Financial transactions, life changes, and events of many kinds can impact your taxes. Such situations are known as taxable events. Some of these taxable events can decrease your tax bill, but others may increase it. Understanding how your taxes might be affected will help you make decisions about what you do and when you do it.
That’s not to say that all taxable events can be controlled. Some taxable events just happen. But if you’re aware of the potential consequences ahead of time, you might be able to manage the effect on your taxes.
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Common Taxable Events
The list of all taxable events is long, but these are some of the most common ones:
- Receiving wages from an employer
- Receiving taxable interest from your bank account
- Receiving taxable dividends from investments
- Taking a taxable pension distribution
- Receiving Social Security benefits
- Making contributions to certain types of retirement accounts
- Selling real estate, stocks, bonds or other assets
- Earning business income
Reducing negative impacts
It may not be possible to completely avoid the negative impact of some taxable events, but you might be able to limit the damage. The calendar can often be your friend, because the timing of taxable events can affect their impact.
Beating bracket creep
If you know the marginal tax bracket you’re in this tax year, you might be able to avoid creeping into a higher bracket by accelerating or postponing taxable events. For example, if your income is down this year, you might want to get as much additional income on the books as you can by the end of the year while you’re in a lower tax bracket. On the other hand, if you can see that you’ll be in a lower bracket next year, you might want to put off events that could result in a larger tax bill, such as selling a major asset, until after the end of the current tax year. That way the taxable income will fall into next year, with its lower tax rate.
Controlling capital gains
Not all capital gains are taxed at the same rate. If you sell capital assets you’ve owned for one year or less, typically the capital gains tax rates will be higher than if you sell the assets after owning them for more than a year. The tax rate for short-term capital gains is the same as the tax on ordinary income such as wages and taxable interest, while the rate for long-term capital gains typically is lower. If you’ve already owned an asset for eleven months and owning it for another month doesn’t pose a financial risk, you might consider waiting to sell it so you can get the lower tax rate and save money at tax time.
Benefitting from taxable events
Some taxable events can actually lower your tax. Often such taxable events are best used in the current tax year, but in some circumstances, it makes sense to delay them. For example, if you’re losing money on an investment and plan to sell it at a loss, you can plan the sale for the best tax outcome. This is known tax-loss harvesting. For example, if your income is especially high this year, you might want to take the loss before the end of the year to reduce your income this year. If you think your income will be higher next year, consider selling the investment next year so it lowers next year’s taxes.
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Selecting the best tax filing status
Life changes such as getting married or getting a divorce can change your tax filing status, and that could have a major impact on your taxes. Your tax filing status for the year is based on your living situation on December 31st of the tax year. If you’re single on that date, your taxes will likely be higher. If you’re married and file a joint return, your taxes likely will be lower. Most people don’t plan their wedding around their tax status, but if you’re planning to get married in January anyway, you might want to tie the knot on or before December 31. You can still have the ceremony and reception in January while benefiting from your improved tax status for the prior tax year. The savings may even pay for the honeymoon!
Avoiding bad decisions
The potential impact of a taxable event is only one factor to consider when making financial and life decisions. In fact, focusing on tax consequences alone can sometimes lead to bad decisions.
For example, let’s say you’ve owned shares of a stock for several years, and the value of that stock has skyrocketed. However, the company recently had a management shakeup, and you have doubts about its ability to perform well going forward. You want to sell your shares in the company, but you realize that because of the increase in the value of the stock, selling your shares could lead to owing significant capital gains taxes.
If you hold onto your shares to avoid a large capital gains tax bill and the stock loses half of its value over the next twelve months, you could lose far more from the decrease in the stock price than you would have paid in capital gains taxes had you sold your shares at their peak value.
To see how certain taxable events might affect your tax bill, try using TurboTax’s TaxCaster tax calculator to plan your tax year. When tax time comes, let TurboTax guide you through filing your tax return. We’ll ask simple questions about your tax situation and identify all of the tax breaks that can lower your tax bill or possibly put a refund in your pocket.