Tax Planning

A few years ago I met a couple for the first time when they came to me in March after they had someone else prepare their tax return. They owed over $15,000 in federal taxes and they couldn’t understand why and they wanted a second opinion. After I reviewed their tax return, it quickly became clear to me what the issue was and the fact that their preparer was correct. As things stood, they owed over $15,000.

However, April 15th hadn’t come yet and with that there were still some opportunities that the taxpayer could explore if it made sense to do so. And luckily for this taxpayer, one of these strategies would work perfectly.

What was their issue and why did it cause such a large tax bill? This couple had gotten health insurance through the Marketplace and was receiving a fairly large subsidy - called the Premium Tax Credit. This happens when you apply for your health insurance and express that your income will be at a certain level. However, if your income is above that level then you typically have to pay some (or all) of the Premium Tax Credit back when you file your taxes. During this year when I worked with this couple for the first time - they fell into the category of having to pay all of it back because they exceeded the IRS income threshold for full payback of the Premium Tax Credit by about $5,000. Luckily for them, I was able to recognize their issue and was also able to recommend something to them that would save them over $12,000.

What was my recommendation? This taxpayer was self-employed and wasn’t covered by a retirement plan and therefore met the requirements to still be able to make a tax deductible IRA contribution by April 15th. If they contributed anything over $5,000 to their IRA accounts (within IRS limits) then their income for the Premium Tax Credit payback calculation would go down below the IRS threshold for full payback - and they would only be required to pay back $2,650 of the Premium Tax Credit. So, ultimately this strategy required the taxpayer to put aside $6,000 into a retirement account - which essentially cost them nothing as it is still their money - but it saved them over $12,000 in taxes for the year.

This story illustrates a couple of important points. First, it is important to work with a tax advisor that has a good understanding of your situation and how the IRS rules apply to you. Second, it is important to have conversations with your tax advisor prior to filing your tax return.

Regarding the first point - there are lots of people that are capable of preparing a tax return for you. Many people I know prepare their own tax return and most of them probably do it accurately or close to accurately. However, not too many of them have a solid grasp of many of the IRS rules that apply to them - and why would they? Taxes are very confusing! Do you personally need someone that understands the rules? Perhaps you don’t, but more often than not when I review returns prepared by other people I can find at least a couple ways that they could have reduced the amount of taxes that they paid.

Regarding the second point - having conversations with your tax advisor prior to filing your taxes is important. The best time to have those conversations are in November and December when you have a good picture of what your income will be and don’t have restrictions that apply once the calendar year closes. Most opportunities for tax savings need to be applied prior to December 31st for the year you are doing your taxes. That might be buying some equipment for your business, making a charitable donation at year end, or pre-paying some of your state income taxes. However some rules, like IRA and HSA contributions, can be done after the year ends. Having a conversation with your tax advisor prior to year end will allow you to explore what needs to be done by year end and what strategies you could do after year end.

Don’t get yourself stuck paying too much in taxes. It is worth the visit with your tax advisor to make sure that you are in a good position for taxes before you have an unexpected tax bill and can’t do anything about it. If you are interested in having someone look over your tax situation, please contact me at 435-681-1277 or email me at mike@brunercpaservices.com .