Yellowstone Financial, Inc.

Learning From Your New Tax Return

By now I hope the end of tax season is in sight for you with the deadline for submitting your return just one week away.  There’s little you can do now to help your 2018 tax situation apart from a Roth or traditional IRA contribution for last year, which both have April 15th deadlines.  It may be the last thing you want to do, but while it’s still fresh in your mind you should review your return now to optimize your situation for 2019.

Did You Itemize Your Taxes?  The number of taxpayers who are itemizing, that is filing Schedule A of Form 1040, has dropped dramatically from previous years.  Look at Line 8 on the second page of the 1040.  It will indicate whether you’re taking the standard deduction ($24,000 for married taxpayers and $12,000 for single ones, with a $1,300 boost if you’re 65 or over).

If you’re taking the standard deduction, there are a slew of tax moves that won’t help you.  Home mortgage interest, state and property taxes, and charitable donations all lose their federal tax benefits with the standard deduction, with the exception that giving still has benefits for your Colorado return.

If you’re not itemizing, you may consider paying off your mortgage more aggressively than the minimum payment.  Imagine you have a 4.5 percent interest loan and you’re taking the standard deduction.  That means whatever extra funds you can use to pay down your mortgage principal in effect “earns” 4.5 percent tax-free.  While we would expect a diversified portfolio to beat that rate of return over time, there are few risk-free investments available that earn 4.5 percent tax-free.

The timing of charitable contributions needs to be more intentional if you’re not itemizing.  “Bunching” your donations every other year or using charitable donor advised funds can help you receive a federal tax break to support your philanthropy by increasing your itemized deductions over the standard deduction.

Do You Owe a Significant Amount?  Since the IRS released its tax withholding guidelines last year as a result of the tax cut legislation, I’ve been concerned that many would owe a significant amount when they file their 2018 taxes.  The irony is that many will pay less in taxes in 2018 than last year.  But if the tax withholding from our pay last year was significantly reduced because of IRS formulas, we may find ourselves owing thousands for 2018 when we planned on receiving a refund.

If you owe taxes for 2018, consider filing a revised form W-4 with your employer to withhold more in taxes for 2018 so you don’t find yourself writing a big check (perhaps including an IRS penalty) for next year.  You don’t have to change the allowances or filing status to increase withholding.  You can simply place the extra amount you want withheld from each paycheck on line 6 of your W-4 that you submit to your employer.

Don’t let low income go to waste.  With the decrease in federal income tax rates across the board, you want to take advantage of the “low” tax brackets.  If you’re married and your taxable income (after deductions) is $78,950 or less, you’re in the 12 or 10 percent federal tax brackets.  The same applies for single filers with under $39,475 of taxable income.  This means you’re paying 12 percent or less federal tax on each additional dollar you earn.  I’m not a tax policy expert, but given the large budget deficits our federal government has been running even in times of prosperity, it’s a good guess that your tax rate may increase in the future.   Taking steps such as moving funds from your IRA to Roth IRA, contributing to a Roth 401(k) versus a deductible 401(k), and selling investments with a long-term capital gain could make sense for you.  With these strategies you’re opting to pay taxes at your low rate now while avoiding paying possibly higher taxes later in life.