Why Reducing Your Tax Refund is a Good Thing

With tax day fast approaching, many people are counting on receiving a big check back from the Government. While you’re probably looking forward to this windfall, there are reasons why you may wish to minimize your end-of-year refund.

Why Big Refunds are Bad

Taxes are refunded to you when the Government takes too much of your pay each pay period. By overpaying each paycheck, only to get the money returned to you once a year, you are essentially lending the Government money at zero percent interest.

This is money that could have been budgeted for and spent, or invested, throughout the year. Even if you had put the money in a savings account over the year, you still would be better off.

How to Minimize Your Refund

In order to adjust the amount that is withheld for the IRS each pay period you need to fill out/change your W-4 form.

The W-4 allows you to specify allowances or exemptions that you are eligible for.

These can include:

  • Donations to charitable organizations
  • Interest on a home mortgage
  • Interest on student loan debt
  • Contributions to traditional IRAs

The W-4 form estimates the amount that you would receive from a tax refund. This amount is then distributed over the number of weeks remaining in the tax year, lowering the amount withheld from your paycheck each pay period.

You should also look into filling out a new W-4 every time you have experienced a major change in your life. Examples of this include:

  • Switching jobs
  • Marriage
  • Having a child
  • Losing a dependent (They either file their own tax return, or you can no longer claim them)

While trying to lower the amount that is withheld in taxes each pay period generally makes sense, it may be prudent to not list all of the exemptions you are eligible for on your W-4.

Why You May Not Want to Claim all Your Allowances

While having too much in taxes withheld can be compared to lending the Government money at a rate of zero percent interest, the reverse is also true.

If you underpay in taxes each paycheck, you end up owing money to the Government. In theory this is great. You could put the money in a savings account, and then at the end of the year pay back the Government while pocketing the interest that you collected.

In practice however this is not a prudent strategy for most people.

Individuals have a tendency to spend money that they have, and forget about longer-term consequences of their actions. Additionally while receiving a refund at the end of the year is exciting, the opposite is also true.

This is why it may make sense for you to leave a few deductions you are eligible for unlisted on your W-4. This ensures that you receive a tax refund, albeit a smaller one, rather than owing money.

What to Do When You Do Receive a Refund

While this advice can be helpful for next year, chances are this year’s tax season will provide you with a large refund.

If you do receive a large refund there are a series of things you can consider to maximize its value. Here are a few ideas to get you started:

  • Invest in yourself – Sometimes the best investment you can make is in yourself. Consider buying a book or taking a class to help improve your performance in work or at life.
  • Get your will done – this can often cost less than a $1,000 in total but can save your beneficiary’s significantly more both in terms of money as well as headache
  • Put money into a college savings plan
  • Pay down your mortgage
  • Invest in a non-tax-exempt account – if you have already maxed out your IRA
  • Save for a rainy day
  • Open/add to an IRA
  • Pay off student loan debt
  • Pay off credit card debt – if you have any credit card debt, this should be an immediate priority
  • Save the money and increase your 401(k) contributions – put your money in a safe place such as a savings account, and bump up your 401(k) contributions to reflect the fact that you have this money sitting on the side.

Regardless of what you do with your tax refund, it is important that you come up with a plan. A trusted financial planner can help you in the process of creating one.

With over a decade’s worth of experience in the financial services industry Brad Sherman is committed to helping individual investors plan and prepare for retirement.

***

The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

If you have any questions regarding this Blog Post, please Contact Us.

A New IRS Withholding Tax Calculator Eliminates the Guesswork

Last week, in response to confusion surrounding the 2018 tax law that was passed in December, the IRS released an updated online Withholding Calculator. The tool is designed to help taxpayers make sure they are not wildly underpaying or overpaying what they will owe.

The new law is highly complex and made changes that included increasing the standard deduction, removing personal exemptions, increasing the child tax credit, limiting or discontinuing certain deductions, and changing the tax rates and brackets.

The online calculator should go a long way to help employed taxpayers plan ahead, particularly those in middle-income and upper middle-income brackets.

This is important because you don’t want to be withholding too much –in effect giving the government a free loan of money you could be investing in your home, the market, educational savings funds, or just your day-to-day needs. On the other hand, you don’t want to be withholding to little and risk facing an unexpected tax bill or penalty at tax time in 2019

According to the IRS some of the groups who should check their withholding are:

  • Two-income families
  • People with two or more jobs or seasonal work
  • People with children who claim the Child Tax Credit (or other credits)
  • People who itemized deductions in 2017
  • People with higher incomes and more complex tax returns

According to Acting IRS Commissioner David Kautter, about 90 percent of taxpayers would have “some adjustment one way or the other” to the amount they are withholding. That’s most of us.

