Tax Surprises: What You Need to Know

Tax surprises often don’t stem from one single choice; more commonly, they accumulate through numerous smaller decisions. Before making moves like selling investments, withdrawing from retirement accounts, or filing jointly without careful planning, it’s wise to consult with a certified public accountant or financial advisor.

• Timing your tax payments is crucial. If you sell an investment without considering this, you might end up in a higher tax bracket.

• Coordinating your financial decisions with a CPA before taking any action can help avoid costly surprises later on.

• Deadline penalties for Required Minimum Distributions (RMD) have increased. Mistakes can lead to severe penalties, so it’s essential to get those calculations right.

The IRS has projected approximately $4.8 billion in underpayment penalties. Fiscal year 2024 is expected to see more than 15 million individual returns, almost triple from two years ago. A significant number of these claims arise from tax underpayments due to selling profitable stocks or withdrawing retirement funds without professional advice.

As Brenton D. Harrison, founder of New Money New Problems, puts it, “The biggest mistake I see is clients underestimating how many financial choices affect their taxes.” He emphasizes that some clients end up with massive tax bills that could easily have been avoided. Consulting a CPA, he argues, is crucial before making any decisions.

Here are a few common pitfalls to watch out for:

If you sell an investment held for less than a year, expect the profit to be taxed as ordinary income, which can range from 10% to 37%. However, holding it for a longer period benefits you with lower long-term capital gains rates—0%, 15%, or 20%. That simple timing decision can have a significant impact on your tax bill.

To illustrate, consider a $10,000 gain: for someone earning $120,000, the short-term taxes could hit $2,400, while the long-term taxes might only be $1,500. Adjust your sale timing carefully, as it could vary by $900.

Harrison notes, “The more you earn, the more valuable tax credits and deductions become.” He points out that factors like employee benefits and investment allocation profoundly affect tax planning.

When it comes to withdrawing from a Traditional IRA, waiting until after age 73 to start withdrawing can push you into a higher tax bracket. However, if you’re in a lower bracket during your gap year, taking from a 401(k) early could be beneficial.

Financial experts generally recommend strategically using pre-tax accounts to manage taxable income, especially between retirement and age 73.

If an investment’s value falls, selling it could actually offset gains elsewhere. This approach, known as tax-loss harvesting, reportedly saved Wealthfront customers about $49.83 million in 2024.

It’s worth noting that capital losses first counterbalance gains of the same type. Any remaining losses can reduce ordinary income by up to $3,000 and can be carried over indefinitely. But be aware that these must be realized by the end of the year.

The period between retirement and age 73 presents a valuable tax-planning window that many people tend to overlook. Thoughtful withdrawals from accounts, rather than waiting until forced distributions kick in, can help balance taxation and avoid spikes in tax liability.

For couples, maintaining siloed finances often prevents effective tax planning. Filing jointly can give larger capital gains limits and allow a non-working partner to fund a spousal IRA.

Strategic planning is essential—whether high-income earners maximize retirement contributions or low-income earners effectively contribute to their future. Collaborating with an advisor can lead to significant tax savings for the household as a whole.

Harrison mentions, “We always inquire about the client’s relationship with their tax professional. If their preparer isn’t providing forward-looking tax projections, we usually suggest seeking someone who will.”

So, remember, tax surprises often accumulate incrementally. Before you make any financial moves, consider reaching out to a CPA or financial advisor. The cost of this conversation is minor compared to the potential tax burdens you might face down the road.