By the time you’re gathering your paperwork to send to your tax preparer, it’s probably too late to do much to change the outcome. You may owe the government a lot, a situation no one likes to be in. Or, you may get a lot back. That’s certainly more fun, but it does mean you’ve essentially been giving the government an interest-free loan all year. In fact, the goal is to more or less break even each year, and to do that, you have to start planning now.
Form W-2 workers
If you’re a salaried employee and all or most of your income comes from your job, your tax situation is relatively simple: Your employer must withhold taxes based on information you provide to them on a Form W-4. Your state may have an equivalent form for state income tax. Your responses depend on multiple factors, and a working spouse, for example, can complicate the situation. It’s a good idea to get advice from a tax professional.
Form 1099 workers
If you work freelance, you’ll get a Form 1099 instead of a Form W-2. Your clients have to give you this official statement of all the money they paid you in a given year. The big difference is that unlike a standard employer, your clients are NOT taking out income tax and other required deductions from your payments. But that doesn’t mean you’re exempt! You still have to give the government its due, typically on a quarterly basis.
It can be tricky to figure out how much to pay. Maybe your first quarter is so quiet you spend weeks just updating your Facebook page, while in the second quarter your clients suddenly keep you busy 12 hours a day. This is why it’s essential that you keep good records and stay in touch with your tax pros throughout the year. What if you have a standard employer and a side gig as a freelancer? It’s perfectly legal but extra complicated — the government will consider all sources of income in deciding how much you need to pay.
Retirement income
Social Security is often the main, and sometimes the only, income retirees have. And it is taxable — up to a point. If your income is below a certain level, Social Security is income tax-free. Even at the highest levels, only 85% is taxable. What about other retirement income? Income from a standard IRA is taxable. (If you have a Roth IRA, you’ve already paid the taxes.) Pension and 401(k) income is taxable. If you’re transitioning into retirement, it is essential you talk to your tax adviser. New income sources may be taxable, but as taxpayers often have less income in retirement, you may be in a lower bracket.
Other situations
Let’s say you have the proverbial rich uncle who left you a $1 million inheritance. You have it all in a stock portfolio, and you periodically sell securities for a Mercedes or a trip to Fiji. If you sell stocks at a profit, you may face a long-term capital gains tax. Most of us will pay 15%, although if you have a substantial income, it can rise to 20%. (Short-term capital gains may turn out to be even more expensive.) Keep track of these sales — they’re another source of income as far as the government is concerned. Your broker will need to send you a form each year.
So that’s it, right? Not even close! These are just some common examples. Taxes are complicated, especially when these sources overlap each other. For example, you may be collecting a pension and Social Security while working 10 hours a week. Maybe you’re retired but your spouse is still working. The point is that you need to create a tax strategy now, so next year goes smoothly. So breathe a sigh of relief for this year — and then get on the phone to your tax adviser to prepare for the future.
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