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!!!