It's November, which means that there's only about five months until Tax Day. It may seem like a lifetime away, but it's really just around the corner.
And if you think you're going to owe money on your taxes this year, you only have a few months to start setting savings aside to pay that tax bill.
"When it comes to taxes, there are a lot of changes that have happened this year from a regulation perspective, but also from your personal financial situation, which then could impact your tax situation," says Eric Roberge, a certified financial planner and founder of Boston-based wealth management firm Beyond Your Hammock.
Here are a few things that you might want to look into to make sure that you are ready for tax season when it comes down the pike next April.
If you got a raise or started a new job at a higher salary this year, congratulations! Although many Americans suffered career setbacks this year, some folks managed to negotiate their way to higher pay. In fact, employers expected worker compensation would grow by an average of 2.9% in 2020, according to WorldatWork's 2020-2021 Salary Budget Survey, conducted starting in May this year.
But that pay bump could affect your taxes. "If you have more income or a different type of income that's coming into your household, that may be something to look at from a tax perspective," Roberge says.
When your pay increases, so do your taxes. But unless your raise boosts your income into a new tax bracket, you probably don't have to worry too much about a major tax increase. However, it's still a good idea to check your withholding levels on your W-4. If you're withholding too little, you could owe the IRS.
Many Americans received some form of unemployment benefits this year. But it's important to understand that unemployment benefits are not "free money." If you are currently receiving these weekly benefits, or previously cashed these checks, you may need to take steps now to avoid a nasty surprise on your tax bill.
"People need to be careful about the way this income is taxed. Similar to income from a job, unemployment income is taxable income," says Elliot Pepper, a certified public accountant, financial planner and director of tax for Baltimore-based Northbrook Financial.
Unemployment benefits are considered taxable income, even the $600 boost that was in effect until the end of July. While you don't have to pay Social Security or Medicare taxes — typically about a combined 7.65% rate — while receiving unemployment benefits, you do have to pay federal income taxes and state taxes in some jurisdictions.
You're not required to have taxes withheld from your unemployment benefits check, so it's up to the individual to decide what they want to do. But experts say it's a good idea to take the tax hit up front.
If you're still receiving unemployment benefits, but haven't requested taxes be withheld, you can request a change by filling out form W-4V (the "V" stands for voluntary). Depending on your state, this may be something you can do online through the benefits portal. A flat federal tax rate of 10% of the benefits paid can be withheld from each payment, according to the Labor Department.
Another option is to withhold the taxes yourself by putting about 10% of the check into a savings account, similar to how freelancers should save part of their paychecks to put toward taxes. "I would rather you be overly conservative, saving more than enough money in a side account, to prepare for the 'what if' scenario where you might owe taxes at the end of the year," Roberge says.
This year many doctors, dentists and optometrists have deferred non-emergency appointments and exams because of the coronavirus pandemic. But for many Americans, that means the funds they set aside for these routine health expenses have been languishing unused in flexible savings accounts.
So much so, the IRS announced earlier this year that it would allow employees to make mid-year changes to their health-care benefits. Under the new guidelines, employees can change health insurance plans and sign up for a plan if they previously waived coverage, as well as alter contribution levels to the health and dependent care FSA plans.
Even if altering your contribution level was the right move, you need to understand that it could alter your tax responsibilities as well, Roberge says. "If you are contributing to a health savings account...that actually reduces your taxable income," he says.
Typically, you're going to pay less in taxes if you're putting money into these types of accounts. So if you suddenly stop or lower your contribution levels, it could increase your taxable income.
Saving for retirement is important, but some experts recommended lowering or even stopping 401(k) and individual retirement account contributions if you were really struggling this year.
Similar to FSA or HSA contributions, putting money in your 401(k) lowers your overall taxable income. If you stop these contributions, you may have more going into your bank account, but you'll also be paying more in taxes.
It also may mess with the credits that you could be eligible for, like the retirement saver's tax credit, which (depending on your income level) can be up to 50% of the contributions made to a Roth IRA or 401(k). Credits can ultimately lower your tax bill, so if you're no longer eligible for them, you could owe more.
"If you've made that kind of change, be aware that your tax bill might be higher than it typically is at the end of the year," Roberge says.
Earlier this year, lawmakers passed new rules under the CARES Act that allowed Americans to make early withdrawals of up to $100,000 from their retirement savings, including 401(k)s or individual retirement accounts, without the typical 10% penalty.
Referred to as "coronavirus-related distributions," they are available only in 2020 and can be repaid over three years to avoid any income taxes on the funds taken. During the first half of the year, about 2.9% of plan participants took the newly created distribution, according to recent data from the Investment Company Institute.
While you don't have to pay any upfront penalties, you will owe income taxes on those withdrawals if you don't pay the money back within three years. And if you took a larger lump sum out, it could take a while to re-invest.
While buying a home may not mean a higher tax bill — in fact, there are a number of tax incentives for first-time homebuyers — this type of purchase may change how you do your taxes.
"People who became homeowners in 2020 need to consider the impact to their tax deductions this year as a mortgage is oftentimes the one personal expense that takes someone from utilizing the standard deduction to itemized deductions," Pepper says.
Itemized deductions can provide a bigger tax write-off, but require a bit more work when filing, he adds.
The CARES Act allowed federal student loan borrowers to temporarily suspend payments and dropped interest rates on federal loans to 0%. These protections are set to expire at the end of January 2021.
"While interest has been waived and payments suspended, the underlying student debt that many young Americans continue to carry has not been forgiven," Pepper says. While there's no interest or penalties for not paying your federal student loans right now, you may also be missing out on a tax deduction.
Depending on your income, you may be able to deduct up to $2,500 in student loan interest from your taxable income. Those eligible for the full deduction need to earn less than $70,000 a year if single and under $140,000 if filing jointly — the deduction phases out for those who make more than $85,000 if single and $170,000 if married.
Keep in mind, however, the deduction only applies to interest, so if you've been paying down the principal this year because interest rates have been zero, the deduction will not apply.
Ultimately, when it comes to taxes this year, Roberge says to look at the income you have coming in and ask yourself: Did the right amount of taxes come out of that income yet or not? "If not, save more money than you think you need to pay in taxes to prepare for that tax bill," he says.
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