How income changes might affect your taxes

Many fear that earning a raise at work, winning a big client, or expanding their business into a new market can leave them worse off than before. How’s that, you ask? By catapulting them into a higher tax bracket, they think they’ll owe more tax on all of their income. This isn’t true because the federal income tax system is progressive. 

What is true is that you may run into other tax issues as your income grows. This article will discuss some potential tax issues you may encounter. We’ll also do our best to share tips on how to avoid them.

Situations where your income may grow

Promotion

As discussed at the beginning of this article, earning a promotion is not bad news for your tax return. A potential tax issue you may deal with when earning a promotion is understanding the graduated tax brackets and progressive tax rates of the federal government. The federal tax rates range from 10% to 37%. This means that as your income increases tax bracket, you’re tax only increases on the portion of income that falls into the higher tax bracket. Consult a tax professional to discuss tax strategies like adjusting your W-4 withholdings.

Inheritance

If you received an inheritance from a deceased person’s estate, you might owe inheritance tax if you live in one of the six states that levy this tax. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania are those states. 

While the recipients of the property pay inheritance tax, the estate tax is paid for by the estate. Seventeen states levy an estate tax, listed in this article from the AARP.

Business or side gig

If you recently started a business or experienced a growth in profits from an existing business, you can experience some tax issues. The most obvious is the increase in income, bumping you into a different tax bracket, but that’s not the only potential issue. 

How you file your return will differ based on how you make your money. If you freelance and have a full-time job, your W2 wages get reported as wages on the front of form 1040. If you own a business that’s a pass-through entity, you’ll do the same. You’re responsible for calculating your revenues and profits as a business owner. This can add a layer of complexity to the standard 1040 tax return.

IRS audits

Every business owner or high-income owner wants to know, “does making more money make me more likely to get audited?” Many factors weigh into your likelihood and the eventuality of the IRS setting its sights on you.

First, the IRS has experienced fluctuations in available resources over the past few years due to factors like COVID, understaffing, and falling budgets. Don’t think you’re completely off the hook because the IRS is currently working to boost audit rates for higher earners. The potential to yield larger tax adjustments lies within the high-income demographic.

So what can you do to lower your likelihood of being audited?

The IRS typically targets filers with large deductions relative to their income. They’ll hone in on these filers and look for fishy write-offs and other unusual tax evasion strategies. We cannot tell you exactly how to file your taxes, but our #1 tip is ensuring you accurately report all your income.

As your income grows, the stakes are higher, so you must take extra care. Extra precautions could include any of the following:

• Tracking down missing records well before the April 15th deadline
• Setting up financial controls in your business so you know where your money is going and where it’s coming from
• Reporting all of your income, even if it’s earned through a cash-based business
• Limiting your expenses' growth rate, especially on luxury items and experiences

Filing late

An audit isn’t the only way the IRS cracks down on delinquent filers. As your income grows, the time it takes to file your return may also increase. This is especially true if that growth is from adding another income stream. The IRS wants to be paid, and it wants to be paid on time. A bigger tax obligation due on April 15th means that if you miss the deadline, you’ll pay more in penalties, too. 

Large bank deposits

The federal government sets up a system of checks and balances to flag suspicious activities that may result from a criminal enterprise. One of those systems is the Bank Secrecy Act, which requires banks to notify the IRS when someone makes a deposit over $10,000. The BSA also requires businesses to file reports that are determined to be useful in criminal, tax, and regulatory matters.

If your income has grown to the point where you routinely make deposits of $10,000 or more, be prepared to justify where that income originated from to the federal government.

Tax management help with ComplYant

As your income grows, you step into an entirely different stratosphere of taxes. There’s big money on the line for the federal government and individuals like you who’d like to save as much on taxes as possible. Unless you're a tax accountant, you want to spend less time thinking about taxes and more time increasing your income. This is where the help from a tool like ComplYant can help.