As we get into the 2021 tax season, you may have already started thinking about having to file your taxes. But whether or not you plan to file early or wait until closer to the deadline, you probably already have a few things on your mind. Will you end up owing the IRS money? Did you earn too much to qualify for a certain tax credit? Or did you earn little enough that you dropped down a tax bracket? Questions abound. Regardless what is on your mind regarding your financial situation, we can just about guarantee one thing: You want to avoid a tax bill.
Nobody wants to owe their state or the IRS money come tax season, but it happens each and every year to millions and millions of taxpayers. And with extra uncertainty in 2020 surrounding income and economic relief, you might find yourself in a tax season that looks more unfamiliar than ever before.
We deal with relieving tax debt each and every day, which means we’ve experienced more than our fair share of tax debt horror stories. From our perspective, the last place you want to find yourself is staring down an unexpected tax bill once Tax Day rolls around.
That tax bill only results in two possible scenarios:
In our opinion, you don’t deserve either of these scenarios. Nobody deserves tax debt, and nobody deserves to feel overwhelmed, strained, stressed, or anxious about how to scrape together money to pay a sudden bill. So we’re here to help you avoid a tax bill this year—and every year after.
For most taxpayers, avoiding a tax bill really isn’t that challenging a task. But like everything to do with your finances, it takes careful planning and forethought to come out ahead. So we’ll walk you through all the tips you need to maneuver through the typical traps and pitfalls that lead to tax debt. And fortunately, if you follow all (or some) of these tips, you won’t just help yourself avoid a tax bill. You might even end up with a tax refund.
For many taxpayers, the W-4 presents the single greatest influence on whether you owe taxes at tax time. Because your W-4 affects your taxes all year long.
As you probably know, you fill out your W-4 with things like whether you’re married and how many children you have. That kind of information applies directly to your taxes, because it tells your employer how much they should withhold from your paycheck and send to the IRS.
The problem most people have? They forget to update their W-4 when they should. For example, if you finalize a divorce six months after starting a job, you’ll start filing as single again—rather than as married. Or if you welcome a baby into the family or a senior parent moves in, you may add a dependent.
While many life changes can save you money on your taxes, others do just the opposite. And if your filing status doesn’t align with your W-4, your employer may have withheld far less of your income than you’ll actually owe. Over the course of a full year, that small difference could add up to thousands of dollars.
So make a habit of checking your W-4 and updating it regularly, and do it any time you have a significant life event—like a marriage, divorce, death, or birth. You can do this any time you want through your employer’s finance or HR department. An updated W-4 means no surprises at tax time. And no surprises at tax time mean you can avoid a tax bill.
In an ideal world, every single taxpayer would know exactly which tax credits apply to them. In reality, very few actually do. Unfortunately, this lack of awareness can result in a tax bill.
And that puts an undue financial burden on folks who might already experience some financial stress on a regular basis. Millions and millions of households have access to money-saving tax credits like the Lifetime Learning Credit and the Childhood Tax Credit. These and dozens of others specifically target families, veterans, and those working toward a degree or taking ongoing classes.
And depending on the type of credit, some of these tax credits can not only eliminate your tax bill, but they may also help you reach into the tax refund range. So they don’t just represent savings and the elimination of your tax bill. They can represent money back in your pocket when it comes time to file.
So, seek out new tax credits. And if you don’t know if a credit applies to you, call a tax expert for extra assistance.
Speaking of tax credits, you need to get to know the American Rescue Plan if you want to avoid a tax bill on your 2020 tax return. While many will focus on the stimulus payments going out to taxpayers earning less than $70,000, scaling back to an $80,000 threshold.
Specifically, you should look out for—and take advantage of—the expanded child tax credit. The child tax credit, which previously rested at $2,000 per child, now can climb as high as $3,600 for the 2021 tax year. While this won’t lower your tax bill for 2020, it may help you to avoid a tax bill next year.
Previously, the IRS only refunded the credit up to $1,400. So if you owed $0 in taxes, the IRS would only credit you in a refund up to that amount. However, the American Rescue Plan eliminates that limit; now you can take the entire credit as a tax refund.
