Just before the 2024 tax return filing deadline, someone reached out to me because he was facing a very large tax bill. I asked him why this happened, and he said it was because he made more money than he thought and apparently didn’t make enough estimated tax payments or withholdings from his paycheck.
While I suspected that his income “problem” could be better addressed by a financial advisor, I thought my experience assisting people with tax problems could help.
So I asked him a few questions about his finances. He is self-employed but makes a point to save a percentage of his earnings for taxes. He also spends less than he earns. So far so good.
I then asked him how often he checks his bank account and his cash flow. He says that he used to check his bank account regularly but now only does so periodically. He said that looking at his bank account sometimes made him feel nervous.
I next asked him how he calculated his gross income. He said that he downloaded a spreadsheet from his bank account and added up all of his deposits. I asked him if he was sure all of those deposits were income as opposed to loan payments, reimbursements or transfers from another account.
I finally asked him how his income tax bill became so high. He said that in addition to being in higher income tax brackets, he also lost deductions, and had to pay the net investment income tax.
To top it off, his new income made him ineligible for the health insurance tax credit and he had to pay back the subsidy through his income tax return. In most cases, the subsidy amounts to a few hundred dollars per month to cover a portion or all of the monthly health insurance premiums. So paying back the subsidy could result in several thousand dollars being added to your tax bill, usually when you least expect it.
Since it is mid-October, I asked if his 2025 income will be the same or close to his 2024 income. And he said yes. This presents another potential problem because not only will he have to pay the 2024 tax, he will also have to make enough tax deposits for 2025 so he won’t get another big bill next April. If he can’t pay both bills, I generally recommend that he pay estimated taxes for 2025 and pay down 2024 in installments.
On the one hand, the guy I talked to didn’t pay attention to his finances as often as he should. If he knew about his growing income earlier, maybe he could have made some tax-deductible purchases to lower his tax bill. But it’s easy for Monday morning quarterbacks to tell someone to pay more attention to how he uses his money. But thinking about money (or lack of it) can make people indecisive or even generate stress.
On the other hand, he is also a victim of an overly complex tax system. He got hit with a huge tax bill because his income put him in a higher tax bracket and made him ineligible for deductions and credits available to low-income and middle-class taxpayers. No one knows all of the tax rules so many people probably missed out on a deduction or two. That may not be a bad thing because if everyone took advantage of every available deduction, Congress may need to pass new tax rules similar to the Alternative Minimum Tax.
Hopefully, the guy’s unusually high tax bill will serve as a reminder to be financially vigilant.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at stevenchungatl@gmail.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.
The post The High Cost Of Not Watching Your Wallet: A Tax Cautionary Tale appeared first on Above the Law.
Just before the 2024 tax return filing deadline, someone reached out to me because he was facing a very large tax bill. I asked him why this happened, and he said it was because he made more money than he thought and apparently didn’t make enough estimated tax payments or withholdings from his paycheck.
While I suspected that his income “problem” could be better addressed by a financial advisor, I thought my experience assisting people with tax problems could help.
So I asked him a few questions about his finances. He is self-employed but makes a point to save a percentage of his earnings for taxes. He also spends less than he earns. So far so good.
I then asked him how often he checks his bank account and his cash flow. He says that he used to check his bank account regularly but now only does so periodically. He said that looking at his bank account sometimes made him feel nervous.
I next asked him how he calculated his gross income. He said that he downloaded a spreadsheet from his bank account and added up all of his deposits. I asked him if he was sure all of those deposits were income as opposed to loan payments, reimbursements or transfers from another account.
I finally asked him how his income tax bill became so high. He said that in addition to being in higher income tax brackets, he also lost deductions, and had to pay the net investment income tax.
To top it off, his new income made him ineligible for the health insurance tax credit and he had to pay back the subsidy through his income tax return. In most cases, the subsidy amounts to a few hundred dollars per month to cover a portion or all of the monthly health insurance premiums. So paying back the subsidy could result in several thousand dollars being added to your tax bill, usually when you least expect it.
Since it is mid-October, I asked if his 2025 income will be the same or close to his 2024 income. And he said yes. This presents another potential problem because not only will he have to pay the 2024 tax, he will also have to make enough tax deposits for 2025 so he won’t get another big bill next April. If he can’t pay both bills, I generally recommend that he pay estimated taxes for 2025 and pay down 2024 in installments.
On the one hand, the guy I talked to didn’t pay attention to his finances as often as he should. If he knew about his growing income earlier, maybe he could have made some tax-deductible purchases to lower his tax bill. But it’s easy for Monday morning quarterbacks to tell someone to pay more attention to how he uses his money. But thinking about money (or lack of it) can make people indecisive or even generate stress.
On the other hand, he is also a victim of an overly complex tax system. He got hit with a huge tax bill because his income put him in a higher tax bracket and made him ineligible for deductions and credits available to low-income and middle-class taxpayers. No one knows all of the tax rules so many people probably missed out on a deduction or two. That may not be a bad thing because if everyone took advantage of every available deduction, Congress may need to pass new tax rules similar to the Alternative Minimum Tax.
Hopefully, the guy’s unusually high tax bill will serve as a reminder to be financially vigilant.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.
