Thursday, April 25, 2013
LEARNING FROM YOUR 2012 FORM 1040
Did you owe too much, or get too large of a refund, this year? You should review and perhaps change your withholding at work.
Uncle Sam wants you to pay in at least 90% of your current tax liability, or 100% of your prior year’s liability (110% if that year’s AGI was over $150,000), paid in during the year via either withholding or quarterly estimated tax payments.
If your 2012 tax return had a balance due of more than 10% of your total tax liability, and this was not the result of a special non-recurring item, you should have more tax paid in during the year.
In my opinion, increasing withholding is better than making quarterly estimated tax payments. It is certainly much easier – and less painful. You do not have to worry about forgetting to make the payment, or not having enough cash on hand to cover the payment when it becomes due.
The penalty for underpayment of estimated tax is calculated on a quarterly basis. In making the calculation income tax withholding is considered to be paid in evenly throughout the year. So additional withholding later in the year will be applied evenly to the entire year. Because of this, increasing your withholding can be “more better” than starting to make estimated tax payments later in the year.
If you elect to make quarterly estimated tax payments you can use the federal EFTPS system to pre-schedule your payments to automatically come out of your bank account so you do not forget to make them on time.
In the past when a client got too big a refund I would scold him/her and say that he/she was making an interest free loan to the government.
While this is still true, I do not scold any more, considering the pitiful amount of interest being paid on savings account today.
Many taxpayers use excess withholding as a kind of “forced savings”, and count on a large refund to, for example, fund their vacation. They know full well that if they had an extra $100 or more in their pocket each week they would spend it. I do actually support this concept.
However, if you have large credit card debt you should use the $100 or more of overwithholding each week to pay down this debt. Because of the usurious interest rates charged by many cards, doing so will provided a substantial “return on investment”. Similarly, you can use some of the overwithholding to make extra principal payments on your mortgage and cut years off the term.
Many states allow taxpayers to file separate state W-4 forms to have different withholding than for the federal tax. If you owed Sam this year, but got a state tax refund you should think about increasing your federal withholding and reducing your state withholding so it is “revenue neutral” but applies withholding more appropriately.