Getting yourself ready for tax season can be a year-round job, especially if you’re looking to minimize what you’ll owe at tax time. In that case, it’s helpful to understand what taxable events are and how you can lessen their impact on what you owe.
In order to take control of your tax bill, take note of what a taxable event is. These are the transactions or occasions that have an impact on your taxes.
Some taxable events have a positive impact and might lower your tax bill, while others can result in you having to pay more. The key is knowing whether any particular situation could impact your taxes and how it will do so before the event happens. That way, you can decide if it's worth following through with the event.
Of course, there are many events that you might not have any control over. In these cases, you'll need to prepare for them in advance and do what you can to manage their impact.
Examples of taxable events
There's a long list of potentially taxable events. Here are some common ones:
- A change in tax filing status, such as from single to head of household or to married filing jointly
- Adding a dependent, such as having a child
- Earning wages from a job
- Earning taxable interest from a bank account
- Earning dividends from taxable investments
- Taxable pension distributions
- Taxable Social Security benefits
- Contributing to certain retirement accounts
- Selling assets such as stocks, bonds or real estate
- Earning income from a business
- Itemized deductions, such as charitable contributions, home mortgage interest, and state and local taxes
Limiting events that result in paying more taxes
Whether you're delaying them or eliminating them altogether, limiting the taxable events that result in paying more taxes might be a smart financial move.
Capital gains taxes
When selling capital assets, the general advice is to wait to sell them until you've owned them for at least a year. At that time, the capital asset typically qualifies for the lower long-term capital gains tax rates rather than the short-term capital gains tax rates (which are the same as your ordinary income tax rates). If you're considering selling an asset once you've owned it for 11 months and there isn't much risk to holding it for an additional month, it may make sense to wait in order to save money on taxes.
Tax planning to lower your overall tax bill
If you're aware of your tax situation, you may know which marginal tax bracket any additional income will fall into this year. If you believe your bracket might be lower next year, you may want to delay events that result in paying more taxes until next year when you may pay less income tax.
Taxable events that may benefit you
Some events can result in a lower tax bill either now or in the future. These events can be useful, but it may make sense to delay them in certain circumstances, too.
One taxable event that could reduce your tax bill is selling investments for a loss. When done strategically to lower your tax bill, this is often called tax-loss harvesting.
Changing your tax filing status
If you get married, divorced, or otherwise have a change to your tax filing status, it can have a huge impact on your taxes. In some cases, this is a positive benefit. In others, it may result in paying more taxes. Either way, you might be able to plan your change in filing status to have the best tax impact possible.
Your filing status is determined based on your circumstances on December 31st of the tax year. If you were thinking about getting married in January but your taxes would benefit greatly by getting married in December, you may want to consider tying the knot before the end of the year. Then, you can hold your ceremony and reception in the next year as planned while benefiting from the new tax status in the prior year.
Don't let taxes force you into bad decisions
It can be smart to minimize certain taxable events at times. But, you shouldn’t allow taxes to dictate all of your decisions. Sometimes you need to make decisions without worrying about the tax implications. Otherwise, you could end up in a worse position than if you had the event and paid the taxes.
One common example of this is an investment in a stock. A person may have owned a stock for 20 years. Over those 20 years, the stock may have skyrocketed in value. Selling this stock could result in paying a decent amount of capital gains taxes due to the large increase in value.
The company may have recently had a significant shakeup in its management structure which leads you to believe the company won't continue to perform well. If you avoid selling the stock because you're worried about the capital gains taxes, you may end up losing money if the stock underperforms moving forward.
Of course, no one has a crystal ball that can predict future stock prices. However, if the stock lost 50% of its value over the next year, you'd lose much more due to the decrease in the company's value than you likely would have paid in taxes if you sold the investment.
Now that you know how taxable events work, you can use TurboTax's TaxCaster tax calculator for tax planning each year.
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