It's That Time Again

Yay, it's a new year, a fresh new start, and more than anything it is time to do those taxes again. Wait a second you say, taxes are not due till April, so why am I talking about them now? Well, now is about that time all the tax forms are rolling in and you are probably starting to either gather them up or pull them together for your accountant. The question is what do you owe or what are you going to get back?

According to the IRS, the average tax refund is $2,828 over the last 5 years. The scary part is that as income goes up the average goes up. In 2020, the $100,000 and under bracket is around $2,800, but as you go over $100,000 the average hits $4,436, and then over $200,000 it more than doubles to $10,316. Why? Simple, the more money people make the less they take control over their spending.

Now if you just take the average, what that means is that you gave the government an extra $200+ per month. As people make more money they are even happier to give upwards of $900 more per month. Meanwhile, 61% of Americans have Credit Card debt, which they are paying 20%+ a month in interest, while at the same time giving the government a free no-interest loan. All of this doesn't make sense, so why are we doing this and how do you correct this?

Here is the easy part, 80-90% of Americans take the standard deduction, so knowing your tax bill should be pretty straightforward. Go online to just about any tax calculator, plug in your income and a few items and you will get your rate. (TurboTax Calculator)

Additionally, you can go here to learn your W-4 Withholding estimator.

I personally like to just work off my bracket. I am also part of that 10-20% that does not take the standard deduction. So I know generally year over year how much my deduction totals up. Then it is pretty simple.  

1. Take the Income you expect to make this year

2. Subtract your Standard Deduction OR your Average Itemized Deduction

3. Look up your tax Bracket

4. Simple Equation

(Income - Deduction) * Tax Bracket = Potential Tax Bill

OR

An easier way, I look at my previous year's tax bill, then take what it says I owe and calculate what percentage that is of my total income. Known as the effective tax rate.

Now that you know your bill you can look at your paycheck, multiply it out, and see what you are going to be paying over the course of the year. If you are paying too much, then go increase your W-4 to reduce the amount of tax taken out (Yes, it is backward). It may take a couple of paychecks to dial this in. If you are unsure then definitely consult a tax accountant for sound advice to get your W-4 where it needs to be. It is possible to predict the amount of taxes you owe, you just have to be willing to talk to someone or sit down and run a few calculators.

I cannot emphasize just how important this is! You need to take control over your pay and that includes your tax bill. One time I owed $6,000 at the end of the tax year. This was not something I was ready for and it hurt, but I can tell you it felt better to me than getting $6,000 back at the end of the year. Why? Because that money was mine throughout the year to keep me out of debt and in charge. Sure the payment hurt and it came at a time when we were adjusting to my wife's real estate business, but overall, it worked out.  

When we finished that year I lowered my W-4 a bit, figured out my effective tax rate, based on my end-of-year tax bill and my income, then started paying quarterly payments for my wife's real estate based on that rate. Since then we usually have had it dialed in pretty well. I'm sad to say I just did mine this past week and I am probably getting a sizeable refund, but that is because real estate was really bad this year, so thankfully we fell into a lower tax bracket (not a bad problem). Overall, we will take it, but ideally, we would prefer to end the year, getting a small refund or owing just a small amount.

Final point, if you believe you may owe, it is just as important for you to start your taxes now. Then if needed, you have the next 2.5 months to put a little extra aside to cover that expense. That is why I always encourage people to get control of their taxes as soon as possible. Learn how to do them, it is really easier than it looks and well worth the time invested into it.