Income Tax Planning
Although we all think of April 15 as tax day, taxes are actually due as income is earned, and employers have become the country's primary tax collectors by withholding taxes from our paychecks. By far, most of the money paid in individual income taxes each year is withheld from employees' paychecks. The government also expects its share of income not covered by withholding - including income from self-employment, investments, and alimony — in installments during the year. In both cases, Social Security taxes as well as income taxes are due on a pay-as-you-go basis. If you are required to make estimated tax payments, you generally must make them quarterly — on April 15, June 15, September 15, and January 15. If you fail to pay in enough (figured quarterly), you may be subject to the penalty for underpayment of estimated tax.
As part of your year-end planning, compare your projected year-end tax payments with your expected tax liability. If your payments are less than 90 percent of current-year tax, you generally will have to increase your withholding or estimated tax payments. But if your payments will be at least as much as your prior year tax liability, you're probably safe from the penalty. If you will fall short, however, some year-end maneuvering can save you some money.
Unlike estimated tax payments - which are considered paid when they are actually paid, so a big year-end payment won't make up for earlier missed deadlines - tax withheld from your paycheck is considered to be paid evenly throughout the year. That means overwithholding in November and December can make up for earlier underpayments. If you have a job, arrange with your employer to withhold extra amounts from the final paychecks of the year. And, remember in January to have withholding readjusted downward.
Despite all the worrying, grousing, and remonstrating we do about high taxes and all the planning and conniving we do to minimize what we owe Uncle Sam, the millions of tax-refund checks the Treasury mails out each spring are proof positive that employees had too much withheld from their payroll checks.
The extent of overwithholding is as massive as it is ironic. In 2001, the government churned out over 91 million tax-refund checks. The total amount sprinkled on appreciative taxpayers was over $150 billion. The average size of the checks was over $1,650.
By keeping your withholding down to the legal minimum, you get the use and enjoyment of more of your money when you earn it rather than making an unintentional - albeit generous - interest-free loan to the government. Although the interest rate on savings accounts is only one percent or so, if you use the extra take-home pay to pay down any credit card debt, you are usually saving interest charged at the rate of 12 percent or more.
But you may want to consider overwithholding if you absolutely cannot save money when it's in your hands. Although overwithholding is an inefficient way for you to save, it's better than simply wasting the money. You can then use the refund from your return for a major purchase (for example, furniture), a vacation, to pay down debt, or for some other constructive use. Below are some tips on how to save taxes.
• Compare standard versus itemized deductions
• Make flexible spending work for you
• Keep track of medical costs
• Get serious about retirement
• Adopt a charitable attitude
• Save with the sales tax deduction
• Put off the wedding
• Sell off stock
• Give the gift of cash
• Don't let extra money sit around
• Strategies for the self-employed
Your best bet is to plan ahead. Michael J. Porro & Co. specializes in just that. We help you prepare and save on your taxes. Please do not hesitate to contact us.