A surprise birthday party is a welcome treat. A surprise on your tax bill? Not so much.
To avoid any unwelcome surprises, it’s important to be as prepared as possible when it’s time to file your taxes.
Why tax surprises happen (and what they mean)
Your yearly tax bill (and your refund) can grow and shrink for many reasons, resulting in a surprise at tax time.
Things that can affect your yearly tax bill
A variety of factors can impact how much you owe, including:
Under-withholding
Self-employment income
Changes in tax laws
Unreported income like tips or money earned from a side gig
Life changes like getting married, having a child or buying a home
Penalties and interest
Reasons why your tax refund could be lower (or your tax bill higher) than expected
Tax surprises usually happen when too little is withheld from your paycheck or when a major life change occurs during the tax year. Existing debts can also affect your tax refund, such as overdue tax debts, owed child or spousal support or payments due on government loans.
Take note if you’re self-employed, as you may owe significant amounts if your self-employment tax isn’t budgeted for.
Read more: Do more with your return with Ally Bank’s smart savings tools
Learning from last year’s tax return
Take the time to review your tax return in detail (especially if you prefer to use an automated software to prepare your taxes). If you’re self-employed, you’ll get a sense of whether your estimated payments were on target. And for this year’s return, take note of deductions you missed last year or credits you no longer qualify for that will affect your bill.
Simple steps to avoid tax surprises all year
Avoid sticker shock with these six tips:
1. Understand your tax obligations
Your tax liability is the amount of taxes you owe, which includes income taxes on earnings and capital gains taxes when you sell certain types of assets that increased in value. Understanding what you owe taxes on can help with budgeting and maximizing deductions or credits.
2. Know your tax bracket
Tax brackets determine the rate at which you’ll be taxed, based on how much you make in taxable income. Since the IRS adjusts tax brackets every year, it’s important to stay up to date on where you fall.
3. Familiarize yourself with tax deductions and credits
A tax deduction is an expense you can subtract from your taxable income to reduce your overall tax liability. These include things like:
Charitable donations
Medical expenses
Health insurance
Educational expenses
State and local taxes
If you qualify, credits can also reduce the amount you owe. Credits are valuable in that they reduce taxes dollar for dollar, unlike deductions. Find which deductions and credits you’re eligible for on the IRS website.
4. Adjust your withholding
Withholding is the amount of tax withheld from your paycheck. This amount depends on:
The amount of income you earn
The information you provide on your W-4 or other withholding document per the IRS, including filing status and withholding allowances
You can, and should, review your federal withholding each year to ensure you don’t have too much or too little tax withheld, especially if you recently went through a salary change.
Tax surprises usually happen when too little is withheld from your paycheck or when a major life change occurs during the tax year.
5. Estimate your tax payments
Online calculators or tax professionals can help you accurately estimate your tax payments. Review your estimated taxes throughout the year to get a sense of how your bill may change.
6. Keep accurate financial records
When it’s time to file, you might have dozens of documents and receipts to report. Maintain a record of income sources, expenses and charitable contributions and scan or photograph your financial documents to stay organized. The IRS provides a helpful list of items to gather on its website.
Employ professional help to avoid tax surprises
It’s okay to be overwhelmed by navigating tax laws. Professional help could be the key to getting through tax season without any surprises.
Consult a tax advisor
A certified tax professional could help you save money and time while giving you peace of mind. Since it’s their job to stay informed on tax regulations, they can answer any questions you have and ensure you get all the deductions or tax credits you are eligible to receive.
Use tax preparation software
You can leverage tax preparation technology to streamline the filing process and save money. When deciding which software is best for your specific tax situation, consider cost, ease of use and live support capabilities.
No more sticker shock
While taxes are inevitable, a surprise tax bill doesn’t have to be. By understanding your tax obligations and leveraging strategies to prepare, you can help anticipate a predictable tax season.
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