Our Huge Tax Bill… Oops

You know what’s fun during tax season?  A call from your accountant.

Why is he calling?  Taxes are due in 2 days, he usually just emails that everything is done, and then we e-sign it. Something must be up.

So, I pick up the phone,

“Hey, what’s going on?”

I just wanted to call to discuss your tax situation with you.

Uh oh, this doesn’t sound good?  What the hell could be going on?

Yeah, sure.  What’s going on?

Well, from what I’m looking at, you’re gonna owe $XX,XXX.  And I just wanted to give you a ring to discuss it, since it’s a pretty big number and I just didn’t want to email you it.

I’ll admit, it took me a little aback.  I wasn’t quite expecting that!  How the hell do we owe that much in taxes?? We had all the proper withholding in place and all that stuff.

I mean I’m all for not giving Uncle Sam an interest free loan throughout the year, but whoa!  That’s a little more than expected.  So, I had him start walking me through it.  Three main things were the culprit:

  1. Withholdings – He started explaining that I had only withheld a fraction of what I withheld the previous year.  When I changed jobs, I upped the allowances, so that I wouldn’t have so much taken out of my check.  Usually, I file as a 0 or 1 on my W-4 but I upped it to a 2.  I had kept getting checks back in the past, so I figured this time I’d stop giving so much to the government.
  2. Dividends – We have a bunch of investments in tax sheltered accounts, and as such we don’t have to worry about capital gains and dividends.  But since we have a fairly large portion in a taxable account as well, we get hit with taxes on the dividends as we’re above the threshold for the capital gains and dividend window.
  3. Distributions – This is the huge one!  So, if you followed along in our small business series, you know there is a bit of a tax break to taking shareholder distributions opposed to wages out of the company.  So, we made it so that Mrs. Wow only got paid a “reasonable” salary from her company, most of which goes into her 401k.  Then we get the profit of the company passed through to our 1040.  This becomes income, and since we didn’t pay expected taxes throughout the year, all of it is taxable now.

As we were discussing these things, he also mentioned that we had a traditional roth rollover.

Wait wait wait… That’s not a taxable event.  I make sure to contribute to a traditional post tax, then roll it over immediately so there’s not any gains.  We’d only owe tax on the gains.

He agreed.  Then he shaved $11,000 off our AGI, so that saved us a 4 digit sum in tax liability.  I guess the moral of that story is:

Regardless if they are professional, make sure you double check their work.

But the point remains, we still owed a substantial amount to the IRS.  After walking through all the different games we could play, I started to realize we were stuck.  We couldn’t do much more.

What actually happened?

So, what actually caused the problem was the distributions from the S-Corp that we own.  It spit off enough money to cause an appreciable increase in our tax liability.  Really our tax bill could be equated to:

S-Corp profit * our marginal tax rate + dividend rate * dividends

So, while it was a little shocking to get the phone call and the number, it was something that shouldn’t have been unexpected.

Is this actually a bad thing?

I don’t know that owing a sizable amount of money to the IRS in April is actually a bad thing, at least for the year of 2017.  There are plenty of stupid irresponsible things we could do with that decent chunk of change through out the year, but being the good little FIRE folks that we are, it just sat parked in our investment account.

2017 wasn’t a bad year to have a bunch of money that you will eventually owe to the IRS sitting in an investment account either.  I mean investing in the S&P for the full year and reinvesting the dividends showed a return of 21.4%, so if we owed the feds $10k, we would have made $2,140 on that money.  So, I think I’ll take that instead of having handed it to Uncle Sam during the year.  Owing that much in tax certainly hurts, but this growth helps soften the blow.

S&P 500 up 20% for 2017!!

What do we do about this now?

This year we are keeping a better eye on the S-Corp earnings.  And we’re trying our damnedest to make sure that we keep as much as possible going into our tax advantaged retirement accounts.  Both are getting maxed out, and we are matching as much as we can from the S-Corp.

Really, I don’t know how much else we can do about it. I’m open to suggestions.  I guess that’s what happens if you make a decent amount of money.

Luckily, this year with the new tax laws, we’ll get a deduction on the pass-through income to the tune of 20%.  That’s most certainly going to help with the burden!

Really it comes down to what someone way smarter than me said one time:

That’s one of those good problems to have.

But, in the mean time I will keep most of it invested and then tell Uncle Sam: Thanks for the earnings on the loan!!!

16 Comments

  • My Sons Father July 25, 2018 at 7:57 am

    You know when your accountant refers to your taxes as “a situation”, you’re in for a bit of a ride. I am painfully ignorant when it comes to taxes, so I’ll be no help, but I know the FIRE community will come through for you.
    My Sons Father recently posted…Random Question with Halt Catch FIRE

    Reply
    • Mr WoW July 25, 2018 at 8:00 am

      Yeah, it’s fine. Again, sometimes you just happen to owe. That’s what happens when you make good money. You do the best you can and then you just suck it up and do your part.

      It was just a little shocking to get that phone call. Since I thought everything was going so well. HA!

      Reply
  • APurpleLife July 25, 2018 at 9:45 am

    Woah – that’s wild! I’m glad you figured out the reason for the bill and checked the accountant’s work. $11K isn’t a small piece of cheddar. Also glad you found a silver lining!

