250,000 or higher, make it 30% to avoid a big tax hit in the spring.
One of my clients just shook his head when I explained it to him, because at one time he had the entire $8,000 he needed to pay off the IRS – but he gambled it away in a local (Las Vegas) casino. He’s an enthusiastic, but not degenerate gambler: Had he known what was coming, he assured me, he would not have gambled it away. He asked me how to do a payment plan, which is also available through IRS.gov.
There is a second action that you may need to take even if you do not have a one-time income bump: Increase your withholding on your ordinary wages. I see too many W-2s that have 10% or less of withholding for salaries of $60,000 a year or more. It is not enough to avoid a tax debt.
The easiest way to increase withholding is to have HR cut your exemptions back to zero. You may have one exemption for yourself, or two for a spouse and self, but if you are owing taxes at the end of an ordinary income year, you need to cut it back to zero.
Not all my clients are thrilled with this advice, and you might not be either, if your preference is to squeeze the most possible free cash out of every pay check. That preference is fine to a point, but ask yourself – do you really want to have pay through the nose on tax day? Wouldn’t you prefer to pay it in dribs and drabs out of each pay check?
The answer may seem obvious, but for many lower-income folks higher withdrawals are not an option. Indeed, they may not be necessary. If child tax credits or earned income credits are involved, for instance, the taxpayer may be likely to achieve a refund, in which case higher withdrawals are certainly not necessary.
Every situation, including your own, is different. If you were unhappy about your tax results this year or last, it may be wise to consult another tax professional. In that case, I can help, count on it. Call 702-222-3212 for a phone appointment.