‘Tis the season – 3 Must-Do’s for Your Taxes

I do not file or complete tax forms for clients, but I do see the fall-out from people’s taxes in the form of IRS debt, penalties, and, perhaps most pervasive, anxiety.

No matter how much anxiety you might have, or how little you have saved to pay your taxes or how little you withheld all year, you are ALWAYS BETTER OFF COMMUNICATING with the IRS and not trying to avoid your tax responsibilities. They will not go away. They will only get worse. Like most challenges in life, it is better to face it and not try to avoid it.

Here are the three tips I give all my clients when it comes to taxes:

  3. Adjust your withholding to suit your needs

The IRS penalizes people not only for not paying, but also for not filing. You must file, even if you cannot pay your taxes on April 15th. What I encourage people to do is to file your taxes no matter what and immediately (prior to April 15th, if possible) arrange a payment plan for the amount you cannot pay.

I know this may sound strange, but the IRS is actually pretty flexible and wants to work with you as long as you tell them what is going on. It’s always better to tell them and work out a solution to avoid mounting penalties and interest. Even if you are already in debt to the IRS, you still MUST file each year and make a payment plan for existing debt and any new debt that might accrue this year.

Lastly, in order to avoid shocks in April, make sure you are withholding properly from you paycheck. The IRS provides a withholding calculator here. Some people like to get a big refund check. If you get a big refund check, chances are better that you will save it or pay down debt rather than blow it during the month as you might do if you withhold less. If you choose to withhold less, yes, it’s more money in your pocket each paycheck, but it’s harder to remember to save $83.16 each pay check and easier to remember to save $2500 each year when you get it in one check from the IRS.

The other side of the withholding coin is that you are giving the government an interest free loan. In theory, you could be earning interest on that money (or having it grow) in some other investment. The reality is that most people do not invest the difference wisely. Mostly, it’s invested in Starbuck’s, Chipotle and Amazon.com. If you are at risk of spending and not saving each paycheck, then go with larger withholding and wait for that refund check. It’s psychological, but it matters.

If you are self-employed and you have to pay quarterly estimated taxes the first two tips still apply, but the third tip is to adjust your estimated taxes so you do not get a shock at the end of the year (plus penalties for underpayment of estimated taxes).

The IRS provides you with what is benignly called “safe harbor” if you pay at least 110% of your last year’s taxes each quarter you will be considered to be paying the minimum acceptable amount for estimated taxes. That math looks like this for someone who, for example, paid $20,000 in total taxes in 2014.

$20,000 * 1.1 = $22,000 divided by 4 (quarters of the year) = $5500/quarter

However, if you have grown your business or are making more money from your self-employment practice this year than last, you SHOULD INCREASE that quarterly payment. Otherwise you will be surprised at the end of the quarter or year. Ask your accountant to give you a quarterlies estimate to stay out of shock.

The bottom line is the IRS will outlast your ability to avoid your taxes and you will only run up a bigger bill. Just do it – file and get on a payment plan if you need to.