It’s November, which means that there are only about five months until Tax Day. It may seem like a lifetime away, but it’s really just around the corner.
And if you think you’re going to owe money on your taxes this year, you only have a few months to start setting savings aside to pay that tax bill.
Here are the top 7 reasons why you should set money aside for taxes in the 2021 tax season when it comes down the pike next April.
If you got a raise or started a new job at a higher salary this year, congratulations! Although many Americans suffered career setbacks this year, some folks managed to negotiate their way to higher pay. In fact, employers expected worker compensation would grow by an average of 2.9% in 2020, according to WorldatWork’s 2020-2021 Salary Budget Survey, conducted starting in May this year.1
When your pay increases, so do your taxes. But unless your raise boosts your income into a new tax bracket, you probably don’t have to worry too much about a major tax increase. However, it’s still a good idea to check your withholding levels on your W-4. If you’re withholding too little, you could owe the IRS.
Many Americans received some form of unemployment benefits this year. But it’s important to understand that unemployment benefits are not “free money.” If you are currently receiving these weekly benefits, or previously cashed these checks, you may need to take steps now to avoid a nasty surprise come tax time.
Unemployment benefits are considered taxable income, even the $600 boost that was in effect until the end of July. While you don’t have to pay Social Security or Medicare taxes — typically about a combined 7.65% rate2 — while receiving unemployment benefits, you do have to pay federal income taxes and state taxes in some jurisdictions.
You’re not required to have taxes withheld from your unemployment benefits check, so it’s up to the individual to decide what they want to do. But experts say it’s a good idea to take the tax hit up front.
If you’re still receiving unemployment benefits, but haven’t requested taxes be withheld, you can request a change by filling out form W-4V (the “V” stands for voluntary). Depending on your state, this may be something you can do online through the benefits portal. A flat federal tax rate of 10% of the benefits paid can be withheld from each payment, according to the Labor Department.3
Another option is to withhold the taxes yourself by putting about 10% of the check into a savings account, similar to how freelancers should save part of their paychecks to put toward taxes.
This year many doctors, dentists, and optometrists have deferred non-emergency appointments and exams because of the coronavirus pandemic. But for many Americans, that means the funds they set aside for these routine health expenses have been languishing unused in flexible savings accounts.
So much so, the Internal Revenue Service announced earlier this year that it would allow employees to make mid-year changes to their health-care benefits.4 Under the new guidelines, employees can change health insurance plans and sign up for a plan if they previously waived coverage, as well as alter contribution levels to the health and dependent care FSA plans.
Typically, you’re going to pay less in taxes if you’re putting personal finance into these types of accounts. So if you suddenly stop or lower your contribution levels, it could increase your taxable income.
Saving for retirement is important, but some experts recommended lowering or even stopping 401(k) and individual retirement account contributions if you were really struggling this year.
Similar to FSA or HSA contributions, putting money in your 401(k) lowers your overall taxable income. If you stop these contributions, you may have more going into your bank account, but you’ll also be paying more in taxes.
It also may mess with the credits that you could be eligible for, like the retirement saver’s tax credit, which (depending on your income level) can be up to 50% of the contributions made to a Roth IRA or 401(k). Credits can ultimately lower your tax bill, so if you’re no longer eligible for them, you could owe more.
Earlier this year, lawmakers passed new rules under the CARES Act that allowed Americans to make early withdrawals of up to $100,000 from their retirement savings, including 401(k)s or individual retirement accounts, without the typical 10% penalty.
Referred to as “coronavirus-related distributions,” they are available only in 2020 and can be repaid over three years to avoid any income taxes on the funds taken.6 During the first half of the year, about 2.9% of plan participants took the newly created distribution, according to recent data from the Investment Company Institute.7
While you don’t have to pay any upfront penalties, you will owe income taxes on those withdrawals if you don’t pay the money back within three years. And if you took a larger lump sum out, it could take a while to re-invest.
While buying a home may not mean a higher tax bill — in fact, there are a number of tax incentives for first-time homebuyers — this type of purchase may change how you do your taxes.
If you became a homeowner this year, you may need to consider setting aside money for taxes in 2021. Being a new homeowner this year may impact your tax deductions since mortgages are usually the one personal expense that takes someone from utilizing the standard deduction to itemized deductions.
Itemized deductions can provide a bigger tax write-off, but require a bit more work when filing, he adds.
The CARES Act allowed federal student loan borrowers to temporarily suspend payments and dropped interest rates on federal loans to 0%.8 These protections are set to expire at the end of January 2021. While there’s no interest or penalties for not paying your federal student loans right now, you may also be missing out on a tax deduction.
Depending on your income, you may be able to deduct up to $2,500 in student loan interest from your taxable income. *10* Those eligible for the full deduction need to earn less than $70,000 a year if single and under $140,000 if filing jointly — the deduction phases out for those who make more than $85,000 if single and $170,000 if married.
Keep in mind, however, the deduction only applies to interest, so if you’ve been paying down the principal this year because interest rates have been zero, the deduction will not apply.
Ultimately, when it comes to taxes this year, you should ask yourself: Did the right amount of taxes come out of that income yet or not? If not, our Los Angeles tax attorneys recommend saving more money than you need to pay for your tax bill. To learn more about year-end tax tips or if you owe taxes and need an IRS lawyer to represent you before the IRS, give our tax team a call at 1-800-290-8160 for your FREE consultation today.