If you already stashed away your tax return, you may want to dig it back out. There are a variety of things you can discover by reviewing each form and understanding the significant impact your taxes can have on your financial health.
Now is a great time to take a second look at your return and discover ways you can make a difference in your tax outcome next year.
1. The reality of your refund
Every year, nearly eight out of ten American tax filers receive a federal tax refund, and according to the IRS, the average amount paid is close to $3,000. Many of those Americans are elated to see that money hit their bank accounts as they already have big plans to spend it.
However, for most of those same Americans, receiving that refund means they had about $3,000 too much withheld from their paychecks throughout the year.
Think about it. A tax refund is a refund of your own hard-earned money. It’s not a gift or an extra paycheck from the government. In fact, it’s quite the opposite.
Receiving a tax refund means you made an interest-free loan to the government. That means you had less money during the year to pay off debts, afford those pesky car repairs, make home improvements or to stash away in your retirement fund or your kid’s college savings account.
So, how do you make sure the right amount is being withheld? File a new Form W-4 with your employer. Your employer deducts taxes based on the number of allowances you claim on your W-4.
Therefore, adjusting your withholdings to better match your tax situation as soon as you can will help you avoid temporarily giving it up to the IRS.
2. Tax bills happen
If you had to pay a significant tax bill after you filed your tax return, you have the opposite problem as someone who received a refund.
Owing money is always stressful, but when other people are talking about their big refunds, you start to question what went wrong.
Luckily, there’s a solution to help avoid this unhappy fate next year. Simply file a new Form W-4 with your employer and increase the amount of federal income tax withheld by decreasing the number of allowances.
3. How to pay less tax
After you file your tax return, it’s easy to only focus on the amount of money you owe or the amount you’re getting back in a refund. However, that’s not the whole picture.
Take a look at your return and add together your total taxes. Don’t forget to include Social Security, state income taxes and property taxes.
Knowing how much you pay can be a surprise and serve as a great motivator to learn ways to reduce your tax bill.
Set aside a few minutes to dive into the numbers. Find out if there any other deductions you could take advantage of to help reduce your taxable income.
Should you consider itemizing your deductions next year, or does taking the standard deduction benefit you the most?
4. Tax benefit leftovers
If you entered deductions when you prepared your tax return, check your return to make sure you were able to take the full deduction this tax year.
In some cases, you may have received little or no benefit from the deduction due to income restrictions.
For example, if you have a rental house, you may have intended to take a deduction for your loss including depreciation.
However, if your modified adjusted gross income (MAGI) was over $150,000 ($75,000 if married filing separately) you wouldn’t have been able to take the loss deduction this year.
The same goes for some education credits. If your income is above certain limits, the tax benefit is lost.
Check your return to see if you have any deductions left-over for these reasons. Next year you may be able to put them to good use if your taxable income is lower.
5. Tax brackets matter
To make smart tax decisions, you must know your tax bracket. Understanding which tax bracket you fall into can help determine if a particular tax deduction will benefit your tax situation.
Generally, when you’re in moderate income tax brackets, you’re better off getting the highest return you can on your money, even if you pay tax on it.
Once you reach a higher income tax bracket, however, tax-free or tax-deferred income sources start to make sense.