Best Practices for Tax Withholding, Allowances, and Payments

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By Karen Harris, CFP®

How did your 2018 taxes end up? Did you get a refund or owe money? Was the outcome significantly different than 2017?

One thing we often hear from clients is that they want to avoid surprises—that’s one of the many reasons they decided to partner with our team of Personal CFOs. We have compiled some tips to help you reduce the likelihood of owing a significant tax payment or, even worse, facing a penalty for underpayment. 

Simple Filers: Tax Withholding and Allowance Calculator

Who is considered a simple filer? Simple filers are W-2 employees with standard or itemized deductions.

For simple filers, one of the best resources to access is the IRS Tax Withholding Calculator. Make sure you have your most recent paystub(s) and/or any itemized deduction information readily available (i.e., medical expenses, mortgage statement, property taxes, and charitable giving). If your itemized deductions tend to remain consistent year over year, your 2018 tax return will provide for solid estimates.

Remember that property and income taxes tend to increase each year (the maximum combined tax deduction is now $10,000) and mortgage interest tends to decrease. Also, note that your home equity interest may not be deductible. You can reference the IRS website for a quick guide to deductibility of interest on home equity loans.

Estimated Payments

Estimated payments are due in the quarter the income was received. Using IRS Form 1040-ES, taxpayers can calculate their estimated tax liability based on estimated income. These payments are due April 15, June 15, September 15, and January 15 the following year.

One thing we hear from clients is that they want to avoid surprises—in fact, it’s one of the many reasons they decided to partner with a Personal CFO.

You can make tax payments through required minimum distributions of individual retirement accounts (IRAs). Individuals can choose to withhold high percentages of these distributions for federal and/or state payments to reduce quarterly tax payments throughout the year. It can be a seamless, easy way to meet estimated payment requirements.

So, I owe taxes. That just means more money in my pocket throughout the year! Should I care?

Yes! Did you know that the IRS Federal Underpayment Penalty interest rate increased to six percent in 2019? There has been a three percent increase since 2015. When you are earning more in your online savings account, it likely means you will also pay more when it comes to interest. As the amount you owe grows, so does the penalty.

To avoid a penalty, withholding and/or estimated payments must equal the smaller of:

  • 90 percent of your tax liability for 2019
  • 100 percent of your 2018 tax liability (110 percent for those with income > $150,000)

In 2018, these limits were lower due to the first year of the new tax law enacted at the end of 2017. You may have a penalty waived in cases involving a casualty, disaster, or other unusual circumstance. If your tax bill is less than $1,000, you will also avoid the penalty.

Don’t forget these sources of income when estimating tax withholding or payments

  1. Social Security: While not taxable in the state of Oregon, up to 85 percent of your benefit may be taxable for federal purposes depending on your total income. To see where you stand, view the full breakdown published by the Social Security Administration.
  2. IRA Distributions: Did you just reach age 70 ½ or inherit an IRA? Getting your tax withholding close on required minimum distributions from the start can save you a headache on the back end.
  3. Pensions: Tax withholding can be adjusted using Form W-4P.
  4. Self-Employment: Due to variance in income, self-employment is where we see underpayment penalties most frequently. Working with a knowledgeable tax preparer throughout the year will save you sleepless nights and reduce stress in the future.
  5. Investment Income: As markets change, your tax liability may be changing as well. You can strategically plan for year-end capital gains distributions if you hold investments inside funds. Do you have losses you can carry forward? Be aware of capital gains, interest and dividends inside your investment accounts.
  6. Pass-through Income: You may receive income from a partnership, LLC, S corporation, or trust, even if you did not receive cash distributions during the year. This income may increase your total tax liability.

Of course, these are just a few best practices to mitigate the uncertainty that comes with tax planning and preparation. If you have questions about your specific situation or want to ensure your portfolio is being managed proactively for tax minimization, reach out to our team for help today.

Karen Harris, CFP® serves as an advisor at Brighton Jones.

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