An unexpected tax bill is a nightmare that happens all too often. 😱 If you had to pay a significant tax bill after you filed your tax return this year, you’re not alone, and here are five ways to avoid this for your 2022 tax bill.
#1: Analyze Your 2021 Tax Return & Adjust Your W-4
In many cases, saving a little bit of money out of each paycheck is a great way to reach a financial goal. As it turns out, taxes work the same way. Your withholdings offer the key to avoiding a nasty surprise on April 15th.
If you received a big tax bill this year, you likely need to raise the number of withholdings that you claim on your W-4 so you can owe less than it’s time to file your tax return.
Some people love receiving a large refund check from the IRS, but remember, that means that you overpaid through the year. Adjusting your withholdings can also put more money in every paycheck.
If you received a large tax refund this year, you likely want to decrease your withholdings on your W-4 so you can potentially invest that money. You can use this tool to estimate your tax withholding and change your W-4 form by contacting your employer at any time.
You’ll also want to understand which tax bracket your household will fall into for the 2022 tax year. For example, if your household has reached a higher tax bracket but is on the lower end of the range, specific tax deductions like itemizing your charitable donations may benefit you greatly and allow you to save and give back to organizations you care about.
#2: Consider Itemizing Your Deductions
Should you itemize or take the standard deduction? This very common question comes down to some simple math:
- If your standard deduction is less than the total of your itemized deductions, you should itemize as you’ll save more money. Itemizing does take a bit of time and organization, so be prepared. (You’ll at least have all your tax-deductible receipts in one place on Daffy.)
- If your standard deduction is more than the total of your itemized deductions, you should continue benefiting from the standard deduction.
Since the standard deductions have gone up recently, outlined below are the standard deductions for 2022.
- Filling status:
- Single - $12,950, up $400 from 2021
- Married, filing jointly - $25,900, up $800 from 2021
- Married, filing separately - $12,950, up $400 from 2021
- Head of household - $19,400, up $600
Although the standard deduction is easier than itemizing, if you have a mortgage or home loan, it’s worth seeing if itemizing would save you money. For most people, the biggest tax breaks come from deducting mortgage interest and their state & local income taxes.
Start by comparing your mortgage interest deduction amount to the standard deduction. In general, you can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately). If you bought the house before Dec. 15, 2017, you can deduct the interest you paid during the year on the first $1 million of the mortgage. If this brings you close to the standard deduction, then consider itemizing as you can also deduct your property taxes, state income taxes, and charitable donations, too.
For example, let’s say you live in a state with a high-income tax, like California, and you got a $750,000 mortgage to buy a house in 2020. If you paid $25,000 in interest on that loan during 2021, and more than $10,000 in state income tax, you probably can deduct the $25,000 in interest plus up to $10,000 of your state income tax on your return.
#3: Max Your 401(k) or IRA
401(k)s, typically offered by employers, and IRAs, individual retirement accounts offered typically by investment firms, are other popular ways to reduce your tax bill.
Be sure to max out your contributions to these accounts as they will prepare you for your future retirement and help you save on taxes.
- For 401(ks): For 2021, you could have stashed up to $19,500 per year into a 401(k) account. In 2022, this rises to $20,500.
- For IRAs: For 2021 and 2022, the limits for an IRA are $6,000 per year or $7,000 for people 50 or older.
#4 Have Children? Start Saving for College
529 plans are another great financial product as they are a tax-advantaged savings plan designed to help pay for education. They were originally limited to college education, but it was expanded to cover K-12 education in 2017 and apprenticeship programs in 2019. The two major types of 529 plans are savings plans and prepaid tuition plans.
While you can’t save and deduct your contributions to these plans on your federal income taxes, you might be able to on your state return if you’re putting money in your state’s 529 plan. Plus, all of your investment returns on these accounts are tax-free, as long as you use the money for education — a big tax advantage versus saving the money in a normal brokerage account.
Another fun fact: you can even open up a 529 plan for yourself, which might make sense if you plan on getting an additional degree or just some additional classes in the future.
#5 Give More to Charity
Charitable contributions are tax-deductible and allow you to give to causes and organizations you care about most. For the 2021 tax year, IRS temporarily allowed individuals to deduct $300 per person (those married filing jointly can deduct up to $600) on their tax return without having to itemize. However, as of April 2022, this does not apply to the 2022 tax year.
If you itemize, however, the limit on the charitable deduction is quite high: up to 50% of your adjusted gross income (AGI) if you are contributing cash, and up to 30% of your AGI if you are donating property like appreciated stock, ETFs, or crypto.
You don’t have to be a billionaire to contribute a large amount to charity. If you want to make the most of your giving, consider “the bunching strategy,” which allows you to stack your gift-giving in a tax year. Let’s say you’re single and you would like to give a total of $8,000 slit between your four favorite charities. But since you don’t have any other itemized deductions, you wouldn’t qualify to claim the full donation as an itemized deduction (the 2022 standard deduction for single filers is $12,950). This is when you should consider bunching your donations. With bunching, you can give $8,000 on January 1, 2022, and another $8,000 on December 31, 2022, which allows you to claim the $16,000 gift as an itemized deduction on your 2022 tax return and may reduce your taxable income.
This is also another reason to consider a donor-advised fund like Daffy because you receive the tax deduction for any contributions made in that calendar year. So in this case, if this individual were to contribute $16,000 to their Daffy fund on December 31, 2022 (although we encourage you to do it sooner, much sooner), they’d receive the tax deduction for 2022, and then they’d still have time to research and gift the money to charities. Plus, you’ll have all your tax-deductible contributions in one place for tax season.
Now don’t wait until the end of the year to figure all of this out, consider setting a goal for how much you want to give this year and automating your contributions on a weekly or monthly, you can get started today.
Please note that the information contained on this page is for educational purposes only and should not be considered tax advice. Any calculations are intended to be illustrative and do not reflect all of the potential complexities of individual tax returns. To assess your specific tax situation, please consult with a tax professional.