Hello All! New Fool here. I just finished inputting all of my tax data, using FreeTaxUSA online. I came up with owing $4250 Federal and 4100 State. Not sure where I went wrong! I have not yet filed.
Anyway, my question is, should I put a chunk of my income into an IRA (or any other tax-deferred instrument) to reduce my taxable income, and then recalculate this years taxes?
I am a retired Federal technician, and retired military, so drawing both of those retirement annuities and also taking $1000/mo out of my Thrift Savings Plan (govt 401k). I also operate a very small photography business that grosses less than 20K/yr. I know I need to change something, but not sure where to start! On my return last year, I received a large enough Federal return to cover the $3500 I owed to State. Not sure what changed so much this year. Well, I did lose my last child dependent, but other than that… help!
Your income earned from your business should allow you to make an IRA contribution. Of course, you may want to seek the advice of a tax professional. A contribution will not completely wipe out what you owe but it will likely help.
If you want to reduce future tax liability at tax time, you could also increase the withholding on your pension(s) and/or your 401k. Also, you could simply take out less from your 401k as putting money into an IRA is effectively offset by the money you take out of the 401k. In other words, no need to make an IRA contribution if you take out less from your 401k (if you have the cash to make an IRA contribution then you did not likely need that 401k distribution).
Thank you for the reply, Hawkwin! Yes, I need to quit taking any out of the 401(k), although they do withhold Federal taxes out of that. But you are right; I don’t need that money at this time. And I will also increase the withholding on my Federal Technician pension, which was really light this year. Thank you for your input!!
Daddy-O
Not really enough information here to actually answer the question. First off, are you filing Single or MFJ (since you no longer have a dependent, I’m assuming you’re not filing HOH)?
If you are Single, assuming you have at least $6,000 ($7,000 if 50 or older) in earnings in the photography business, and you don’t have any other compensation/earnings from work (pensions and retirement accounts don’t count), you could make a fully deductible IRA contribution for 2022. That would reduce your income by $6,000 ($7,000 if 50 or older), which would reduce your Federal tax owed by $1,320 ($1,540 if 50 or older) if you are in the 22% bracket, slightly more if you are in the 24% bracket.
If you are MFJ, then your contribution may or may not be fully deductible, depending on if your spouse works and if so, is your spouse covered by a retirement plan? Depending on those answers, and what your total income is, you may be able to make fully deductible IRA contributions for both you and your spouse, some of the contributions may be deductible, or none of the contributions may be deductible.
Since you are retired military, I’m assuming you are covered by TriCare, which would make you ineligible to contribute to an HSA, so you don’t have that option to try to reduce your income. If you’re not covered by TriCare, and you had eligible HDHP coverage, maxing out an HSA contribution would help reduce income, too.
For 2022, it’s too late at this point. If you had enough taxes withheld to have paid at least your tax liability from 2021 (110% of your tax liability from 2021 if your AGI is $150k or more), then you can avoid underpayment penalties and interest for 2022. Otherwise, you will need to be sure that FreeTax USA filled out Form 2210 for you.
For the future, if you don’t mind paying taxes from your TSP, you can take a distribution that is 100% withheld that meets at least your tax liability from the prior year (110% if your AGI is $150k or more) to meet a safe harbor to avoid underpayment penalties and interest, without having to have any withholding from your other income. You can do this at any time during 2023 - even December - although I probably wouldn’t wait until the last week of December. You may still owe some taxes when you file, but you will avoid penalties.
That’s a big change, especially if you have changed from filing HOH to Single.
The IRA contribution may be non-deductible, totally deductible or partially deductible, depending on circumstances not shared by @DaddyO406, like filing status and whether the photography business already has a retirement plan associated with it. Additionally, if filing status is MFJ, deductibility depends on whether the spouse is working, spouse is covered by a retirement plan at work and the total MAGI for the couple. Details on deductibility can be found in IRS Pub 590-A 2021 Publication 590-A (irs.gov)
Hello aj485, and thank you for the detailed response!
To explain the unknowns you brought up;
I have always filed Married Filing Jointly
My wife does not work, and is not drawing a pension
My AGI this year is 120K
My taxable earnings from my photography business was 12,900
Yes, I am covered by TriCare
I am 61, my wife is 60 (but don’t tell her I told you that!)
Yesterday I suspended my 401(k) distribution. I really want to leave that totally alone for awhile.
I was thinking I need to increase the Federal withholding from my Federal Tech (OPM) annuity, and begin State withholding from my Military (DFAS) annuity. I assumed that DFAS would automatically withhold State, but apparently that’s not the case, and I didn’t notice until now.
