“Taxes, taxes never fail, pay ’em up or go to jail.”
This was a fond saying of an IRS agent and friend I knew when living in Modesto, California. (We were both part of an international service association for professional women called “Soroptomists.” Basically, this organization was like Rotary for women before women were welcomed into Rotary. But, I digress.) My friend’s saying still rings true along with the inevitability of taxes and passing on.
Taxation is both incredibly important and complex. Some estimate that the Internal Revenue Code for federal taxation is more than 4 million words and 70,000 pages long. Politifact gives us a more likely precise answer: “It’s so long, no one is really sure of its length.” https://www.politifact.com/missouri/statements/2017/oct/17/roy-blunt/tax-code-so-long-nobodys-really-sure-its-length/.
The point is that having at least a basic understanding of the mechanics of taxes and their impact is essential– despite the bewildering array of chapters, subchapters, parts, subparts, sections, subsections, paragraphs, subparagraphs, clauses, and subclauses that make up the IRS Internal Revenue Code (IRC).
Because of the complexity of the IRC, I have long relied on knowledgeable and qualified Certified Public Accountants (CPAs) to shepherd us through the tax preparation and filing processes. In all things tax-related, consult your tax advisor. The discussion and tools/resources below are not intended as tax advice. Rather, they are to help you build your readiness in talking about taxes with your tax advisor. This will make you a better, more informed, more engaged and more prepared client — and maybe even reduce your fee.
Knowing what you’re paying today and conservatively estimating anticipated future tax liabilities are essential. Here are some points to consider and to remember:
For many — especially single or dual professional incomes — the yearly tax bite far exceeds necessary expenses for housing, food, healthcare, and transportation combined. Taxes touch nearly everything we do. When I give examples about the importance of cohesive, comprehensive planning, there is invariably a discussion about taxes.
Understanding the math structure of income taxation — or basic 1040 math — provides a good starting point. Here is the basic equation:
- Begin with your gross income (lines 7 – 22 on form 1040)
- + Add All Income (lines together to get total income)
- – Subtract Adjustments (from total income also known as ” above the line deductions”).
- = Equals Adjusted Gross Income (AGI)
- – Less Standard or Itemized Deductions
- = Taxable Income
- – Subtract Tax Credits
- = Total Tax After Credits
For more detailed information on the 1040 mechanics and to run hypothetical numbers, check out the 1040 calculator on this website.
Please note you may be subject to the Alternative Minimum Tax (AMT), that supersedes the tax liability calculated through Form 1040. Taxpayers that are subject to AMT calculate taxes both using the standard (1040) and AMT methods.
The AMT which was first put in place to presumably make sure that those with high incomes couldn’t deduct or exempt their way out of tax liabilities. The calculation for AMT involves starting with your AGI and adding back in certain deductions (e.g., state and local income taxes, personal property taxes). Alternative Minimum Taxable Income (AMTI) begins at $95,750 for married filing separately and $191,500 for all others. (Suggested reading on AMT changes: https://www.fool.com/taxes/2018/02/05/how-the-alternative-minimum-tax-is-changing-in-201.aspx)
The fundamentals for your current tax situation:
- Know understand the basic mechanics of taxation,
- Know your key numbers and if ever in any doubt,
- Consult with your tax advisor.
As important but not as urgent or well acknowledged as tax filing, is the need to project the potential impact of taxes in the years to come. Anticipating — with a good measure of conservative assumptions — the impact of future taxes is imperative in planning for anything more than 3 – 5 years out.
It is especially important in the analysis of retirement income distribution needs. Will taxes likely rise or fall in the future? If rising, what inflation rate should be applied? How much income will be subject to ordinary income taxation, vs. capital gains, dividends, tax-exempt or deferred income? When will income be needed and for how long? These are all questions that come into play and taxation plays a very important role in their answers.
Projecting the impact of future taxation can be done through a well-qualified Certified Financial Planner(TM) or CPA who is also a Personal Financial Specialist (PFS). Here is a useful and objective tool from the Certified Financial Planner Board on how to vet a financial advisor: http://www.letsmakeaplan.org/other-resources/selecting-an-advisor