Tax Planning - Using Tax Projections (Tax Forecasts) To Avoid Surprises

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David M. Kaufmann, CPA

Voice: 720.493.4804

Email: contact2@kaufmann-cpa.com

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1466 Adobe Falls Way
Fruita, CO 81521

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PO Box 700
Fruita, CO 81521-0700

Tax Surprises Can Be An Inconvenience –Tax Surprises Can Also Ruin Your Life

Here are some examples of situations that can cause these unwanted, possibly devastating, surprises:

• Receiving a substantial bonus without sufficient withholding
• Receiving a large inheritance
• Realizing large amounts of capital gains or capital losses
• Taking large amounts from a 401(k) plan or from an IRA
• Receiving a moving allowance without sufficient withholding
• Owning all or part of a business that suddenly does very well or is sold
• Withholding too little or not paying in enough in estimated tax payments
• Other significant increases in income or significant decreases in deductions

Notice that many of these situations causing tax problems would otherwise be considered very good financial events.

Tax surprises can also be caused by changes in the tax law. For 2013, you may be looking at tax law changes as follows:

• Higher tax rates (39.6%) for incomes over $400,000 (married over $450,000)
• Itemized deductions being phased out when income is over $250,000 (married over $300,000)
• Tax exemptions being phased out when income is over $115,000 (married over $154,000)
• Wages and other compensation taxed at an additional .9% when income is over $200,000 (married over $250,000)
• Investments taxed at an additional 3.8% when income is over 200,000 (married over $250,000)

The Solution Is To Run One Or More Tax Projections

Like anything else when using good software the quality of your inputs is critical. GIGO - Garbage In Garbage Out. The key to making a good tax projection is to use your most recent tax return, and determine what items will change. This can be as much of an art as a science.

The most serious problem in creating reasonable tax projections is dealing with uncertainty. For example, what wage amount should you assume, when it is too early in the year to know what your wages will be? The best way to deal with uncertainty is to consider realistic alternatives. Using wages as an example, what is the lowest wage amount that you can realistically earn for the year; what is the most likely wage amount that you can realistically earn for the year; and what is the highest wage amount that you can realistically earn for the year?

There are several different strategies when making tax projections. One strategy is to look at multiple alternatives for a given year. Another strategy is to look at multiple years. A more complex strategy would be to look at multiple alternatives for more than one year.

It is imperative to use good quality software. Good tax projection software is not cheap. The gold standard in tax planning is the BNA Income Tax Planner starting at around $600.

What to do once the tax projection is done?

If you are in a situation where you can take more or less income at your discretion, or you can increase or decrease deductions (this might trigger the Alternative Minimum Tax (AMT)), you have something to work with since you can alter your tax situation.

If there is not much that you can change to alter your taxes, plan to adjust how you pay your taxes:

• Modify your withholding
• Modify your estimated tax payments
• Come up with a plan to set aside funds for your future taxes