Q: How do you know when you’ve been at this too long?
A: When you you are halfway done on a post about how to underwitholding taxes without paying a penalty, only to find out you’ve already done it! Check out my post on April 23rd of last year – Maximizing My Tax… Bill? Underwithholding On Purpose. Let’s see if I can add to what I wrote already without too much overlap…
First, a quick summary from the IRS:
Generally, most taxpayers will have paid enough tax to avoid this penalty if they have paid at least 90% of the tax shown on the return for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
The easiest way is to use the 2nd option, taking 100% of the tax you owed from the prior year. That way you have a solid number to work with. Of course, this won’t help if your income drops. In 2004 we paid $8,600 in taxes. So $8,600 was the magic number. All we had to was make sure we at least withheld that much by the end of 2005, no matter what our income was.
To do this, we just raised the deductions on our W-4 forms to have less money withheld from each paycheck. Once it was about November, we checked in and hadn’t contributed enough, so we just did a one-time extra witholding request to payroll. We ended up paying a little over $9,000 in taxes, even though we owed a lot more. Still, no penalty, confirmed by Turbotax. We just have to pay up by April 17th.
Now, this didn’t really save us all that much money, it was really more of an experiment. Say we averaged $2,000 in savings over the year, that would have earned about $80 interest in a savings account. If you add in that you don’t have to pay up until April 15th, we’d net about $100. (Still, free money is free money.) But, if you got a huge refund this year, or plan to earn a lot more in 2006 than in 2005, this could be an easy way of Uncle Sam giving you an interest-free loan instead of the other way around.
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Random comment, but I thought I would share. So I got my state refund last week electronically ($77). Great. But then I got a check in the mail a few days ago… for a state tax refund. WHAT?? For $147. Needless to say, I was confused. So I checked my bank statement online. Yep, $77 last week for a state tax refund. I check the copy of my taxes and, yes $77 was the correct state tax refund. Well, what is this $147? Maybe they messed up? I stared the check and the sheet of paper with it for a few minutes. Then I saw it. State tax refund for the 2004 tax year. 2004??? I check my old taxes. Yep, I was owed $147 from the state. Yet, I only received the payment over a year later! First off, that’s crazy. Second off, how’d I not realize I didn’t get my state tax refund last year??? Oh well…
Miller
Sounds like you have so much money, you can’t even keep up with it. LOL
I make quarterly adjustments to my W-4 throughout the year. Since I’m closing on the house next month, I’m about to decrease my withholdings some more. I’ve never owed taxes, but I’m coming pretty close to breaking even.
Ack… the title should be withOUT penalty…
I made my first mutual fund investments in 2000 (good timing!), and in 2004 reinvested in some much-better run funds. That left me with a substantial capital loss, of which I had a $1700 carryover for this year.
Knowing that, I lowered my withholding, which would have put me a couple hundred short and (despite some capital gains and other investment incomes) ended up with a smooth $12 refund this year. How’s that for precise targeting?
I’ll have to check to make sure I’m not withholding too little for 2006, though.
This subject always confuses me. I think that I must owe a penalty this year since I owed the gov’t $6000 last year and $6000 again this year…but Turbo Tax didn’t say that I owe one, so I don’t know. I basically hate evreything about our tax system…so damn confusing.
With some planning, you can adjust your W-4 to pay most of your tax late in the year. Invest the extra take-home early in the year.
Note: this only works when taxes are witheld from your pay, NOT if you make estimated tax payments quarterly.
Random curiosity: I was looking at the TreasuryDirect.gov site, and noticed that new rates are going to take effect on May 1st. Now, I bought an I-Bond a few years ago and it’s at about 7.5 right now, whereas the one I bought last fall is only at about 6.7. Do we know whether the rates are going to go up, and I should wait to buy more, or they’re going to go down again, and I should buy some more now, like I regret not doing last time? Is there any way to know, or is it a complete surprise each time?
this is very confusing, although it seems like a good strategy. knowing me, i would forget to change the number of dependants on my w-4 and end up having to pay back.
Great information thanks heaps