5 Unexpected Insights from Your Tax Return

With the 2021 tax filing deadline behind us, it may be tempting to put taxes out of sight and out of mind. But taking a deeper dive into your tax return can uncover some important insights and help you identify opportunities for optimal planning in the future.

Now is the ideal time to review your current financial situation and consider changes for the year ahead. Here are a few of the most common areas to consider.

1. Review Your Refund (or Tax Bill Owed)

People often look forward to getting a refund because it feels like a bonus, but it’s not. It’s an overpayment of your own hard-earned dollars. Getting a large refund isn’t necessarily a good thing — you’re essentially giving an interest-free loan to the government. It may be more beneficial to have that money throughout the year instead.

If you find yourself with a large tax refund or if you significantly underpaid and were charged a penalty, you may want to take another look at your withholdings to see if you should have more or less withheld throughout the year.

In the case of retirees, you may also want to review your distributions from retirement accounts. You may have taxes withheld from those distributions automatically, and it’s important to confirm if the withholding percentage is adequate.

2. Understand Your Effective vs. Marginal Tax Rates

There’s often a misconception around tax rates and how they work. When we talk about tax rates, we often talk about the marginal tax rate, or the highest bracket into which income falls. However, because the U.S. has a progressive tax system and not all of your income will be taxed at your marginal tax rate, your effective tax rate may be much lower.

For example, if you’re a single filer making $100,000 annually, you have reached the 24% marginal tax bracket, but only a small percentage of your income is actually being taxed at that 24% rate. In 2022, the first $10,275 of your income will be taxed at the 10% rate; income above $10,275 up until $41,775 will be taxed at 12%; the next tier is a 22% rate up to $89,075 and so on. Only income above $89,075 will be taxed at your marginal rate of 24%. To calculate your effective rate, take your tax liability and divide by taxable income. 

Knowing these “break points” can help you make financial decisions. For example:

• You may want to be aware of how much more income you could potentially earn without being bumped into a higher tax bracket.
• If you are anticipating a lower-income year, you could consider doing a Roth IRA conversion to “fill up” your marginal tax bracket.  This would entail paying income tax now on the conversion amount, rather than paying tax on IRA distributions in retirement when you may be in a higher tax bracket.
• Or, if you are anticipating a higher-income year, you could consider giving more to charity to increase your tax deductions in a year when you are at a higher marginal tax rate.

3. Plan for Standard vs. Itemized Deductions

Take another look at IRS Form Schedule A — were you able to itemize your deductions for 2021? After the 2017 Tax Cuts and Jobs Act increased the amount of the standard deduction and capped the amount you can deduct for state and local income taxes, it has become more difficult to exceed the standard deduction threshold. This is particularly true if you don’t have other areas to itemize, such as mortgage interest or medical payments.

If you weren’t able to itemize this year but want to maximize future planning opportunities, think about updating your charitable giving strategy. If you’re currently giving to charity but not itemizing, you’re not getting the direct tax benefit. You could consider using a donor-advised fund to “bunch” charitable donations into one tax year to help bring your itemized deductions over the standard deduction threshold to optimize the tax benefit from giving.

For example, if you give $1,000 to charity every year, but you don’t itemize your deductions, there is no added tax deduction for making that gift.  Instead, consider bunching your giving into one large contribution that you make to a charitable donor-advised fund. With a donor-advised fund, you receive a tax deduction in the year the gift is made, but you can donate the money to charities of your choosing at any point in the future.

If you put $5,000 into a donor-advised fund this year, you would receive the full $5,000 charitable deduction in 2022, which could help get you over the standard deduction threshold.  You could then donate that money to charities over a five-year period.

4. Consider Gifting in Stock

When reviewing charitable contributions in Schedule A, make sure to always take a look at the breakout between cash and non-cash contributions. If you have appreciated securities, like stock, it may be more advantageous to gift securities rather than cash.

There are a couple notable benefits here. First, if you donate to a charity with stock, you’re both able to take a charitable deduction and avoid incurring capital gains taxes normally associated with selling stock. Furthermore, if you have a concentrated stock position, this can be an easy way to reduce your position in a tax-efficient way.

5.  Revisit Your Retirement Contributions

Depending on your level of earned income and eligibility, you may want to consider creative ways to increase your retirement contributions and lower your taxable income. There are several lesser-known rules that could ultimately allow you to contribute more.

For example, retirees who continue to earn income through consulting opportunities can contribute to a SEP IRA.  If you’re a solo entrepreneur and hoping to max out your retirement contributions, you could consider setting up a solo 401(k), which operates similarly to the plan one would have under an employer. A solo 401(k) often allows for higher contributions than a SEP IRA given the different formula.

Another option could be for a non-earning (or lesser-earning) spouse to contribute to an IRA for themselves under the Kay Bailey Hutchison Spousal IRA Limit. If filing jointly, this could allow you and your spouse’s combined contributions to be as much as $14,000.

There’s much to be learned from reviewing your tax strategies while it’s top of mind this spring. Review these five steps as a starting point, and don’t wait until the end of the year to make changes.