• Leyder "Aiden" Murillo, MBA

Surprised With This Year’s Taxes? Review These 5 Things - Sample Financial Plan Included

Every year you and many others begin the journey of doing income taxes. Whether you do them yourself or hire someone to do them for you, one common theme is wanting to lower the amount paid in taxes and increase the tax refund. Keep reading if you were shocked by paying taxes or received a lower tax refund than expected. The rising trend for the 2021 tax year is paying capital gains taxes. Most retail investors who began investing during momentum trading and cryptocurrencies now face how the US tax system functions.


I owe the IRS $163K from gains now what? surprised irs taxes
Source: Reddit Post

The value of a financial plan is unknown until you quantify the various topics within a financial plan. For example, one of the topics within a financial plan is “Tax Planning Strategies,” which helps minimize current and future income taxes as part of your overall financial planning picture. As financial advisors, we recommend which type of accounts or specific investments you should own based on their “tax efficiency,” considering the possibility of future changes in federal, state, or local tax laws. View a sample financial plan below.


Always consult a qualified tax professional before initiating any tax planning strategy. Consider hiring a certified public accountant (CPA) as they are licensed accounting professionals who enforce professional standards. CPAs gain their license after completing hours of education and passing a rigorous exam.


Sample Financial Plan
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Download PDF • 6.51MB

What’s the difference between a financial advisor and a qualified tax professional like a CPA?


To understand the difference between a financial advisor and a qualified tax professional, like a CPA, you need to think of the professionals you hire as those who want you to succeed. The best analogy is to think of yourself as an athlete. The financial advisor is the coach providing you with the plan and tools to help you succeed. A qualified tax professional, like an accountant, keeps track of the score or your success and reports it. Some qualified tax professionals like CPAs provide advice like financial advisors because they are also licensed.


5 Things That May Affect Your Taxes


If you were shocked by paying taxes or received a lower tax refund than expected, consider adding “Tax Planning Strategies” to your overall financial plan. You can create a financial plan independently on your own or hire a professional to help you create one. In either condition, the following are things to consider, although not inclusive, and look over one more time before the end of the new tax year.


IRS Form W-4


When you start a new job, you fill out the IRS Form W-4 that every employee must fill out to determine the taxes withheld from each paycheck.


In 2020 the form changed because of the Tax Cuts and Jobs Act (TCJA). The new form is much more simplified as it asks you questions such as your IRS filing status, if you work more than one job and if you claim dependents.


You may want to revise your W-4, especially since the form changed and your employer is using an older version of the W-4 that you filled out perhaps years ago before this new form update.


Another reason to modify your W-4 is if you owed a lot of money in taxes on your recent tax return, meaning you underpaid in tax withholding. Another scenario is that you had a significant refund because you overpaid in tax withholding.


Always revisit and update your W-4 whenever you experience a life-changing event: the birth of a child, marriage, divorce, you become a widower, or you start a new freelance job (side gig).


Retirement Plans


If you have a retirement plan with your employer, such as a 401(k), 403(b), or 457(b), the more you contribute to your retirement plan, lowers your taxable income. You contribute more to your retirement by reducing your take-home and lowering your taxable income. Remember that employee contributions (this is you) are deducted from your paycheck pre-tax. Pre-tax means that it is not subject to payroll or income taxes.


Also, if you contribute more and have an employer match up to a certain maximum, this extra money is helping your retirement nest egg. Of course, there may be a maximum amount that an employer matches. Consider the following examples:


You earn $50,000 in salary; your employer offers a 100% match on all your contributions each year, with a 3% max of your annual income. The maximum amount that your employer would contribute each year is $1,500, but you must also contribute the same amount meaning you would need to contribute the 3%. Yet, that is $3,000 contributing to your retirement nest egg.


Another example is that if you contribute 7% of your salary because you want to minimize your taxable income, the additional contributions are unmatched. You contribute $3,500 (7% of $50,000), and you retain the 3% match of $1,500 from your employer for $5,000 into your retirement nest egg.