Per usual, the plan intends the tax credit for lower and middle income families. So it phases out at these thresholds:
The upper limits for the credit? $200,000 for individuals and $400,000 for married couples. Plan for 2022 with this knowledge and use it to your advantage. With the proper planning, parents can not only avoid a tax bill but earn a solid tax refund.
For many looking to avoid a tax bill in 2021, they might look to their trusty old friend in deductions. However, deductions don’t quite have the same impact they used to, which requires some advanced planning to counterbalance.
Let us explain. As you may know, when you file your taxes, you can either choose the standard deduction or to itemize your deductions. If the deductions you take exceed the value of the standard deduction, then you can itemize your deductions and take that value. This gives some savings to everyone who files, while allowing for extra savings for those who have more of certain types of expenses.
The 2017 Tax Cuts and Jobs Act raised the value of the standard deduction. However, that had the effect of making the itemized deduction less accessible to a majority of tax filers. Because the standard deduction is higher, you must have more qualifying deductions to leap over that hurdle. And many low or middle class taxpayers don’t have the deductions to do that.
However, with the right planning, you can still take advantage of the itemized deduction and avoid a tax bill. If you have a mortgage or pay student loans, you pay interest regularly—all of which you can deduct. These big ticket deductions can pave the way to crossing that threshold, especially if you add things like sales tax on car purchases and trips to the grocery store throughout the year.
If you freelance or own a small business, your taxes work slightly differently than those who work for an employer, large or small. And if you work for yourself, you still want to avoid a tax bill.
For employees, an employer will withhold taxes on every paycheck. Then they pay these withheld income to the IRS and your state on a quarterly basis. Once per year during tax season, you file your taxes and share your expenses with the IRS. They either give you a refund after determining you withheld too much of your income, or they determine you withheld too little income, and you pay them the difference. That second you may know as a tax bill.
For the self-employed, you have the responsibility of estimating and paying your taxes on a quarterly basis. You pay quarterly, and then once a year you file your tax return and determine with the IRS whether they owe you, you owe them, or everything is square.
When you fail to save and pay your taxes quarterly, you can end up with accruing interest on your taxes or a big tax bill at the end of the year that you haven’t prepared for. Avoid a tax bill you can’t cover by paying your quarterly tax payments on time and in full.
While some taxpayers earn all their money from one job, or for joint filers, two, that reality doesn’t apply to most people in 2021. Instead, many find themselves with additional income streams both large and small, and keeping track of them can help you avoid a tax bill.
Income can come from all sorts of places. You may work multiple part-time jobs. Or you work one full-time job during the week and a part-time job on nights and weekends. You may Uber or run Instacart orders for extra spending cash, or you own an Etsy shop to sell the art you make on weekends. Having a podcast might earn you money from ads or Patreon supporters. Perhaps you’ve purchased a rental property and earn rent from tenants or Airbnb guests. And maybe you spent some time unemployed and collecting state or federal unemployment insurance.
Amidst the complexity of 2020, more people than ever found themselves with diversified and changing income streams. And when you’ve earned money from three or four different avenues throughout a year, it can be easy to forget one when filing your taxes. But forgetting can lead to an unexpected tax bill, or worse, an audit. Instead, avoid a tax bill or audit by making a list of all your income streams before it’s time to file.
One big ticket item that can lead to a tax bill: lottery or other prize winnings. And while you may not like the thought of it too much, you should absolutely estimate and set aside that money if you want to avoid a tax bill later on.
Because of their size, the IRS and states typically tax large cash prizes, annuities, or gambling sums at a high rate. And if your prize winnings came from an out-of-state trip, perhaps to Las Vegas or Atlantic City, you may also owe taxes an an additional state.
Of course, a significant temptation exists to think of that money as all yours and start spending right away. But as tends to happen with lottery winners, the overspending up front will come back to bite you later on. And if the IRS comes knocking and you haven’t planned for them to take a cut, you may find yourself with a tax bill you just can’t handle. Tax levies, wage garnishments, and bankruptcy happen to “winners” all the time.