I am also thinking I should begin making estimated quarterly payments at least to State
Since you have $12,900 in taxable income from your photography business, and neither of you has any other earned income, you are actually eligible to make up to $12,900 in IRA contributions (combined) for you and your wife. Since you are both over 50, you are each eligible for $7,000 in IRA contributions, but the total cannot exceed the $12,900 in taxable income. So you could split it evenly, one of you could max out your $7k and the other would get a $5,900 contribution, or any other combination of contributions, just so they don’t add up to more than the $12,900 in taxable income from the business.
Assuming you use the standard deduction of $25,900 for MFJ (note: the year that you each turn 65, that will increase slightly), with your $120k in income, you are about $5,000 into the 24% bracket. That means that making a total of $12,900 in IRA contributions, you should cut your Federal tax bill by about $2.9k
You may want to consider doing some Roth conversions. The difficulty is, if you don’t currently have a Roth IRA, you would not be eligible for qualified withdrawals until 5 years from now, or 2028. That said, you should be considering how much RMDs will increase your income when you are required to take them. If they will push you into a higher bracket, doing some conversions now may reduce your overall tax bill on the TSP account. (I will note that being 61 now, your RMD age is either 73 or 75 - there is some confusion in how the SECURE 2.0 Act, which increases the RMD age from 73 to 75 in 2033, calculates the RMD age for those who turn 73 in 2033 - but they have 9 years to get that fixed.)
Yes, many states don’t require tax withholding from pensions, even when there is required Federal withholding - you have to request it.
You should check to see if your state imposes underpayment penalties if you don’t make estimated tax payments - not all do. They just require that you make the total payment by the filing date. If it makes you more comfortable to make estimated payments so that you don’t end up owing a big chunk the following April, then that’s a reasonable strategy. But as long as you avoid penalties, the total amount you pay won’t be any different - just when you pay it.
On the Federal side, you do need to make estimated payments if your withhholding is not going to meet the one of the safe harbors of paying at least your prior year’s tax liability (110% if AGI is more than $150k), owing less than $1000, or paying at least 90% of your tax liability. (The first one is usually the easiest one to calculate, so that’s the one most people go with.) If you don’t meet one of those safe harbors, you will likely end up owing additional penalties for underpayment. So if your state doesn’t charge underpayment penalties, it’s probably more important to understand if you need to make Federal estimated payments.
Again AJ, thank you very much for the detailed information! I am going to look into putiing12K into a Roth. Not sure of the best way to do that, but I’ll bet I can find a whole lot of information to that regard on this website. Again, thank you!
Thank you for your response Paul!
Yes, I have compared this years return to last years. The big differences are:
No longer have any dependents
Started receiving my military retirement annuity. Knowing this was starting, I greatly reduced the disbursement I was receiving from my 401(k), so my AGI for this year only went up $4200.
Other than that, everything was pretty much the same. Such as, no State tax withheld out of either my military annuity, or my 401(k).
It seems like a very large difference in Federal, for such small changes. It’s an $8000 swing from last year! ($3800 return in 2021, $4260 owed 2022)
You can make IRA contributions for 2022 based on your business income to either a Roth IRA or a Traditional IRA. If you make them to the Traditional IRA, based on the figures you’ve provided, it will help to cut what you owe the IRS for 2022. If you make them to the Roth IRA, you won’t get a break on your 2022 taxes, but, since you are making contributions for 2022, that will start your 5 year clock for qualified withdrawals in 2022 instead of 2023.
You can also convert money from the TSP into a Roth account in the TSP, or you can do a rollover from your TSP to a Traditional IRA, and then do a conversion from the Traditional IRA into a Roth IRA. The converted amount will be added to your income for 2023, so you will end up paying taxes on it when you file your 2023 taxes.
How much did your withholding change? TSP/401(k) accounts are required to withhold a minimum of 20% of your distributions. The way I understand it, military pensions are not required to do any withholding, and if they do withhold for taxes, it’s often based on information from when you left the military, not current information. So if you had lots of dependents back then, your military pension would probably have been withholding significantly less than the 20% that was withheld from your TSP distributions.
I will point out that the $3800 is a refund, not a return. Your return is all of the forms that you used FreeTax USA to fill out.
That said, you are focusing on the wrong thing. What matters is how much your tax liability (the number on line 24 of your 1040) changed, not how much your refund/what you owe changed. The change to that is nearly all due to your child no longer being a dependent. The extra $4200 in income probably added a little to your tax liability, although a lot (maybe all) of that increase would have been offset because of the inflation factor that is applied to the tax brackets. So how much different is line 24 on your 2022 1040 from line 24 on your 2021 1040? That will explain part of the difference between getting a refund for 2021 and owing for 2022. I suspect that’s only a small part of the $8,000 swing, though.
