It’s tax season so I thought it’d be a perfect time to talk about some tax misconceptions, explain a few tax basics, and set you up for my next blog post… how I actually do my own taxes. I am NOT a CPA or an Enrolled Agent, so I can’t do your taxes for you or give specific advice, but I can help you with general tax information and explain concepts so that you feel more confident either doing your own taxes or in hiring someone to help you.
1. Refunds are Good
Getting a refund means you overpaid taxes throughout the year. Whereas “owing” means you underpaid your taxes and now you’ve got to catchup by paying more. I wouldn’t say getting a refund or owing is good, instead you should be aiming to have your refund (or amount due) as close to zero as possible. Receiving a large refund means you gave the government an interest free loan for 12 months and you could have been putting that money to good use, like paying down debt or investing it. While owing a large amount could mean you lived (and therefore spent) more money each month thinking you had more than you really should have. Ultimately, receiving a refund is good if you planned for and expected it all year long and the same can be said for owing. If you know you’re going to owe $1,000 that’s fine, as long as you’ve tucked away $100 each month into a HYSA to then pay it come tax season.
2. Going over an Income Threshold can hurt you
If someone ever tells you not to go above a certain income because your taxes go up, simply show them this article! Yes, going into a new higher tax bracket does increase your tax rate, but only the income in the new tax bracket is taxed at that higher rate. And despite that, you’ll still be pocketing more money than what you’re going to pay in taxes on, so it’s never a good idea to turn down a raise or bonus simply because of taxes. For example, for someone filing single if you have $100,000 in taxable income in 2023, only the amount above $95,375 would be taxed at the 24% rate. The rest would be taxed in their respective 10%, 12%, and 22% buckets. Here’s a link to the 2023 tax brackets: Federal income tax rates and brackets | Internal Revenue Service (irs.gov)
3. Tax Credits vs Tax Deductions
Deductions and Credits get thrown around and interchanged quite a bit, but they’re very different. Understanding them is important. A deduction reduces your taxable income so if you made $100,000 but had a $2,000 deduction, you’d now only have $98,000 of taxable income. In this very simple example, a single person with $98,000 of taxable income would pay about $14,000 in taxes in 2023. If the same person received a $2,000 credit (not deduction), their taxable income would still be $100,000 and their tax bill would be closer to $15,000. However, they’d then be credited $2,000 from the $15,000, leaving them with a smaller tax bill of $13,000. Credits are dollar for dollar reductions of your overall tax bill and thus are “better” than deductions.
4. Owning a Home saves you money every year on Taxes
You CANNOT deduct property taxes IF you don’t itemize. Most people (90%) don’t itemize. Repeat that line again. I haven’t itemized since the Tax Cuts and Jobs Act (TCJA) of 2017. If you do itemize, that’s great but there’s also no guarantee that the standard deduction will stay in line with where it’s been since the TCJA was passed (the TCJA doubled the standard deduction). That said, maybe the standard deduction will go back down, and if it does then more people (like me) may start being able to itemize again. If you itemize, keep in mind there are limits on property taxes and mortgage interest. All of this isn’t to say that there aren’t benefits to homeownership. There are lots of them, and the biggest one is how much you can save on taxes from the profit of selling a home you’ve lived in primarily for 2 of the last 5 years (more on that topic in a future blog post). But that won’t save you money in taxes every year, just in the year that you sell.
I hope these topics have helped to clear up things you have heard or read from other sources. If you still have questions, drop me an email or comment on this post. Lots of advisors and websites will give you tax tips or tell you only the positives of something. Not me. I’m going to give you the truth both good and bad about any financial topic you want to hear about. Along those lines, have you ever seen an advisor actually share how they do their own taxes? When looking for a CFP professional, you need to make sure you’re comfortable working with them and talking about things that are very personal to you. Not every advisor will share right back with you, but I will. So, stay tuned because later this week I’ll post Blog #3: How I Do My Own Taxes
Comments