    Reply
    • Mr WoW July 27, 2018 at 8:05 am

      It’s one of those things. It sucks at the time, but in hindsight it’s not really that bad. I think someone said about Warren Buffett losing about $10BB – “I wish I had $10BB to lose”.

      Reply
  • freddy smidlap July 25, 2018 at 9:46 am

    sometimes you just gotta pay what you owe. our accountant said the same thing in a sense. “if you owe taxes you made money.” is this a quarterly bill or what? i was just looking over tax brackets when we lost most of one income for the year. the cash flow sucks but the tax rates are great now.
    freddy smidlap recently posted…Can the FI crowd shoot a basketball?

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    • Mr WoW July 27, 2018 at 8:02 am

      So that was for the full year. It wasn’t all that more than we usually pay, it’s just it came as one big shock instead of incrementally throughout the year. So, usually it’s just a small adjustment to make it whole or a small return. This just shifted our income around enough to cause an issue.

      But, I agree, when this type of thing happens, you kinda gotta look at it and say… “I’m thankful that I have this to pay.” It also helps that we could just cut the check and be done with it.

      Reply
  • Jason@WinningPersonalFinance July 25, 2018 at 10:39 am

    This certainly is a good problem to have. Thankfully, you had the cash available.

    It sounds like you’ve done everything to minimize your tax bill. It’s okay to still owe a little when your earnings are high. Well done.
    Jason@WinningPersonalFinance recently posted…Can You Have it All? (My Everyday Money Podcast Appearance)

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    • Mr WoW July 27, 2018 at 7:59 am

      It’s funny, I have so many friends that ask about how to minimize their taxes. And I just look at them and reply, “Make less money.” There are only so many things you can do, and then once that’s done, you kind just cut the check and enjoy the roads and fire department you’re paying for.

      Reply
  • Dads Dollars Debts July 25, 2018 at 5:38 pm

    Man…that S corp is powerful stuff. Just remember to pay in advance so you don’t get hit with a big penalty next year either. If you owed this year, they will expect you to figure out why you owed money and make reasonable estimated payments.

    Reply
    • Mr WoW July 27, 2018 at 7:58 am

      It certainly is powerful. It’s changed the way we look at a lot of things from the tax and income perspective.

      So, I’ll talk to the accountant again, but as I understand it, since we pay most of it out as wages, we are paying “expected” taxes through payroll and paycheck withholdings. I could be wrong, so I need to follow up. Again, it was the first time it happened like that.

      But, even with the penalty, we might come out ahead investing it for the year then paying the taxes and penalties.

      Reply
  • Susan @ FI Ideas July 27, 2018 at 6:06 pm

    I had an S Corp back in the years 1999-2006. I did my own everything — incorporation, taxes, even payroll which was tough to understand in California. Doing it yourself has it’s drawbacks too, but I found that in the end I would understand these things better and have a good strategy going forward.

    You have successfully avoided having more payroll taxes, and I’m guessing your salary is around the 18K you can put in the 401K. It is nice that you are not limited to a percentage. I believe that’s new. Your penalties should not have been too high because if you pay 100% of what you owed the year prior, then they are zero even if you made a substantial amount more this year.

    In the end, I like that you got such a great return this year on their dime. And I totally love your cartoon. Don’t we all really care more about this than the meaning of life?!

    Reply
    • Mr WoW July 28, 2018 at 9:18 am

      Honestly, going forward, I want to start taking more of this on myself. Unfortunately, I don’t have the time at the moment, and I figured I’d have a professional take care of it so I have a pattern to follow when I do have the time to sit and do it myself. I read through it every year to get an understanding of it.

      I agree with you. We pay everything in full as soon as it’s owed, so there shouldn’t be any issues there. Also, any penalties will be fairly minor, and I don’t know that the company is going to spit off as much this year.

      Yes, I found that cartoon and thought it was eerily appropriate. What if avoiding taxes IS the meaning of life??? ******mind blown*******

      Reply
  • Ms. Fiology July 28, 2018 at 8:00 pm

    First off, congrats on having a good year financially. Woah on the accountant making the mistake about taxes on the traditional Roth roll over. Yep, all smart humans need a check! Plus I always feel like no one cares as much about our money as we do. This is such a good example of why it’s valuable to know the tax laws even when you hire a CPA.

    It is certainly nice you made some money off the money before you had to pay it.
    Ms. Fiology recently posted…Breaking The Circuit
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    • Mr WoW July 29, 2018 at 12:28 pm

      It’s always worthwhile to double check stuff. You never know what you’ll find.

      Yeah it takes the sting away if we’re making money on the money we owe. It really helps to have the market play along. When it doesnt thats another story.

      Reply
  • Woolloongabba bookkeeper August 2, 2018 at 6:41 am

    Don’t waste time on doing things that require professionals. Hire the best to get the best services out there for your company.
    Woolloongabba bookkeeper recently posted…End Of Financial Year; Getting Your Tax Deductions Right

    Reply
  • Karen Ching September 13, 2018 at 2:40 am

    That was crazy! It could really be a big shock for us when a problem arise concerning our finances and budgets. That’s why i’m so relieved to have professionals (whom I trust personally) have my back when it comes to these matters. Anyways, thanks for sharing your experience 🙂

    Reply

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