The bigger part of the swing is probably the difference between line 33 on your 2021 and 2022 Form 1040s. That’s where your withholding and any refundable credits are accounted for. I suspect that’s probably where the biggest part of the $8,000 swing is. If there is a large difference in those lines, that’s what you need to adjust your withholding to account for.
Tax liability in 2021 - $10,601
Tax liability in 2022 - $13,333
So, $2732 MORE tax liability this year
Total payments in 2021 - $14,413
Total payments in 2022 - $9,075
So, $5,338 LESS total payments in 2022. And, there’s that $8000 swing!
It looks like my military pension is withholding a little over 10%? ($4515 fed tax withheld divided by $44,200 distribution). But here’s what looks wacky to me: on my Federal Tech pension they are only withholding 3.9%! ($1600 fed tax withheld on $41487 taxable distribution) Is that messed up, or what? And it is the same rate for last year, so it didn’t just change. But it looks like a call to OPM might alleviate a lot of my issues. The only tax liability I should have to estimate is that from my photography business.
Again, thank you very much! You are opening my eyes to things I should have been paying attention to as soon as I retired!
Daddy-O
I didn’t contribute to this thread, but welcome to the Fool. Hang around and visit some other boards / topics - you may just end up more wealthy than you thought you’d be!!
I think you are inadvertently looking at the wrong column (of the tax bracket table). If they are MFJ and AGI is $120k, and they use $25.9k standard deduction, then they are $10,600 into the 22% bracket. So a ~$10,600 IRA contribution would drop them into the 12% bracket and save only $2,332 in income tax.
I will point out that it appears that you do have an underpayment penalty issue for 2022, since your payments in 2022 were $9,075, which is less than your 2021 tax liability of $10,601.
Well, if the Fed Tech pension were your only income, it’s not actually very far off. For a couple MFJ with $41k in income and a $25k standard deduction (rounding on both numbers), they would have $16k in taxable income, all of which would be taxed at 10%, or $1,600 in tax liability, which is what was withheld, and you would have basically broken even with either a small refund or owing a small amount.
The problem is that you have more than just that income stream:
Fed Tech pension
Military pension
TSP distributions
Photography business
When you were initially getting just TSP distributions, your Fed Tech pension and doing photography, the fact that the TSP distributions over withheld at 20% offset the streams that were under withholding enough that you got a refund. Once you significantly cut the TSP distributions, you had 3 income streams that were significantly underwithholding and the income stream that was over withholding was much smaller - which is where you got in trouble for 2022.
I will note that this problem is pretty common for taxpayers with multiple jobs/income streams, which is why the IRS provides a withholding calculator Tax Withholding Estimator | Internal Revenue Service (irs.gov) to use to help you figure out if you need to change withholding or make estimated payments.
To avoid an underpayment penalty for 2023, you should be sure that your withholding from all sources will total at least $13,333 for 2023, if that’s what your final 2022 tax liability ends up being.
@DaddyO406 - You mention Roth. Remember it is two separate Roth accounts - one for you, one for your wife. The funding source for each is earned income from you, your wife, or both of you
I will mention again that using the photography business earnings to make Roth contributions will not help @DaddyO406 reduce his tax bill for 2022. He will be better off doing Traditional IRA contributions for him and his wife for 2022 to help reduce the taxes. If he wants to then get the money into a Roth IRA, he could immediately convert the Traditional IRA accounts, which would result in taxes that would be owe for 2023.
If he and his wife don’t already have Roth IRA accounts open and funded, and they fund them solely with conversions beginning in 2023, then they will have to wait until 2028 before they will be able to make qualified withdrawals, where all distributions are tax-free. Because they are both over 59 1/2, any distributions before then would be penalty-free, but they will have to follow the ordering rules from IRS Pub 590-B 2022 Publication 590-B (irs.gov) If they distribute enough of the account to start distributing earnings, they will have to pay taxes on those earnings.
If they wanted to set the accounts up to be able to take qualified (totally tax-free) distributions in 2027, rather than 2028, they could each make a nominal (say $100) contribution to a Roth IRA for 2022. That would still leave $12,700 for contributions to Traditional IRAs in order to reduce their 2022 tax bill. After each making a $6,350 contribution to a Traditional IRA, they could each immediately convert the Traditional IRA into their own Roth IRA, where they already have the $100 contribution. Again, that $12,700 conversion will be income that will be taxed on their 2023 return.
I will also note that if he’s converting money from his TSP, it will end up in his Roth IRA, not both.
