Although individual tax filing season has just passed, there are some important early tax planning tips you should be considering for next year, right now. If you filed on time and didn’t request an extension, here are some steps you can take during this after Tax Day period.
1. Retaining Your Records
One of the most important early tax planning tactics you can employ is to organize and retain the records you included in the tax return you just submitted in April. The IRS has the ability to audit your tax return many years after you file it so you should be mindful of retaining all pertinent records of both the return itself and the supporting documents and receipts, associated. Generally, you need to hold onto the documents that support your income, deductions, and credits for at least three years after the tax-filing deadline. (An important exception to note is that if you’ve failed to file or have filed a fraudulent return, the IRS can pursue and audit, indefinitely.)
Documents that are essential for you to retain include:
- Form W-2, “Wage and Tax Statement,”
- Form 1099-NEC, “Nonemployee Compensation,” 1099-MISC, “Miscellaneous Income,” and 1099-G, “Certain Government Payments,”
- Form 1098, “Mortgage Interest Statement,”
- Property tax payments,
- Charitable donation receipts,
- Records related to contributions to and withdrawals from Section 529 plans and Health Savings Accounts, and
- Records related to deductible retirement plan contributions.
Additionally, until the period of limitations expires for the year in which you dispose of any property, you’ll also want to retain any records pertaining to that property as they’ll be needed to calculate your gain or loss.
2. Advanced Planning for Next Year’s Taxes
The next tip focuses on staying on top of your early tax planning by assembling any documentation you’ll need for next year’s tax filing deadline on an ongoing basis. Up-to-date records for items like any charitable contributions you make or mileage expenses (if self-employed) that can be claimed should be gathered and held in the same place until tax time rolls around again.
Reassessing Current Tax Strategies
This early tax planning tip also involves reassessing some of the tax strategies you’ve employed in the past to determine whether they still make sense, for next year. The time just following April’s tax deadline is a good time for you to review your current tax withholding to determine if you need to update your Form W-4, “Employee’s Withholding Certificate.” If you owed taxes this year, you might want to consider increasing your withholding or moving to quarterly payments. Conversely, you might want to reduce it if you received a hefty refund. If you have an upcoming major life change such as a marriage, birth or adoption, or divorce, you may also need to alter your tax planning strategies to incorporate those events.
Estimated Tax Payments
If you’re already making estimated tax payments throughout the year, you may want to consider reevaluating the amounts you pay. If you’ve experienced changes in self-employment income, investment income, Social Security benefits, or other types of nonwage income, you might choose to increase or reduce the estimated tax payment amounts. By paying at least the lesser of:
- 90% of the tax for the current year, or
- 100% of the tax on your prior year’s tax return (110% if prior year adjusted gross income exceeded $150,000)
You may be able to preempt the risk of a penalty for underpayment of estimated tax.
Converting Traditional IRAs to Roth IRAs
If you’re looking for ways to reduce your 2022 tax bill, recent downturns in the stock market may actually provide a benefit. If you have substantial funds in a traditional IRA, this could be a good time to convert them to a Roth IRA which has no required mandatory distributions and also offers tax-free distributions. Although you’ll be required to pay income tax on the fair market value of the converted assets, you could end up paying less in taxes now than you would in the future if you convert securities that have fallen in value or you’re in a lower tax bracket in 2022. Also, all subsequent appreciation will be tax-free.
Another upside of the market downturn is that it could provide loss-harvesting opportunities. By selling poorly performing investments before year-end, you can offset realized taxable gains on a dollar-for-dollar basis. If you end up with excess losses, you can apply up to $3,000 against your ordinary income and carry forward the balance to future tax years.
Medical Expenses
Medical expenses may also offer you another early tax planning opportunity. If you itemize deductions on your tax return, you might consider “bunching” expected medical expenses into 2022 to increase the chances that you can claim the medical and dental expense deduction. You’re allowed to deduct unreimbursed expenses that exceed 7.5% of your adjusted gross income. If you expect to have a surgery or other large medical expense next year, accelerating it (along with all of your follow-up appointments and physical therapy) into this year could put you over the 7.5% threshold and pave the way for tax savings.
3. Responding to IRS Questions or Audits
Do not panic if you receive a letter from the IRS (reminder: the IRS doesn’t initiate inquiries or audits by phone, text, or e-mail) with a question or request for an audit. This doesn’t necessarily mean that you’ve made an error. Your tax return could have been flagged based on a statistical formula that compares similar returns for deviations from IRS norms.
What to do if Selected for an Audit
70% of audits are accomplished through a correspondence audit. Correspondence audits are conducted by mail for a single tax year and involve only a few issues that the IRS anticipates it can resolve by reviewing relevant documents. Most audits involve returns filed within the last two years.
Contact your tax advisor as soon as you receive notification of a correspondence audit so you can follow the instructions precisely. If you’re unable to submit all of the requested documentation by the deadline noted, you can request additional time. Keep the original of all documents you submit and submit copies of those documents to the IRS, making sure to include your name, Social Security number, and the tax year being reviewed on each page you turn over.
Make Sure You Respond
Ignoring the letter could bring additional penalties with it including the possibility of the IRS disallowing the item(s) claimed and issuing a Notice of Deficiency (that is, a notice that a balance is due). You’ll then have 90 days to petition the U.S. Tax Court for review.
There is a lesser possibility that, instead of a correspondence audit, you could be selected for an office audit (in an IRS office) or field audit (at the taxpayer’s place of business). As these are more intensive, you’ll need to contact your tax professional immediately to have them help you navigate the audit process.
Following these tax planning tips early is the best way for you to stay ahead of the game, keep your tax filing running smoothly, and prepared for next year. To minimize your filing burden, your tax liability, and the risk of an eventual audit, get in the best practice of keeping your documents together throughout the year and staying in contact with your tax advisor. For questions, reach out to your Untracht Early tax professional.
