A note to clients: If you know someone who is frustrated by a surprise on their tax return this year, please consider forwarding this along to them.
Unpleasant tax surprises are usually symptoms of a deeper, process-focused problem. One of the most common frustrations we hear from high-income families (especially those not yet working with us) is an unexpected bill in April. In most cases, the surprise isn’t caused by one mistake. It’s the result of reactive (instead of coordinated) planning.
Common Example: Mutual Fund Surprises
A frequent culprit is capital gains distributions from mutual funds. Even if you didn’t sell anything, the fund may have realized gains and passed them on. This creates taxable income you didn’t anticipate. This tends to happen when:
- Investments aren’t tax-sensitive by design
- Assets are held in the wrong type of account
- Selections are made without regard to how and when gains are distributed
The frustration is less about the tax itself and more about not seeing it coming and not realizing you can do something to change it.
Stacking Income Without Coordination
High-income families often have multiple sources of income at once, like wages or bonuses, business income, investment income, and one-time events (asset or business sales). Without coordination, those layers can stack up, pushing you into higher marginal brackets and triggering surtaxes you weren’t prepared for.
This is especially common in the years leading up to financial independence.
Thresholds That Trigger Tax Changes
As income rises, crossing certain lines—even by a little—can have outsized effects:
- The Net Investment Income Tax (NIIT) surcharge on investment income at higher levels
- Medicare premium surcharges (IRMAA)
- The loss or phase-out of deductions and credits due to income floors/ceilings.
These thresholds aren’t intuitive and are rarely discussed unless someone is looking at the complete financial plan.
For Business Owners
Surprises often appear when a business interest is partially sold, stock options are exercised, concentrated positions are trimmed, or other business activity flows through to the owner. Without proactive planning, these moments are treated as tax outcomes rather than tax decisions—evaluated after the bill arrives rather than before choices are made.
Determining how to pay your taxes is not tax planning.
Choosing Proactive Planning
Tax surprises are rarely about doing the accounting “wrong.” They’re usually about missing the coordination that could have produced a better outcome. A comprehensive plan helps move taxes from something you react to into something you plan for and plan around to optimize. It won’t eliminate taxes (we wish!), but it does mean fewer surprises and more intentional decisions.
Bottom line: Tax surprises are typically symptoms of planning that didn’t happen early enough.
If you are not a client of Covenant Wealth Management, we invite you to experience the difference proactive planning makes across your entire financial plan.