Midyear is a good time to review your tax situation. You can make sure your estimated tax payments are on track and look ahead to see if there are any tax-saving opportunities you can take advantage of before year-end.*
The IRS requires individual taxpayers to make four quarterly installment payments of estimated tax (based on the amount of the "required annual payment") to satisfy their tax liability for the year. Individuals also have the option of paying their income taxes throughout the year through payroll withholding.
To avoid penalties, payments must equal the lower of (1) 90% of the tax liability for the current year or (2) 100% (110%, for higher income individuals) of the tax liability on the prior year's return. No penalty will apply if the tax shown on the return (after withholding) is less than $1,000.
Though you don't want to underpay, you might not want to overpay either. A refund may be welcome, but it's essentially an interest-free loan to the government.
If you need to change the amount being withheld from your paychecks, contact your payroll department and ask for IRS Form W-4 so you can make the appropriate adjustments. If you have additional nonwage income, you may need to increase your withholding or make estimated payments to avoid an underpayment penalty. If you are self-employed, you probably need to make estimated tax payments.
Do you (or your spouse) have a retirement savings plan at work, such as a 401(k) plan or 403(b) tax-sheltered annuity? You can reduce your 2020 income tax liability by making pretax contributions to the plan. Permitted contribution levels for such plans are typically generous. For 2020, an employee may contribute up to $19,500 ($26,000 for those 50 and older) to either a 401(k) or 403(b) plan, unless a lower plan limit applies.
You also might be thinking about selling an investment that has performed well. If the investment is held in a regular taxable account, your capital gain would potentially be subject to tax. However, long-term capital gains are taxed at lower rates (generally 15% or 20%) than your ordinary income.
*This communication is not intended to be tax advice and should not be treated as such. Each individual's tax situation is unique. You should contact your tax professional to discuss your personal situation.