Midyear tax check: 9 questions to ask

You may be able to prepare now for the tax costs of any life changes this year.

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Key takeaways

  • Evaluate the tax impact of life changes such as a raise, a new job, marriage, divorce, a new baby, or a child going to college or leaving home
  • Check your withholding on your paycheck and estimated tax payments to avoid paying too much or too little.
  • See if you can contribute more to your 401(k), 457, or 403(b). It is one of the most effective ways to help lower your taxable income for the year.
  • If you have an HSA-eligible health plan, consider contributing to a health savings account (HSA). It can also help lower your current income and help you save on qualified medical expenses now or in the future.

In the midst of your summer fun, taking time for a midyear tax checkup could yield rewards long after your vacation photos are buried deep in your Facebook feed.

Personal and financial events, such as getting married, sending a child off to college, or retiring, happen throughout the year and can have a big impact on your taxes. If you wait until the end of the year or next spring to factor those changes into your tax planning, it might be too late.

"Midyear is the perfect time to make sure you're maximizing any potential tax benefit and reducing any additional tax liability that result from changes in your life," says Gil Charney, director of the Tax Institute at H&R Block.

Here are 9 questions to answer to help you be prepared for any potential impacts on your tax return.

1. Did you get a raise or are you expecting one?

As an employee, the amount of tax withheld from your paycheck should increase automatically along with your higher income. But if you're working more than one job, have significant outside income (from investments or self-employment), or you and your spouse file a joint tax return, the raise could push you into a higher tax bracket that may not be accounted for in the Form W-4 on file with your employer. Even if you aren't getting a raise, ensuring that your withholding lines up closely with your anticipated tax liability is smart tax planning. Use the IRS Withholding Calculator and Form W-4 (PDF).

Another thing to consider is using some of the additional income from your raise to save more in tax-advantaged accounts. That way, you're reducing your taxable income and saving more for retirement at the same time. For instance, you could increase your contribution to a 401(k) or similar qualified retirement plan. Or, if you have an HSA-eligible health plan, consider contributing to a health savings account (HSA). Money is contributed pre-tax to an HSA. When it's time to take money out, now or in the future, withdrawals of contributions and earnings are tax-free* when used for qualified medical expenses.

2. Is your income approaching the net investment income tax threshold?

If you're a relatively high earner, check to see if you're on track to surpass the net investment income tax (NIIT) threshold. The NIIT, often called the Medicare surtax, is a 3.8% levy on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for couples filing jointly, and $125,000 for spouses filing separately. In addition, taxpayers with earned income above these thresholds will owe another 0.9% in Medicare tax on top of the normal 2.9% that's deducted from their paycheck.

If you think you might exceed the Medicare surtax threshold for 2018, you could consider strategies to defer earned income or shift some of your income-generating investments to tax-advantaged retirement accounts. These are smart strategies for taxpayers at almost every income level, but their tax-saving impact is even greater for those subject to the Medicare surtax.

3. Did you change jobs?

If you plan to open a rollover IRA with money from a former employer's 401(k) or similar plan, or to transfer the money to a new employer's plan, be careful how you handle the transaction. If you have the money paid directly to you, 20% will be withheld for taxes and, if you don't deposit the money in the new plan or an IRA within 60 days, you may owe tax on the withdrawal, plus a 10% penalty if you're under age 55.

4. Do you have a child under 17?

With all the expenses associated with having a child, you don't want to be giving the IRS more of your paycheck than you need to. So consider adjusting your tax withholding if you have a newborn or if you adopt a child.

Since 2017 some things have changed with regard to tax breaks for parents. The new tax laws passed in December 2017 did away with personal and dependent exemptions. In place of these exemptions, there's a higher standard deduction of $12,000 for individuals and of $24,000 for married couples filing jointly.

But the new tax laws doubled the Child Tax Credit. For qualifying children under age 17 as of year-end, the credit is worth up to $2,000. The credit phases out at higher income levels: $200,000 for single filers and $400,000 for joint filers.

5. Do you have a child starting college?

College tuition can be eye-popping, but at least you might have an opportunity for a tax break. There are several possibilities, including, if you qualify, the American Opportunity Tax Credit (AOTC). The AOTC can be worth up to $2,500 per undergraduate every year for 4 years. There are some income limits: To get the full credit your modified adjusted gross income must be $80,000 or less for single filers, or $160,000 or less for joint filers. The credit is phased out over incomes up to $90,000 and $180,000 respectively. Different college-related credits and deductions have different rules, so it pays to look into which will work best for you.

