Reduce the Surprise on Tax Day

Are you the type of person who likes to be surprised? How about when it comes to your tax return? It’s that time of year when Americans turn their focus to their taxes. For those of you that like to plan ahead, I’d like to share some tips for filing your taxes and smart uses of your tax refund.

Tax Filing Tips

  • Consult financial professionals when making important decisions such as selling or purchasing a house, business expansion or adding a partner, or a change in your family. On that note, be sure to hug your CPA or tax preparer. Their job, which is helping you pay the minimum tax legally required, is made more difficult by a complex tax system and you’re a moving target each year. You’re better off when they are not the last ones to know about material changes in your life.
  • Electronically file and auto-deposit. The average refund this year is about $2,880 (down from $3,125 from last year). Remember, tax refunds are overpayments – not bonuses. Think of them as getting change back for your purchase. You may be reunited with your money faster by choosing direct deposit to your designated account.
  • Update your tax withholding. Tax policy, economic conditions, and the pandemic impact your financial situation. Withholdings and quarterly tax payments help you pay as you go throughout the year. Unfortunately, according to a recent survey by the American Institute of CPAs, less than half (44%) of people say it was their goal to pay close to their actual bill. The remainder purposely over or under-pay. April 15th doesn’t have to be a surprise of an unusually large tax bill or refund.
  • Did you move into the gig economy this past year? Many people found new ways to earn a living in a year of surprise and change. Remember income is taxable and consider making quarterly tax payments.
  • Working from home? You may be entitled to a home office deduction for qualifying self-employed taxpayers and independent contractors. However, if you’ve been blessed (or cursed) to work from home by your employer, you might not be eligible. The Tax Cuts and Jobs Act suspended business use of home deductions through 2025 for employees. This is another technical area to discuss with your CPA.

Smart Uses of Your Tax Refund

  • Increase your ‘Rainy Day’ fund. A good rule of thumb for cash reserves is an amount equal to three to six months’ living expenses – or more if your income significantly fluctuates. Retirees should consider having one to two years of living expenses stashed away in cash. These funds should be safe and earn competitive interest. Talk to your banker and consider online FDIC-insured money market accounts.
  • Reduce your debt. You can only do two things with money – save or spend – so use your debt wisely. Budget to save what is required for you to retire, and it may be well-advised to adopt an aggressive debt reduction plan now to enable you to save in the future. For example, use the refund to pay off an 18%-interest credit card balance. Or use it to pay closing costs if refinancing your home makes sense rather than rolling those costs into the loan amount.
  • Make contributions to your retirement plan. Are you saving enough? Contribution limits to IRAs and 401ks are higher this year ($6,000 plus $1,000 catch-up, and $19,500 plus $6,500 catch-up, respectively). Do you have the option of contributing pre-tax or after-tax (Roth)? Answer is dependent on your future tax brackets. If your rates will be lower in retirement, then taking the deduction now (pre-tax) makes more sense. If not, then consider after-tax Roth contributions. And update your tax withholding accordingly.
  • Invest in yourself. Consider self-improvement for professional or career enhancement or well-being. Ideas include a training or certificate program, a hobby to keep you active and engaged, or a personal trainer or home gym equipment.
  • Roll it to 2021. We do not yet know what the Biden administration tax policy will propose, or Congress will pass. Pay attention and adjust accordingly.

Some surprises in life can be exciting. However, you may prefer to not be surprised by Tax Day or your retirement finances, so it’s best to have a plan. May you secure your future wisely and always have sage advice.

About Brian Loy

Brian Loy writes insightful and inspiring articles about the ever-changing world of personal finance and the global trends that affect the risk and return on investments and shape the financial- and retirement-planning process.
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