Surprised in spring by a tax bill you didn't anticipate? Consider strategies for settling up without disrupting your longer-term financial progress.
Filing season is underway, and many working Americans are already receiving their refunds—but what happens if you were expecting to break even or receive a refund and are facing a bill instead?
First, stay calm and investigate by discussing with your accountant. Have you included every deduction? Has anything changed since filing last year? Second, start to think strategically about how to pay what you owe, particularly if your money is invested, earmarked for retirement or stashed away in an emergency fund. Lastly, put plans in place now to include tax-mitigating strategies into your financial plan for next year.
ACTIONS TO TAKE
Explore a securities-based line of credit. With a securities-based line of credit1 (SBL), you can pay the taxes you owe without touching the investments you own. With an SBL, you won't have to sell any of your holdings and will avoid disruption to your investment strategies as well as capital gains. An SBL can also help you leverage non-retirement assets by pledging your portfolio as collateral. SBL balances are paid at your discretion, with only a minimum monthly interest payment required—making it a flexible way to access liquidity without liquidating assets.
Consider tapping into your home equity. A home equity loan2 may be a more cost-effective way to pay instead of selling securities that are part of your long-term investment plan. These types of loans can offer quick liquidity and flexibility to help you meet your tax obligation, at competitive interest rates. And you may be able to avoid capital gains taxes that could result from selling appreciated investments.
Carefully select investments that could be sold for additional liquidity. In some cases, selling securities to capture capital losses or rebalance a portfolio is a good idea. Talk to your advisor about securities that could be harvested for capital losses or ones that you can sell to help bring your portfolio back into alignment with your long-term goals. Another possible benefit? Unused realized capital losses may be available to offset future tax bills. Remember, rebalancing may result in tax consequences.
IF POSSIBLE, AVOID ...
An unfavorable offer in compromise. The IRS may negotiate an offer in compromise (OIC) to help you settle your bill for less than you owe. However, be aware that there are associated costs, including a filing fee.
Paying with a high-interest-rate credit card. This kind of debt can negatively impact your credit score and quickly rack up fees, making it harder to pay down the principal. Even though the IRS also charges interest (federal short-term rate plus 3%), it's far lower than most credit card companies.
Taking money from your retirement accounts. It's not a great idea to undermine a long-term plan by withdrawing funds early. You'll be faced with penalties, as well as additional taxes on the amount you take out, which could mean you won't have as much to pay your tax bill as you thought. And you'll have even less for retirement.
If you do end up owing taxes, talk to your tax and financial advisors about other ways you can pay the bill without disrupting your investment plan or depleting savings. If you anticipate owing taxes again, you may also want to discuss your withholding amount as well as investment and tax-saving strategies to reduce your liability next year and beyond.