Regardless of which tax break you use, here's a critical consideration before you write that first tuition check: You can't use the same qualified college expenses to calculate both your tax-free withdrawal from a 529 college savings plan and a federal tax break. In other words, if you pay the entire college bill with an untaxed 529 plan withdrawal, you probably won't be eligible for a college tax credit or deduction.

6. Is your marital status changing?

Whether you're getting married or divorced, the tax consequences can be significant. In the case of a marriage, you might be able to save on taxes by filing jointly. If that's your intention, you should reevaluate your tax withholding rate on Form W-4, as previously described.

Getting divorced, on the other hand, may increase your tax liability as a single taxpayer. Again, revisiting your Form W-4 is in order, so you don't end up with a big tax surprise in April. Also keep in mind that alimony you pay is a deduction, while alimony you receive is treated as income—but only if your divorce or separation agreement is signed before the end of 2018. For divorce agreements signed after December 31, 2018, alimony payments will no longer be tax deductible, and alimony recipients will no longer include the payments in taxable income. In other words, for those divorced in 2018 and prior years, alimony is taxable to payee; but starting in 2019 it will be taxable to the payer.

7. Are you saving as much as you can in tax-advantaged accounts?

OK, this isn't a life-event question, but it can have a big tax impact. Contributing to a qualified retirement plan is one of the most effective ways to lower your current-year taxable income, and the sooner you bump up your contributions, the more tax savings you can accumulate. For 2018, you can contribute up to $18,500 to your 401(k), 457, or 403(b). If you're age 50 or older, you can make a "catch-up" contribution of as much as $6,000, for a maximum total contribution of $24,500. If your employer offers a Roth option in your retirement plan, you can split your contribution between Roth and traditional—but it's important to note that contributions to the traditional option will give you a tax break this year by reducing your pre-tax income. Self-employed individuals with a simplified employee pension (SEP) plan can contribute up to 25% of their compensation, pre-tax, to a maximum of $55,000 for 2018.

This year's IRA contribution limits, for both traditional and Roth IRAs, are $5,500 per qualified taxpayer under age 50 and $6,500 for those age 50 and older. Traditional and Roth IRAs each have advantages, but keep in mind that only traditional IRA contributions can reduce your taxable income in the current year.

Retirement accounts aren't the only tax-advantaged option. Consider contributing to an HSA if you have an HSA-eligible health plan. The contribution limit for HSAs in 2018 is $3,450 for single coverage under a high deductible health plan (HDHP), and $6,900 for family coverage. If you're over 55, you can make catch-up contributions of an additional $1,000. This applies to both single and family HDHP coverage. Family coverage includes any level of coverage other than self-only coverage. Since contributions are made pre-tax, contributing money to your HSA can reduce this year's taxable income.

8. Are your taxable investments producing capital gains?

If your investments are doing well and you have realized gains, now's the time to start thinking about strategies that might help you reduce your tax liability. Tax-loss harvesting—timing the sale of losing investments to cancel out some of the tax liability from any realized gains—can be an effective strategy. The closer you get to the end of the year, the less time you'll have to determine which investments you might want to sell, and to research where you might reinvest the cash to keep your portfolio in balance.

9. Are you getting ready to retire or reaching age 70½?

If you're planning to retire this year, or are already retired, and plan to begin withdrawing money from your savings, the accounts you tap first and how much you withdraw can have a major impact on your taxes as well as how long your savings will last. A midyear tax checkup is a good time to start thinking about a tax-smart retirement income plan.

If you'll be age 70½ this year, don't forget that you may need to start taking a minimum required distribution (MRD) from your tax-deferred retirement accounts like a traditional IRA, although there are some exceptions. You generally have until April 1 of next year to take your first MRD, but, after that, the annual distribution must happen by December 31 if you want to avoid a steep penalty. So if you decide to wait to take your first MRD until next year, be aware that you'll be paying tax on 2 annual distributions when you file your 2019 return.

No significant changes in your life situation or income?

Midyear is still a good time to think about taxes. You might look into ways you can save more toward retirement, gift money to your children and grandchildren to remove it from your estate, or manage your charitable giving to increase its tax benefits and value to beneficiaries. A little tax planning now can save a lot of headaches in April—and maybe for years to come.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.
* With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
The information provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at 800.829.3676.
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