Self Employed (Including Side Gigs) Taxes


If you are self-employed, you are both the employee and employer. Just because you are both does not mean you cannot contribute to your retirement nest egg and help lower your taxes. You have options on retirement accounts to reduce your taxable income. The most common retirement plan for the self-employed without any employees is the Simplified Employee Pension (SEP). One caveat of being self-employed is that you need to pay quarterly taxes. However, certain tax deductions are allowed when you are self-employed, such as taking the deduction for half of the self-employed tax.


If you work a regular job with a retirement plan and do side gigs, you can contribute (up to certain limits) to the SEP to lower your taxes on the side gig jobs and still contribute to your current employer’s retirement plan.


There are more retirement plans for the self-employed as it is a vast separate blog topic, but you get the idea.


Capital Losses


You may think that you pay taxes on short-term capital gains, long-term capital gains, interest & dividends in regular investment accounts. In essence, you are correct, but depending on your investment strategy, if it does not perform well and you are below your cost basis, you can create capital losses to help minimize capital gains taxes. This strategy is called “Tax-Loss Harvesting.”


As of 2022, you can claim up to $3,000 of losses to offset your taxes. Consider the following example.


You have the following capital gains and losses for the tax year:

  • Short-term gain: $1,000

  • Short-term loss: $13,000

  • Long-term gain: $4,000

  • Long-term loss: $500

Your short-term loss is $12,000 ($1,000 - $13,000) and your long-term gain is $3,500 ($4,000 - $500). When netted against each other, you have an overall loss of $8,500 ($3,500 - $12,000). The overall loss eliminates your original taxable long-term gain of $4,000. Although you cannot fully deduct, all at once, your overall loss of $8,500. The IRS allows up to $3,000 in capital losses. Therefore, if you claim the $3,000 loss, you have $5,500 in excess loss to carry over into the following years. You continue to claim the $3,000 loss per year until the depletion of the loss; this is called “tax loss carryforward.”


Beware of Wash Sales


Capital losses are great to lower your taxable income if you have an investment loss, but you cannot create artificial losses continuously, also known as “wash sales.” A wash sale is when you sell or trade a security at a loss 30 days before, and 30 days after the sale, you buy the same security. Wash sales prevent you from abusing the tax deduction of capital losses against capital gains.


Wash Sale Rule The wash sale rule covers 60 days: 30 days before & 30 days after.  If a sale and subsequent purchase happens between this period, a loss cannot be claimed.

Consider the following example:


You bought 50 shares of XYZ stock during a momentum run-up at $100 per share on February 1.

  • Your total investment of $5,000

  • The cost basis is $5,000

On March 15, the stock deflated and now trades at $40 per share.

  • Investment value is $2,000 (50 * $40)

  • You decide to sell because you want to get a capital loss tax deduction of $3,000 ($2,000 - $5,000)

On March 30, you decide to purchase the stock again to “buy the dip.” The stock now trades at $50 per share, and you purchase 50 shares again.

  • The initial loss on March 15 will not be allowed as a tax loss because you purchased XYZ within the time window period of 30-days after the original sale.

  • You trigger a wash sale and an original cost basis adjustment on your transaction.

  • Instead of the cost basis of $2,500 it is now $5,500 as the original loss is added back ($2,500 + $3,000)

Your Takeaways


Surprises aren’t always fun, especially when it comes to taxes. But not all is lost. Closely monitoring your tax situation may help ease the surprises. Consider adding “Tax Planning Strategies” to your overall financial plan. These tax strategies help minimize current and future income taxes as part of your overall financial planning picture. You can create your financial plan with these tax planning strategies in mind.


If you feel it may be too cumbersome to keep track of everything or think a professional is best for this situation. You may want to hire a qualified tax professional, such as a CPA, to handle your tax situation. A financial advisor will help with your financial plan and provide insight into what investment strategies are available to you. Or perhaps your financial situation is very complex, and both make sense. These professionals will guide you to your overall financial goals and help minimize any surprises.

 

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