TaxAssurances Blog

Executive Summary

Life happens. Getting divorced and working at a government agency and having children and starting a business and filing taxes is an example of life happening in 2022. Those details and more are part of what I had to work with with one particular TaxAssurances client. This case study walks through the tax implications of those details.

Background

• They worked as a network analyst for a federal government agency as a W2 employee and made just over $112k in 2022.
• They set up a cyber security company as an LLC in the state of Maryland.
• They took a small taxable IRA distribution.
• They had recently been divorced and the former spouse claimed the children so they filed their tax return as single.
• They had health insurance coverage through their employer.
• They did not have any other income for the year including any cryptocurrency transactions.
• They contributed to 529 college savings plans but could not take the deduction because the former spouse is claiming the children.
• They did not own the home, they rented it.

Results

• They owed the IRS almost $2k for 2022 after the tax preparation process was completed. Their marginal federal tax rate was 24% and their effective federal tax rate was 17,7%. Their employer took out federal withholdings at a rate of 13.7%
• They received a Maryland state tax refund of over $900 and likely used the refund to satisfy an outstand tax debt.
• They did have to pay a small 10% penalty on their federal tax return for the early withdrawal they took from their IRA plan
• They had no revenue but roughly $2k worth of total business-related expenses for the LLC business.
• Because they did not own their home or make any contributions to any charitable organizations it was more beneficial to take the standard deduction than the itemized deduction.

Challenges & Solutions

Owing the IRS was something that my client expected going into the tax preparation process. They just weren’t sure what the amount was going to be. Getting the $2k figure gave them a sense of closure on the uncertainty. With that, I offered solutions to the immediate and long term issues with the tax bill.

Solution #1

I first recommended that they adjust their w4 withholdings if financially possible with their government employer. Bottom line, their employer wasn’t taking out enough in federal taxes every paycheck based on the W4 form they currently have so that’s why they owed the IRS. I say financially possible because they may need the extra money in not paying taxes to pay for rent, car, food, child care and other life expenses.

Solution #2

When we initially met to review tax documents and go over the tax preparation process for 2022, the client did not mention the new business. When they did, we were able to uncover deductible start up expenses that helped reduce what would have been a larger IRS and Maryland state tax bill.

Solution #3

Divorces can be challenging. One of those challenges from a tax perspective is who is going to claim the children on the tax return The IRS provides guidelines if it becomes really nasty but many times divorced couples can negotiate who is going to claim the children on the tax return. The 2022 agree between my client and their former spouse, the former spouse claims the kids on their tax return. I recommend that they try to alternate going forward but that will be worked out between them done the road.

Solution #4

To resolve the current tax liability I recommended that the client either pay of the bill in one payment or set up a payment plan to pay it off in installments.

Solution #5

Going forward, they are going to have business income and expenses. They want to make sure they are accurately tracking that income and expense information. Along with that, I advised them to pay any quarterly taxes when the business becomes profitable. The payments will serve as the equivalent of having taxes taken out of a paycheck at their government job.

Conclusion

This case study exemplifies the complexities of personal taxes when major life events occur. My client experienced several impactful changes in 2022, including a divorce and a new business venture. By taking the time to thoroughly understand their unique situation, I was able to provide customized tax preparation that maximized deductions and ensured full legal compliance.

A key outcome was uncovering business expenses to reduce their final tax liability. We also recommended solutions to improve tax withholding and make quarterly estimated payments going forward when they have business income. Despite owing taxes this year, our work secured them a state refund and avoided further penalties. Going forward the client has more information that will help them maneuver their tax liabilities more comfortably.