The changes do not affect 2017 tax returns due this April. Your completed 2017 tax return can, however, help you input data to the Withholding Calculator to determine what you should be withholding for 2018 to avoid issues when you file next year. And if you do need to change the amount you are withholding (remember- 90% of us might), there is also a new version of the W-4 form to download and submit to your employer.

More information is available from the IRS here: Withholding Calculator Frequently Asked Questions.

And if you have questions about how these important changes may affect you, please call us for a free consult or reach out to your CPA.

How to Make “Cents” of the Changes to 529 Plans

Are you saving for your child’s education with a 529 account?

If you are already contributing to a 529 plan, reduced deductions in the new 2018 tax law mean you may want to increase your contributions – or even create a second 529 account – to offset higher state taxes.

If you haven’t yet opened a 529 account, this year’s important changes in tax and 529 regulations have made 529 accounts an even more valuable option for parents of school-aged or college-aged children.

Here are the changes and why contributing to a 529 account is more important than ever:

K-12 Tuition is Now Covered by 529 Plans

529 plans were originally created to let you to save and invest for your child’s college education – while paying no federal tax on qualified withdrawals. The good news is that benefit has now been expanded: you’ll be able to withdraw up to $10,000 per year per student for elementary, middle, and high school tuition if your child attends or will attend a private or religious school. And, if you’ve already been saving for K-12 with a Coverdell ESA, you can also rollover that account to a 529 plan without tax consequences.

Saving by Off-Setting State Taxes

The new 2018 tax law limits deductions for your state income and property taxes to $10,000, so you might find yourself paying more state tax this year. But if you live in one of the 34 states that offers a state tax deduction for contributions to a 529 plan, you can lower your state taxes by contributing more to your 529. In most states you have to be enrolled in one of that state’s own plans to take the deduction, but several allow you to deduct contributions from any state plan. And, if you live in one of the several states whose 529 plans include state tax credits, you could also find yourself paying considerably less.

Turbo Charging the Benefits for Younger Children

529 plans allow “front-loading,” a term for making up to five years of contributions at once. This not only allows you to “catch up” for a child already in elementary or secondary school, it also allows you to maximize state tax deductions or credits. And anyone can make contributions to your child’s 529 plan. Friends and relatives can each contribute up to $15,000 per recipient, they can also “front-load” up to five years of contributions as well, maximizing their own tax savings. Additionally, if they make direct payments to services provided for beneficiaries’ tuition or medical expenses, these expenses would be tax-free, even though the costs surpass the annual gift tax exclusion.

New Benefits for Special Needs Students

The new tax law allows assets in 529 accounts to be transferred to ABLE accounts without any penalties as long as they are transferred by 2025. ABLE plans – named for the Achieving a Better Life Experience Act – are designed to provide tax-favored savings for people with disabilities without limiting their access to benefits such as Medicaid, Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). The annual contribution cap for ABLE plans is $15,000 and an account can reach $100,000 without affecting SSI benefits. You can also make tax-free withdrawals when paying for expenses such as housing, legal fees and employment trainings.

Plans Can Be Transferred to Another Child

If you no longer need the account for the child it was created for, you can change the plan’s beneficiary to another family member, saving you the income tax on 529 earnings and 10% federal penalty you pay if you withdraw money for non-educational purposes.

The Bottom Line

Every parent – and grandparent – should consider opening one or more 529 accounts for their children’s education. There is no limit to the number of plans you can contribute to, or the number of accounts that can be opened for any child, so study up to determine which plans make the most sense for you. But remember: each state’s rules are different so – like your kids – you’ll want to do your homework.

Then, as with all smart savings plans, contribute on a regular basis over time, through market ups and downs, to benefit from dollar cost averaging and watch your interest compound – and your child’s educational opportunities grow.

 

For how the new tax law affects the “Kiddie Tax” for Uniform Gifts and Transfers to Minors (UGMAs and UTMAs) please click here.

At Sherman Wealth Management we’re passionate about children’s education so please give us a call if you have any questions about your state’s 529 options.

A version of this article initially appeared on Investopedia.com

 

 

How Will The Proposed Tax-Plan Affect You?

On Wednesday, the Trump Administration released their nine-page tax plan titled “United Framework for Fixing Our Broken Tax Code.”  That’s a mouthful.  The full text of the plan can be found here.  So how will the proposed tax-plan affect you?

The reviews are in, and they suggest that while the plan is considered “finalized,” there is still a high level of uncertainty and vagueness in the plan that makes it difficult to assess how it would impact the average American.  

