Financial experts advise that if you had a surprise tax bill this year, it’s not too early to start preparing for next year.
The IRS processed nearly 76 million refunds as of April 14, with an average payment of $2,840, which is 8.5% smaller than refunds at the same point last year. Regardless of whether you received a refund or a tax bill this year, there are several steps you can take to prepare for next year’s taxes.
Now let’s start with the first tip.
1. Review your 2022 tax return
When it comes to taxes, it’s important to understand how they work and how they affect your financial situation. One way to do this is by reviewing your previous year’s tax return to identify any unexpected tax bills. By doing this, you can determine the root cause of the issue and take the necessary steps to prevent it from happening again in the future.
For instance, if you received a bonus or earned income from a side hustle, it’s possible that you didn’t have enough taxes withheld throughout the year to cover the additional income. In this case, it’s important to be proactive and make adjustments to your tax withholding or make estimated tax payments to avoid a surprise tax bill.
One way to make these adjustments is to update your Form W-4 through your employer. This form tells your employer how much federal income tax to withhold from your paycheck. If you reduce the number of allowances on your W-4, your employer will withhold more tax from your paycheck, which can help you avoid an unexpected tax bill.
Alternatively, you can also make quarterly estimated tax payments to the IRS. These payments are typically due in April, June, September, and January of the following year. By making these payments, you can spread out your tax liability throughout the year and avoid a large tax bill at the end of the year.
Overall, understanding your tax situation and making the necessary adjustments early on can help you avoid surprises and better prepare for the next tax season.
2. Check your withholdings
If you owed more taxes than expected for 2022, you may want to revisit your paycheck withholdings for 2023 and make the necessary adjustments. You can decrease your number of allowances or set aside more from each paycheck, which can be done on Form W-4 through your employer.
A simple calculation would be dividing the extra tax paid in 2022 by the number of remaining paychecks in 2023.
3. Revisit your portfolio
When it comes to your investment portfolio, it’s important to consider the tax implications of each type of account. As mentioned, you may have three types of accounts: brokerage, tax-deferred, and tax-free. A brokerage account typically involves investments that are subject to taxes on an annual basis. This means that any income or gains generated by the investments in the account may be taxable at the end of the year.
On the other hand, a tax-deferred account, such as a traditional IRA or 401(k), allows you to contribute pre-tax dollars and defer taxes on the investment gains until you withdraw the money in retirement. This can be advantageous since it allows your investments to grow tax-free for a longer period of time.
Lastly, tax-free accounts, such as a Roth IRA, allow you to contribute after-tax dollars, but the investment gains and withdrawals are tax-free as long as you meet certain requirements.
Given these differences, it’s important to be strategic about where you keep your assets. Income-producing assets, such as bonds, certain mutual funds, or real estate investment trusts, may be more likely to trigger a yearly tax bill within a brokerage account. Therefore, it may make sense to hold these types of investments in a tax-deferred or tax-free account to avoid paying annual taxes on the income they generate.
It’s also important to note that depending on your income level, you may not owe taxes on your investments. For instance, in 2023, you may qualify for the 0% long-term capital gains rate if your taxable income is $44,625 or lower (or $89,250 or less for married couples filing together). This means that you could potentially earn investment gains without paying any taxes on them.
Overall, by being strategic about where you hold your investments and taking advantage of tax-free or tax-deferred accounts, you may be able to minimize your tax bill and maximize your retirement savings.
To sum up, by reviewing your 2022 return, checking your withholdings, and revisiting your portfolio, you can prepare for next year’s taxes and avoid any unpleasant surprises. It’s never too early to start planning for your financial future, and these steps can help ensure that you’re on the right track.
