Here's One Reason You Might Have a Bigger Tax Bill for 2023
Nobody wants a surprise tax bill. Read on to see why yours may be higher than usual when you file your 2023 return.
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It's often (though not always) the case that the more money you earn, the more taxes you have to pay. Our tax system is set up with different tax brackets that impose a higher rate of tax as your earnings increase. (To be clear, that higher rate of tax only applies to your highest dollars of earnings.)
But it's not just wages from a job that you have to pay taxes on. Any income you earn is something the IRS wants a piece of. And that includes the interest you earn in a savings account.
Meanwhile, savings accounts have been paying generously in 2023, with many high-yield accounts paying in the ballpark of a 5% APY this year. But while that's a good thing from an income perspective, it may lead to a higher tax bill for 2023.
Will you owe the IRS money in early 2024?
Your 2023 tax return is due on April 15, 2024. And if you earned a lot of interest in your savings account in 2023, then during the first few months of the new year, you might have to write the IRS a bigger check than you expected.
The problem with interest income from savings is twofold. First, it's treated as ordinary income and is subject to the highest tax rate that applies to you.
Secondly, unless you're earning a ton of interest in your savings account, you're probably not making estimated tax payments on that money during the year. But think about it -- when you collect a paycheck from work, you have taxes taken out. And when you earn a consistent income from a side hustle, you're supposed to pay the IRS a portion every quarter.
If you earned a decent sum of interest in your savings account this year but never paid the IRS a portion of that total, then it's conceivable that you might have a notable tax bill on your hands in 2024.
How to minimize that tax hit
If you earned thousands of dollars in a savings account this year, then you may be looking at owing the IRS money in 2024. But you may be able to minimize that tax bill or even wipe it out completely by making some strategic moves before the end of the year.
One thing you can look at is selling investments in your brokerage account at a loss. You can use a capital loss like that to offset up to $3,000 in ordinary income. So, let's say you take a $3,000 loss but made $3,000 in interest in 2023. Your loss could offset that interest income.
Another thing you can do is contribute more funds to an IRA, 401(k), or HSA. Doing so will shield more of your income from taxes, thereby indirectly offsetting your interest income.
With an IRA and HSA, you technically have until next year's tax-filing deadline to finish funding your account. But you only have until Dec. 31 to finish funding your 401(k) for 2023 purposes.
Earning more interest on your money is a good thing. But it's important to recognize that your tax bill may be higher because of it.
If you think you'll earn a lot of interest in your savings account in 2024, one thing you may want to do is make estimated tax payments on it every quarter. You probably don't need to do this if you're talking about, say, $1,000 in interest. But if you're earning 10 times that much in interest, it's something to consider. Either way, talking to an accountant and getting their input is a good idea, especially if you have a tax professional you work with already.
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