Over the past decade of specializing in tax planning for young families across the country, we have observed three key tax mistakes. Between the sleepless nights and all the time you spend with your young children, it is hard to find the time to do the proper tax and financial planning. However, this is the time when planning becomes most important and mistakes can become most costly.
Mistake #1 Owing More in Taxes Than You Expected
One of the hardest messages to deliver to a parent is that they owe more money than they thought they would have to pay in taxes. Having kids is expensive and no matter how affluent a couple is, it is a hard thing to hear that you owe more in taxes than you planned for.
The first question is why does this happen? After all, you would think that your payroll department would just automatically withhold the right amount of taxes for you. Unfortunately, the payroll department doesn’t factor in two things: alternative minimum tax (AMT) and marriage penalty.
The purpose of this post is not to teach you how to calculate the AMT, which is better left to tax professionals. However, you should know that once your income begins to exceed approximately $200,000 depending on various other deductions, you may end up owing this additional tax. Your payroll department will NOT factor this in to your withholdings and this could cause you to owe at tax time.
Additionally, there is a marriage penalty meaning that dual income households often pay more in taxes than they would as individuals filing as single people. As an example if one spouse earns $250,000 and the second spouse earns $100,000, the second spouse’s income will be taxed in the same high income bracket as the first spouse.
So what can you do about this? It is important to do a projection midyear. The projection should include all the major items on your tax return and reflect any income and bonus changes. If you are on track to owe at the end of the year, you can make adjustments to your withholdings and fill out a new w-4 or make estimated tax payments. The AMT and marriage penalty are difficult to project and a professional may be able to help you with this.
Mistake #2 OVER Estimating Tax Benefits of Buying a Home
Real estate brokers won’t hesitate to tell you about all the “amazing” tax benefits of buying home. However, they are not accountants and are eager to make a sale, so often neglect to tell you two important limitations on deductions.
1. Property tax is not deductible for “high earners” in the AMT mentioned earlier. As we all know, $200,000 in income does not make someone rich in New York, San Fran or many of the large cities where young families live. Unfortunately it is often around that income level (depending on other deductions) that a couple is pushed into the AMT. The difference between deducting thousands in property taxes or not can make a huge difference in whether you can afford that new home.
2. Mortgage interest can only be deducted up to $1.1 Million worth of mortgage balances. With real estate prices the way they are in major cities, mortgages exceeding this amount are not unusual. When you do your planning, it is important to realize than only that first $1.1 Million of your mortgages is deductible. Depending on the size of your mortgage this could vastly reduce the tax savings you derive from your mortgage interest. You may also want to plan around this and try to keep your mortgage under $1.1 Million when possible.
Mistake #3 Neglecting Retirement & College Planning Deductions
With everything so expensive these days, it is easy to ignore college and retirement planning, but this is a big mistake. For many parents, the tax rate between city, state and federal can exceed 50%, which means that any deductions save you 50% of that amount in taxes. (This is particularly true in NYC or CA and would still be in over 45% for most states.) For example putting an extra $10,000 in a 401k can save up to $5,000 on your taxes. 529 savings plans are also deductible up to $10,000 on your NY state return and many other state returns. Even more important are the longer term benefits of tax deferred growth. Most new parents lack the time to deal with these complexities and often make these and other mistakes mentioned above.