Today is Tax Day.* Hopefully by now you have filed your taxes and paid all your taxes. Maybe you paid them all in advance through paycheck withholdings and/or estimated tax payments and received a refund, or maybe you had to pay a balance due today. Either way, tax season is over, so now it is time to consider how to do better next year. If you simply hope for the best each year and are grateful if you do not owe, now is the time to start being intentional.
There is no one-size-fits-all approach. As I discussed back in February, receiving a tax refund is not necessarily ideal. In a perfect world, you could predict your expected tax liability with 100% accuracy, pay exactly that much throughout the year, and file a tax return with no refund or balance due. You will likely not achieve perfection, but you should still try!
Your starting point for determining your 2023 tax burden is your 2022 tax return. Then, list any changes that have already happened this year or are on the horizon. Here are some questions to consider:
Is your family unit going to see changes? Will you get married or divorced? Take in an aging parent or other relative? Adopt a child? Will a child attend college or leave home?
How will your income change? Do you expect to switch jobs? Earn more money? Earn less money?
Are you going to start a side venture? Cash out stocks? Withdraw more or less from your retirement account?
How will your expenses change? Do you anticipate fewer medical expenses? Will you pay off your mortgage? Donate more to charity?
Will you likely qualify for any tax credits? This may be the same child tax credit you have been claiming, or perhaps you are adding solar panels to your house.
What changes will you make to your retirement investments? After all, the limits have changed from 2022, so now is a good time to revisit your retirement strategy! Because of the amazing power of compounding, even small changes can make a big difference over time.
This list is not exhaustive, but you get the idea.
Once you have your best estimate of how 2023 will differ from 2022, you can figure your expected tax liability. Next, use that figure to determine whether you need to make adjustments to your tax payments. Should you be paying more? Should you be paying less?
If you need to make adjustments to your paycheck withholdings, complete a new Form W-4 and give it to your employer. You will need to submit a state version as well if you want to make changes to your state withholdings. The IRS even has a tax withholding estimator tool that you can use to help you along the way!
The key here is to make small changes that will add up over time. If you owed $3,000 in taxes, paying an extra $250 per month is probably easier than forking over that balance due in a lump sum at the deadline. (Whether you pay that money directly to the IRS – perhaps through increased paycheck withholdings – or to yourself in a high-yield savings account is a separate question, but either way you are setting it aside.)
If you are already close to breaking even, but just want a little bit of wiggle room so you can breathe easier, and your 2023 situation is likely to be similar to 2022, I recommend that you leave your tax payments as they are now, and set aside some extra funds each month (or after each paycheck) in a dedicated high-yield savings account. (The easiest way to do that, of course, is to open the account and then schedule automatic transfers.) That way, you do not need to go through the hassle of updating your paycheck withholdings with your employer, you make that extra money work for you all year, and you will be able to withstand a worse result. For example, if you set aside $3000 total throughout the year and owe $1,200 when you file your 2023 return, that is the same as receiving an $1,800 refund!
Another way to maximize your tax return results that is often overlooked is recordkeeping. Every year I have dozens of people tell me that they “donated a bunch of stuff but did not keep records.” Keep records! Get into the habit of asking for a receipt, and set up a file system that is easy to maintain. That last part – easy to maintain – is crucial; otherwise, it will probably fail. Maybe that means simply having a folder marked “donation receipts” where you deposit them. Then, they are all in one place at the end of the year and you can quickly add them up, and they are available should you ever need to document the expense. Or download an app on your phone that turns it into a scanner (DocuScan and CamScanner are good options, but there are others out there as well) and then upload the receipts into a dedicated DropBox folder.
Another example related to recordkeeping is tracking your business miles if you are self-employed. (If you are an employee and get reimbursed for business miles, that is not taxable but you definitely want to make sure you are getting the full extent of this benefit!) Business miles can be a substantial deduction, but there are rigid IRS rules you must follow. The easiest way to rack your business miles is usually to download a free app for your cell phone that will handle this for you and generate reports as requested. Just press start and stop in the app at the beginning and end of each trip (whether one or 1000 miles), and the app does the rest.
There are as many other possible examples where better recordkeeping can improve your tax results as there are tax deductions: child care, elder care, energy-efficient home improvements, and perhaps even car registration fees (depending on your state), just to name a few. You get the idea.
This year, move away from simply hoping for the best when you file your taxes. Take charge and be intentional.
* Tax Day is normally April 15 every year. Since April 15 fell on a Saturday this year, the deadline moved to the next business day. However, yesterday (Monday, April 17) was Emancipation Day in the District of Columbia, and local holidays in the District of Columbia impact federal tax deadlines. Emancipation Day falls on April 16, but since that was a Sunday this year, it moved to the next business day. Be aware, though, that the extended due date resulting from weekends and holidays only applies if you actually file and/or pay by that extended date. If you still owe taxes or have not filed, penalties and interest accrue from April 15 onward, and any automatic extensions run from the original April 15 due date.
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