Friday, April 30, 2010


The tax season is over - to which I once again exclaim a hearty Thank God! You have sent in your return with check, or are eagerly awaiting your refund.

Now is the time to look back and learn from this year’s 1040 filing so that you can make next year’s process less taxing.

Did you get too big a refund? You should revise your withholding at work so that less is withheld.

While everyone loves, and hopes for, a big refund, from a strictly financial standpoint when it comes to your tax return it really is better to give than to receive.

Getting a refund, especially a large one, means that you made an interest-free loan to the government. If you want to loan money to Uncle Sam buy Savings Bonds or Treasury Bills.

Interest rates on deposit accounts these days are truly pitiful, and I certainly sympathize with clients who use tax withholding as a kind of “forced savings” or “vacation club”. I also know that if many of my clients got an extra $100 in their paycheck each week it would be gone before the next one arrived. But there are alternatives.

If you belong to credit union at work have the additional amount of your pay directly deposited to your account. Credit unions often pay more than banks. Or you can increase your employee contribution to a pension or thrift savings plan. This way the extra $100 never finds its way into your hands.

You can have the additional money directly deposited to a ROTH, if you qualify, or traditional IRA account.

Another good idea is to use the increased in take home pay to pay down a credit card balance. With finance charge rates as high as 20+% this is truly a good return on your investment.

Did you have a large balance due on your 2009 Form 1040 (or 1040A)? You should revise your withholding at work so that more is withheld.

While it is ok to owe your “uncles”, as long as you have the money set aside, there comes a point when you may be penalized for owing too much. The IRS and the states could charge you a penalty for “underpayment of estimated tax”.

On the federal level you could be subject to a penalty for underpayment if you owe at least $1,000.00. To avoid the penalty you must have either 90% of the current year total tax liability (Line 60 on the 2009 Form 1040), or 100% of the prior year’s total tax, paid in during the year either via withholding or quarterly estimated tax payments. If your 2008 AGI was over $150,000 - $75,000 if filing separately – you must have 110% of the 2008 total tax paid in for 2009 to be covered under the “safe harbor”. The state may have different safe harbor rules.

The penalty for underpayment of estimated tax is calculated on a quarterly basis. Withholding is considered to be made evenly throughout the year – even if more is withheld at the end of the year. If your total federal income tax withholding for the year is $10,000 it is assumed by the IRS that $2,500 was withheld each quarter, even if $5,000 was actually withheld from January through September and $5,000 from October through December.

So, if the total tax liability on your 2009 Form 1040 was $10,000, the safe thing to do is make sure that for 2010 you have $10,000 in federal income tax withheld from your various sources of income.

To change your withholding you must fill out a new Form W-4 and give it to your employer. To have less withheld you increase the number of withholding exemptions (i.e. go from Married-1 to Married-3). To have more withheld you would decrease the number. If you are married you can have more withheld by claiming “Married but withheld at higher Single rate”.

You can try to avoid or reduce the penalty for underpayment, if charged, you can “annualize” your income to show that a larger portion was received late in the year. If you sold an investment or property for a huge gain in October your penalty would be calculated on one calendar quarter.

If you choose to pay quarterly estimated taxes you can download the 2010 Form 1040-ES at the IRS website.

The IRS website also has a W-4 Calculator. And you can go to and use the free Salary Paycheck Calculator or Hourly Paycheck Calculator to review various withholding scenarios.

If you got a refund from Sam but owed your state you may be able to file a separate state Form W-4 to change only the state withholding.

More lessons to follow.