Rianka R. Dorsainvil, CFP®
Traditional tax season has come to a close, and the feelings are flowing!
Perhaps you received a small (or large) refund and you’re feeling optimistic with grand plans about reinvesting the money, paying down debt or even scheduling a “treat yourself” day. If you just flustered through the last few months gathering random documents or even worse, you owe a substantial amount of money back to the government — you’re not alone.
Let’s take a look at three red flags that might signal the need to hire professional help:
1. You’ve Owed More Money Than Expected For Multiple Years in a Row
If you recently learned you owe more money to the government than expected, you can be in for a painful experience. You know the saying “fool me once, shame on you”…but, when you have been fooled twice (or more) it’s time to get strategic.
Did you know that having a tax strategy in place can actually reduce your overall tax liability? A great strategy may be to transfer additional funds into a traditional retirement account such as a 401(k) to help offset your taxable income. By adding money to this account, you would only be taxed on what you withdraw in the future. This would allow you to keep more of your money now, and think ahead. Understand, these planning measures are a solid investment in your future. Stashing away rainy day money to help offset unplanned expenses can also help alleviate future stress. The best way to do this — talk with your tax professional to set up the most realistic strategy for your financial situation. We could all use a little stress relief!
2. Your Job Includes Equity Compensation or Profit Sharing
Entrepreneurs and professionals in industries like technology, are often paid in a combination of ways. While payment that doesn’t appear in a regular paycheck might feel like phantom income, rest assured it’s not; nor does the IRS consider it as such.
It’s a good time to investigate any trends in how your employer is compensating you. Consider tech titans who pay their employees stocks as part of their compensation. Professionals in lucrative spaces might be granted restricted stock units (RSUs), which have the potential to bump them into a new tax bracket when vested. These stocks are vested over a set amount of time. This type of compensation is considered supplemental income. While some federal taxes are usually withheld when your RSUs vest, if your effective tax rate has increased over time, you may be surprised by a tax bill in April.
Alternatively, let’s say you are a full or partial owner of a company. As overall company revenue increases, you may receive a quarterly K-1 distribution.
Whatever the case may be, make sure you are accounting for all forms of compensation to avoid underpayment penalty fees, and adjust your quarterly tax payments as necessary.