Quick – before the holiday season erupts!
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The holiday season is upon us but before you go into party mode, sit back a moment and reflect upon your year. Financially, that is. Especially if you encountered a lot of financial changes – lost a job, got a new job, bought a house, sold a house, moved, got married or divorced, had a baby, went back to school, took an early distribution from a retirement plan, started a business or closed a business – then you need to crunch those numbers and see what kind of tax liability has been created. After all, better to know now than have that deer-in-the-headlights look in your eyes next April 15. And because the year isn’t over, you may likely counter some of the damage with additional tax planning to staunch the bleeding.

And who knows? After compiling your data, you may be pleasantly surprised. Maybe a financial event has gone in your favor tax-wise and you may be anticipating a refund.

Whatever the case, a projection of your anticipated liability is in order which may involve a visit to your tax pro. A review of your numbers might elicit some excellent advice for warding off the tax man and minimizing your tax liability.

Some things to consider:

  1. If you lost a job or changed jobs sometime during the year, your annual income may have increased or decreased and should be examined to determine if proper withholding has accumulated. Also, you may have been receiving unemployment benefits for part of the year. Did you know that these benefits are taxable income at the federal level? Yes, that’s right; they kick you while you’re down. They may also be taxable at the state level, depending on your state’s tax laws, but usually not. If you elected for federal withholding from your benefits, you may be okay. Otherwise, plan on paying additional taxes on the amount you received. Discuss this and the job change with your tax professional. A benefit in your favor is that all job seeking expenses and continuing education costs to improve existing skills are tax deductible if you are able to itemize deductions. If you moved because of a job, you may be able to deduct moving expenses.
  2. Buying or selling a home can affect your tax situation. Buying a home is always good news. Not only do you have the benefit and pride of home ownership but the transaction results in numerous tax deductions you didn’t enjoy as a renter. Any points (loan origination fees) paid is deductible. Mortgage interest, mortgage insurance (PMI), and property taxes are deductions that will save you money on your tax bill. Selling a home can result in a taxable capital gain if you didn’t live there two out of the last five years or if your profit exceeded $250,000 (single) or $500,000 (married filing joint). Ask your tax pro to analyze the bottom line and educate you on all the qualifiers to determine if your profit will be excluded from taxable income and if not, to learn how much you will owe so you can plan for it.
  3. Changes to your family structure can greatly affect your tax picture. If you marry, you gain another exemption. But you also gain this individual’s tax situation. It is always advisable to sit down with your tax pro to go over the pros and cons of filing jointly or separately and to determine the resulting tax liability if you were to combine your income and deductions. Having a child results in an additional exemption as well. Other tax benefits include the child tax credit and the dependent care credit. If you are in a low income tax bracket, you may receive a larger refund due to the Earned Income Tax Credit (EITC).
  4. If you went back to school last year, you will likely qualify for American Opportunity or the Lifetime Learning tax credits. If the schooling was in the form of continuing education to improve your current job skills, the costs associated with the training is deductible. Please note that any education costs to train you for a new position entirely are not deductible but if the education is pursued at a qualifying institution, you may enjoy one of the education tax credits.
  5. If you took an early distribution from your retirement plan, did you ask for taxes to be withheld? If not, review the numbers with your tax pro to determine the tax liability resulting from this transaction. Many people think that having withholding at the source automatically covers the additional tax liability but beware! This is not the case. Typically, the fund manager, upon request, will withhold 20%. But what if you are in a higher tax bracket? Not only that, but if you took the distribution prior to age 59 ½ and there are no exceptions to exclude the penalty, be advised that you can add another 10% penalty for early withdrawal. And don’t forget the state. If you live in a state that levies income tax you may be subject to state taxes and penalties as well. With the highest tax bracket at 39.6%, the tax liability including penalties could be more than 50% of the amount distributed to you.
  6. If you started or closed a business, I sincerely hope you ran straight away to your tax pro. If you are new to self-employment activities there is a lot to learn when it comes to pleasing Uncle Sam. The IRS Website provides plenty of information on this topic. Read up prior to visiting your tax professional. Not only will you receive free intel but you can subsequently compile a list of questions to pursue. Closing a business can result in a tax obligation. But generally if you are operating as a sole proprietorship, you needn’t worry about that.

Right now is an excellent time to contact your tax professional. Final extensions for the year were due October 15, so your tax pro has had time to unwind and is not enduring as hectic a schedule.  There is still time to implement a tax plan with the very little time we have left in this year.  Once you have that out of the way… Party on!

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© Taxpertise | Bonnie Lee, E.A. | Ph: 707.935.1755, ext 1 Fax: 707.938.1891 | 450 2nd Street West, Sonoma, CA 95476