By Babak Gahvari, CFP®, AIF®,Managing Partner
Around late February, my inbox usually starts to fill with the same kinds of tax questions. Some are simple logistics. Others are a little more nuanced once investment income, partnership income, or side businesses enter the picture.
One of the first things people ask is when taxes are actually due. Most people know the answer is sometime in April, but the details matter more than you might think. The filing deadline is typically April 15 unless the calendar shifts it slightly. Extensions are available and fairly common, but there is a misconception that an extension means you have extra time to pay. It does not. The IRS still expects payment by the April deadline. The extension simply gives you or your tax preparer more time to finalize the return.
After that, the next conversation almost always drifts into tax brackets. Every year, someone tells me they turned down income because they were worried about “jumping into a higher bracket.” The tax system does not really work that way. Income is taxed in layers. Crossing into the next bracket only affects the dollars above that threshold. The rest of the income stays taxed at the lower rates. Where things get a little more interesting is once income reaches the levels where additional taxes show up. Investors often run into the Net Investment Income Tax, and higher wage earners can see the Additional Medicare Tax appear without realizing it was coming.
Deductions have also changed quite a bit over the last several years. Before the tax law changes in 2017, itemizing deductions was far more common. Today, many households simply take the standard deduction because it is larger than what they would itemize. That said, there are still situations where itemizing makes sense. Charitable giving is the one I see most often. Some families have started grouping multiple years of charitable gifts together so that they exceed the standard deduction threshold in a single year. Donor-advised funds make that possible while still allowing the charities to receive the money gradually.
Investment income introduces its own quirks into the tax conversation. The biggest one is the difference between short-term and long-term gains. The holding period matters more than many people realize. Gains on investments held for less than a year are taxed at ordinary income rates, which can be meaningfully higher than long-term capital gains rates. Dividends can also be taxed differently depending on whether they qualify for preferential treatment. Once income rises high enough, that 3.8 percent Net Investment Income Tax can quietly add to the bill as well. This is also where the topic of tax loss harvesting tends to appear.
The basic idea is straightforward. If part of a portfolio is sitting at a loss, selling that position can generate a tax loss that offsets gains elsewhere. Sometimes that loss can even offset a small portion of ordinary income each year. There is one rule investors should know about, though. The wash sale rule prevents someone from selling a security at a loss and then immediately buying it back simply to capture the tax benefit. It forces a waiting period before repurchasing a substantially identical investment.
Estimated taxes are another area that surprises people, particularly those who move from being an employee to earning consulting or partnership income. When income comes through payroll, taxes are withheld automatically. When income comes from other sources, the IRS generally expects payments to be made throughout the year. That is where quarterly estimated payments come in. Many taxpayers rely on the safe harbor rules, which essentially allow payments based on the prior year’s tax liability to avoid penalties.
More recently, I have also seen questions about reporting investment activity, particularly with digital assets. Brokerage firms typically provide forms summarizing stock sales during the year, but taxpayers are still responsible for making sure the information is correct. Cryptocurrency transactions can be more complicated because activity might be spread across multiple exchanges or wallets. Even trades that never convert back into dollars can sometimes trigger taxable events.
Finally, people who earn income outside a traditional employer relationship often discover they have access to retirement planning options that employees do not. Self-employed individuals can contribute to plans like SEP IRAs or Solo 401(k)s, which allow significantly larger contributions than a traditional IRA. In some cases, they may also qualify for the Qualified Business Income deduction, though that deduction comes with several income thresholds and limitations.
When you step back from all of these questions, one pattern becomes clear. The tax return itself mostly documents what already happened during the prior year. Many of the decisions that influence the final tax bill occur long before filing season. By the time the return is being prepared, the window for most planning has already passed. For that reason, the most productive tax conversations usually happen well before April and often benefit from working with a financial advisor.
This article is intended for general informational purposes and should not be considered tax advice. Individuals should consult their tax professional regarding their specific circumstances.