Instead, if you find yourself the lucky recipient of a cash windfall, start by reaching out to an expert tax team or a CPA. They can help you estimate your state and federal taxes and put that money aside so you won’t run into any surprises later on down the road. And the plus side? They might help guide you toward other smart financial moves you can make. That way, your life-changing win can truly remain life changing.
2020 was the year of remote work. And while many workers simply moved their offices to a virtual home setup, others took the opportunity to move out of their state or quarantine with family elsewhere in the country. However, this trend has left many with unexpected tax obligations they didn’t expect.
Avoid a tax bill by learning the laws of remote work in your state. We’ll go into this further in a later blog, but here are the basics. You’ll always need to pay taxes in the state in which you live and your employer exists. So if you live in California and work at a tech company, you will pay taxes in California. However, if you performed that work for 6 months in Illinois, you will need to file a tax return in Illinois.
Exceptions abound. For example, some states don’t tax income at all. Some states have agreements with other states and will provide you a credit so you don’t owe two states taxes. But other states aggressively target remote workers. The best way to avoid a tax bill you weren’t expecting is to understand the laws of remote work in your home state—and the state you worked from in 2020—and plan accordingly.
To avoid a tax bill, you can also make timely contributions to your retirement accounts. While this falls into the general bucket of “tax deductions” as we discussed earlier, we believe it holds enough difference to stand on its own. Your retirement contributions can ultimately contribute to lowering—or altogether—eliminating a tax bill you might otherwise expect.
If you have an IRA, you can deduct your contributions year round. Not only with this allow you to save and grow your wealth for retirement, but it will also help you in the moment when offsetting your income. For 2020, you can contribute $6,000 to your IRA (or $7,000 if you’re 50+ years old). And while setting a regular contribution schedule may help you to better plan ahead for your savings, you can contribute that total all at once. If you think you’ll face down a tax bill, this can come in handy.
Of course, some contribution limits can affect how much of your contributions will qualify for your deductions. For the 2020 tax year, the IRS takes into consideration any retirement plans you may have at your work. As far as single or head of household filers are concerned, adjusted gross incomes (AGIs) up to $65,000 qualify for full deductions up to your contribution limits. For joint filers, AGIs up to $124,000 qualify. If you have some additional savings around, contributing to your retirement makes for a great way to avoid a tax bill.
For various reasons, you may still end up with a tax bill—small or large. Things happen, people make mistakes, and you can’t always anticipate what life has in store for you. But the last thing you want to face down is a tax bill you can’t pay.
If your best laid plans don’t prevent you from owing some money to the IRS or your state, that’s okay. You just need two things:
One a tax bill transforms into tax debt, it begins accruing interest and penalties each and every month. That is the primary mechanism behind mounting tax debt. Somebody owes $200 but fails to or can’t pay, then interest and penalties stack up.
Avoid a tax bill becoming unwieldy tax debt by filing your tax return early. If you’ve taken the right precautions, you probably won’t owe anything! But if, for some reason, you do owe taxes to the IRS or your state, filing early gives you a chance to figure out payment before it’s too late. Scraping together $500 in one day may be annoying at best, but impossible at worst. Pulling together $500 over a month and half? Much more doable.
Don’t allow a tax bill to ruin your tax season. With the right moves now (and throughout the year), you can avoid a tax bill entirely. Or you can ensure that the tax bill doesn’t turn into a tax debt you can’t entirely manage, and one that haunts you for months—or years—to come.
Regardless the time of year, you should always make an effort to strategize how to save yourself on your taxes. With these tips, you can do just that.
It shouldn’t take tax season to make it a priority. But when you do prioritize it, you give yourself a great advantage. You can avoid a tax bill, reduce your tax bill, or even end up with a refund. And you’ll totally avoid the dangers of mounting tax debt. And isn’t that what we all want?
Regardless of your tax situation, you may find yourself in need of an experienced team of tax experts. We can help you avoid a tax bill on your next tax return, or reduce or eliminate your current tax bill. Get in touch with us today free with our live chat.
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