Written by: Guest | Best Company Editorial Team
Last Updated: July 10th, 2020
Guest Post by Lee Reams
As the end of 2019 approaches, it also means that the 2020 tax season is imminent. If your tax situation is pretty simple — for example, you don't take any deductions and your income only comes from one job — you may think that you don't need much financial planning in this department. But if you're a taxpayer who has more complex sources of income like freelance work or owning a business, or if you experienced a major life or career change in 2019, you'll want to get moving on your 2020 tax planning strategy right away.
Even if your financial situation seems simple, understanding where your money is going can help you with both long- and short-term decision-making.
How soon should I start the tax planning process?
Now that November is upon us, you want to get started right away. Certain aspects of your personal finances can be handled up until mid-January or even later, like making a last-minute IRA contribution or an estimated tax payment, but for most of them, you will only have until December 31 to have them count for 2019.
The holiday season can also be a busy and stressful time of year, and tax planning could be neglected as a result. Holiday credit card bills are tough enough to deal with in January, and the last thing you want is a higher tax bill that could have been prevented with proper foresight.
What to prepare for in 2020
Have you contributed the maximum to your retirement assets yet? If not, are you financially able to? The maximum 401(k) contribution for 2019 is $19,000. If you are 50 or older, you can make extra catch-up contributions as well for a total of $25,000.
The contribution limit for IRAs is $6,000 for 2019 ($7,000 if you are over 50), and you can make this contribution until April 2020 and have it count for the 2019 tax year.
If you are self-employed and able to start saving significantly more than you used to, this could also be a good time to assess opening your own 401(k) or SEP account to take advantage of the significantly larger contribution caps compared to what IRAs offer.
Marriage and divorce
If you and your partner were planning your wedding in 2020, you should get a look at how your taxes would look as a married couple compared to filing as two single people. If there's a significant benefit, it could be worth going to City Hall at the last minute: You literally have until midnight on December 31 to be considered married for the entire year. (You can still have the wedding, but just be married in the eyes of the law and the IRS.)
If this is your first tax year as a married couple, you may have some teething issues if you and/or your spouse have been used to the tax planning process while single. If you are more on the up and up with financial planning than your partner is or vice versa, end-of-year tax planning is a great time to start getting on the right track financially as a couple. Your taxes also may have changed, and this is a good time to review those changes and other bureaucratic hurdles, such as notifying the Social Security Administration if your name has changed due to marriage.
The inverse is true for divorce as well. Divorce can be financially devastating for both former spouses, especially if you have children or are still having disputes over assets and prior tax problems. Regardless of the stage your divorce is in, year-end tax planning is when you need to determine how your tax situation is going to be different and how you can prepare.
Withholding and estimated taxes
Year-end tax planning is a good time to assess if you are having enough taxes taken out of your paycheck. It's not just federal taxes, but also state and local taxes. If you changed jobs, your employer changed payroll providers, or you moved, your tax withholding may have changed.
Review all of your tax withholding and determine if you are having the correct amounts, and types, of income taxes deducted from your paychecks. If you start receiving other income like rent, a side hustle, or investment income, then you may need to increase your withholding. If you don't mind a smaller tax refund and would rather have more of your money every payday, you might want to reduce your withholding by increasing the number of allowances claimed. Fill out a new W-4 form, plus a state-level equivalent, and give it to your payroll department or provider.
If you are self-employed and have to pay estimated taxes on your own, it's common to fall short every tax season. Take a closer look at your net earnings over each quarter and determine how you can stay on top of these payments so that you don't end up with a tax bill you can't pay. Automatic deductions into a savings account dedicated to taxes can help, or you can set reminders to pay estimated tax every month instead of every quarter.
Starting a family
If you adopted or had a child in 2019, this definitely changes tax planning for 2020 as well as your overall financial planning since your priorities completely change upon starting a family.
It's important to track down records for your expenses pertaining to adoption and childcare because there are valuable tax credits for them. If you'd like to get a jump-start on saving for your child's higher education expenses, you can also open a tax-advantaged educational savings account like a 529 plan. You can contribute up to $15,000 for 2019, and although you don’t get a tax deduction for the contribution, the investment earnings accrue tax free in the account. In the future, the proceeds will be tax-free provided that they are used for qualified education expenses like tuition and books.
What if I owe money?
If your tax planning efforts determine that you will owe money when you go to file, this gives you time to discuss your options and tax reduction strategies with a tax professional. You may need to go on a payment plan or figure out a way to make more money before April 2020 so you can pay your tax bill without incurring interest, late fees, and other associated costs.
If your total expected federal tax liability is less than $1,000, you won't be charged an underpayment penalty, so you can wait until you file your tax return to pay the whole balance. However, if it exceeds $1,000, you'll want to take advantage of that mid-January deadline to make one more estimated tax payment that counts for 2019 so you won't face an additional penalty on top of the taxes you owe. You want it to be at least be below $1,000 if you can't afford to front the whole amount at the moment. Another option: increase your year-end withholding.
The further in advance you can get a jump on planning for 2020, the less stressed and broke you will be with another tax season on the horizon. When it comes to taxes, being proactive is the most important factor.
Lee Reams Sr., BSME, EA is the Chief Technical Officer for ClientWhys, TaxBuzz, and CountingWorks. In addition to being an expert on taxation and a leading speaker on tax-related topics, Lee has experience in managing his own 600+ client tax practice.