Some have suggested that President Trump and the Big 6 (Gary Cohn, Steve Mnuchin, Mitch McConnell, Sen. Orrin Hatch, Paul Ryan and Rep. Kevin Brady) might not have learned as much as they could have from the failure to repeal and replace the Affordable Care Act, which arguably was defeated due to a lack of clear details and shortage of bipartisan support.  In a repeat tactic, the push for passing the bill under “budget reconciliation” would require only a simple majority in the Senate to pass the law.  But it should be noted that this can only happen if projections show that the total revenue differential over the next 10 years is $1.5 trillion or less.  Right now, projections place it at $2.5 trillion over the next 10 years.  That means the GOP will either need bipartisan Senate support with 60 votes or find $1 million in reduced projections.  

Here are some of the highlights of the proposed plan and how they could impact your personal income taxes if they should be passed:

  1. Fewer Tax Brackets – Instead of the seven tax brackets we face today ranging from 10% to 39.6%, the new plan proposes only three: 12%, 25%, and 35%.  Because the plan does not specify where these cut-offs will be, though, we can only speculate on how these will impact individuals positively or negatively.  If speculation is correct, those currently facing 28% and 33% tax rates would see a tax cut to the new 25% rate, which would be beneficial.  The idea of adding a fourth bracket for the wealthiest Americans has also been floated. 
  2. Doubles the Standard Deduction, but Eliminates Personal Exemptions – The marketing tactic for the bill is that it is a huge break to middle-class Americans by doubling the standard deduction from $6,350 to $12,000 for single filers and from $12,000 to $24,000 for joint filers. 

    There is a catch, though.  These increases are being offset by the elimination of personal exemptions. The result is what seems like a 50% increase to most taxpayers, in reality, is closer to 15%. 

  3. Reduction of Elimination of Itemized Deductions – If in the past you have chosen to itemize your deductions, you could be getting the short end of the stick here.  The plan calls for reductions or elimination of many itemized deductions, without providing specifics on which ones.  It has only been stated that they will keep the deductions for home mortgage interest and charitable contributions.  It also mentions benefits that encourage work, higher education and retirement savings, but provides no details on these. 

    The largest red flag for many is concerning the elimination of state and local tax deductions.  Currently, you can deduct what you pay in state and local taxes from your federal income bill.  If this is eliminated, it could disproportionately affect those who live in high-tax states such as Connecticut, New York, New Jersey, California, and Maryland.  Only two days after the plan was released, objections from Blue-state Republicans have caused them to reconsider eliminating these deductions.

    Additionally, homeowners or anyone paying real estate taxes will see that their property taxes are no longer deductible under the new plan.  Again, this will have a disproportionately large impact for those living in states with high real estate taxes.
    Below is a breakdown of what the new and old tax brackets could look like for single filers:
    Source: Business Insider 

  4. Changes for Families– There may be some significant changes to the tax code surrounding families as well, including single parents and households with two or more children. 

    Currently, single parents fall into a favorable tax bracket somewhere in between single and married-filing-joint rates as well as a 50% boost to their standard deduction.  The new plan would likely eliminate this, meaning single parents could face higher rates.That being said, these cuts could potentially be offset by an unspecified “significant increase” to the Child Tax Credit.  Depending on the size of this Child Tax Credit, households with a two or more children could also see increased rates because of the elimination of the exemption based on the number of children.

  5. Eliminates the Death Tax and Alternative Minimum Tax – The estate (“death”) tax only currently applies to 0.14% of Americans, whose assets exceeded $10.9 million and did not hire a competent estate planner.  So this likely does not affect you, but it would be eliminated under this plan. 

    The alternative minimum tax forces those who have an outsized number of deductions to pay an alternative tax rate instead.  The truth is, very few people understand it anyway.  This is likely a good thing, especially if the goal is simplicity.

  6. Small Businesses, including ours! – In terms of small-business owners, there is a whole separate set of changes to be considered.  For ‘pass-through’ businesses like ours, the plan wants to lower the maximum rate from 39.6% to 25%, which is particularly appealing to making smaller firms more competitive. 

    Questions still surround this due, though, to Steve Mnuchin’s vague statements regarding limitations on what types of businesses will get this lowered rate as well as how they will distinguish between personal income and business income.  Additionally, many have pointed out that nine in 10 businesses that pass through their income already pay at the 25% rate or less, meaning this change could be ultimately inconsequential. 

    For larger corporations, the plan proposes lowering the tax rate from 35% to 20% and a one-time repatriation of overseas assets at an unspecified lower rate.   

 

If you have any questions related to your specific situation, don’t hesitate to contact us here.  We will keep you updated as more developments are made and the plan evolves.  

 

***

The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions.  They are for information purposes only. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

If you have any questions regarding this Blog Post, please Contact Us.