Video: Income Tax Payments: Are You Withholding Enough or Too Much in Income Taxes? May 18, 2021
Income Tax Payments: Are You Withholding Enough or Too Much in Income Taxes?
Mark Twain once asked “what is the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.”
This is Blaine Carr with Petersen Hastings. You have probably filed your 2020 income tax return by now. Did you owe or did you get a refund? Either is fine, but you might need to modify the amount of tax you pay throughout the year.
Most people like to receive tax refunds. The bigger the refund the happier they are. What usually is forgotten is a refund means you overpaid and didn’t get to hold onto that money during the year. Assuming you pay enough tax in to avoid a penalty, and set aside some money for the tax you will eventually owe, it is actually better to owe some tax when you file your return.
I think the best plan is to base your tax payments throughout the year on the lesser of what you think your tax will be for the year and the amount required to avoid an underpayment penalty. There is test for determining whether you are assessed an underpayment penalty if you owe tax when you file your return. You will not have a penalty if you satisfy one of the following:
- You pay in 100% of your prior year tax, or
- You pay in 90% of your current year tax, or
- You owe less than $1,000 when filing your tax return
Let’s say your total tax for 2020 was $5,000 and you estimate your total tax will be about $7,000 for 2021. If you pay in $5,000 during 2021 you would satisfy the first test. If you pay in $6,300 you satisfy the second test and if you pay in $6,000 you satisfy the third test. This means you could pay in the lowest of those three amounts, $5,000. Then you can hold onto the additional $2,000 and pay it when you file your tax return and avoid an underpayment penalty.
How do people pay their tax in? Aside from paying tax when you file your return, most taxes are paid via: 1) withholding out of income or 2) estimated payments. Withholding is nice because whoever is paying your income has to send your tax to the Treasury on your behalf. It is also considered paid evenly throughout the year. That is important in terms of penalty calculations. If you have your taxes withheld you typically fill out Form W-4 and provide it to the payer of your income, but sometimes you make the election online or by filling out some other form.
If you make quarterly tax payments, you either need to base these on your actual income each quarter or pay even estimates throughout the year. Estimated tax payments are mailed in with Form 1040-ES vouchers or made electronically. The due dates for these are April 15, June 15, September 15, and January 15.
Let’s recap. You should pay enough tax throughout the year to avoid an underpayment penalty yet try to avoid getting large refunds. Consult the safe harbor rules provided by the IRS and pay the least amount of taxes in that you have to, until you file your return. Save the amount you think you will owe and earn some interest on it. Withholding from income is the preferred way to pay tax throughout the year, but you can also make quarterly payments by each respective due date. You work hard for your money so you might as well hold onto as much as you can during the year.
I recommend you consult a tax advisor prior to implementing anything discussed in this video. Please share this video with your friends and family. Come back next time and I’ll teach you how to “bunch.”