Too High, Too Low, or Just Right.
At some point during the year, you need to make sure that you are set to pay the right amount of income tax to your state and federal governments. If you estimate too low, you may end up paying penalties. Estimate too high and you are essentially giving Uncle Sam a free loan. How do you effectively project your tax liability? Here are some ways to help you avoid April 15th surprises.
Estimating Income for Tax Projections
You may think you’re fine because you made the same amount last year, but you need to consider more than your pay check. While your salary and withholdings may be the same, other factors may have changed that impact your income and taxes you owe. You and your accountant need to look at all sources of income as well as things that may alter your tax rates, including:
- Multiple employers or extra income
- Interest and dividend income
- Investment gains
- Home (or land) purchase or sale
- Change to marital status
Projecting Your Taxes
Once you have completed your income projection, your accountant can help you estimate the taxes that you will owe for the year. The goal, of course, is to pay the right amount so there are no large payments or refunds. If for some reason your calculations are off, it still may not be the end of the world.
- Underpayment – If you’ve paid at least 90% of the current year’s tax due, or 100% (110% if Adjusted Gross Income is more than $150K) of the prior year’s tax payment, there’s a good chance that you’ll be just fine. Beyond that, there may be penalties. The penalties may vary based on how you’ve paid your taxes, so you’ll want to ask a CPA for assistance calculating the correct penalty amounts.
- Overpayment – Some clients like to see a big refund check after April 15th and use the windfall to pay for vacations or make other purchases. Rather than giving the government a loan, why not keep that money in your pocket and use it over the course of the year to save for retirement or pay off your debt? It’s not as much fun, but certainly more practical.
If you wait until April 14th, there’s not much that your accountant can do to help. It’s better to review your tax situation twice during the year. Make your first projection early in the year while there is still plenty of time to adjust tax withholding amounts. Then review those projections at the end of the year in case you need to pay incremental estimated taxes or make additional contributions to retirement plans.
Bach, James, Mansour & Company can help you organize sources of income and estimate tax liability. Please contact us to set up a meeting.