Got Burned This Tax Season? Don’t Let It Happen Next Year

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The sun is out, tax season is over, and you’ve probably already spent that tax refund check… right? Alas, not everyone is lucky enough to slide through April with an effortless tax return and get a healthy refund check with their name on it.

Every year, millions of good-intentioned Americans are blindsided by a tax code as cryptic as James Joyce’s “Ulysses.” Ignorance is bliss, of course, until the day the numbers in TurboTax turn red or you get that dreaded  letter from the IRS.

So if you got caught with your pants down this year, here are a few of the common pitfalls that you should keep your eyes on to make for a better April next year.

Withholding Allowances

In a perfect world, your tax refund check would be for exactly $0. Tax withholding is a pretty simple process on the surface: Your employer takes a percentage of your paycheck and sends it to the government every quarter on your behalf. If they send too much, you get it back in April in the form of your tax refund. So when you get a tax refund, it means that the government has been holding your money for you for a year, interest free. If that money were in your pocket the whole time, you could have invested it and earned interest (or, you know, used it to pay rent).

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If you owed money this year, and have a regular “W2” job, it’s most likely because you instructed your employer to deduct too little taxes. What’s worse, you may even be subject to underpayment penalties. So for this year, it’s generally a good idea to err on the side of caution and aim to get a small refund rather than owing money in April.

So how do you even adjust this stuff? Well, you may remember when you started your job you filled out a Form W-4. This form tells your employer how much to deduct from your paycheck based on the number of “allowances” you claim. There is a calculation “worksheet” on Form W-4 to help you figure out how many allowances to claim. Long story short, if you got a big refund you will want to increase the number of allowances (and thus reduce your withholding), and vice-versa.

Freelance Income

If you are a freelancer, blogger, or any other kind of self-employed worker, you don’t have an employer sending payments to the government on your behalf every quarter. Unfortunately, the government always wants their money sooner rather than later, which means that you may need to send in “estimated payments” on your own. The IRS publishes a helpful guide on its website that outlines the entire set of rules on who must pay and when. If you are subject to estimated payment requirements you may also be subject to self-employment taxes.

Making estimated tax payments basically comes down to forecasting your tax outcome in advance, which unfortunately can feel a little bit like filing your taxes four times a year.  Painful as it is, however, avoiding an underpayment penalty is one of the easiest ways to pay less to the IRS.  Sadly, Americans paid over $1.5 billion in penalties in 2012 – yikes!

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Investment Gains

Finally, did you sell off those Apple shares from 1997? Well, you may want to sell those Blockbuster shares, too. It’s a good idea to harvest some losses to balance out your gains otherwise you may have to pay hefty capital gains taxes. Investors tend to sell their winners so they can lock in their profits, but hold on to the losers when they’ve tanked, hoping for a rebound.

The key is to sell the winners and losers in the same year so that they combine or “net out” to zero gains. This is especially important since net capital gains are taxed immediately, and net capital losses can only be utilized up to $3,000 per year. It’s all about the timing.

New Tax Laws

Every year, the tax law changes, and 2012 was no exception. If you were unlucky, your unpleasant April surprise may have been the result of a change in the tax code.

Unfortunately, 2013 is going to be even worse. These changes will impact just about every American in one way or another. Here’s a quick rundown of some of the most important changes:

  • 2% increase in Social Security payroll taxes, resulting in less take-home pay
  • A new net investment income tax and Medicare surtax, resulting from the Affordable Care Act (Obamacare), will impact many people earning more than $200K
  • New and reinstated tax rules reducing the benefit of itemized deductions (e.g. charitable donations) and personal exemptions (that extra “help” from the IRS for each child) for those earning over $250K
  • A new, highest tax bracket for the wealthiest Americans, and a new highest tier to the Capital Gains tax
  • Medical expense deduction “AGI floor” increased from 7.5% to 10%, resulting in a smaller medical deduction

And as if the tax code wasn’t already complicated enough, 2013’s changes just add to the complexity.

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GoodApril Tax Checkup

If you don’t want to get caught off guard by the 2013 tax law changes, and you want to know what savings opportunities are available to you, check out GoodApril’s free Tax Checkup. It analyses your 2012 tax return to produce an easy-to-read analysis of how you’re impacted by the law changes, and actions you can take to pay less next April. If you want to stay ahead of the curve on your taxes, and avoid getting burned again next April, head on over to GoodApril.com for a free Tax Checkup today.

Mitchell Fox is a Tax Nerd and the Co-Founder of GoodApril (www.goodapril.com), the first online tax planning solution for consumers.  GoodApril offers a free “Tax Checkup” service to help you identify actions you can take to reduce your taxes. You can follow Mitch and GoodApril on Twitter at @mitchellwfox and @goodapril.

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