Today we take a break from holiday stress for something new. Tax stress! The last two years, my husband and I completed the draft tax forms to make sure our withholding was correct. Both years, it wasn’t, so we made arrangements to fix that. Now is the best time to do a bit of tax prep to ensure that you don’t receive a penalty, or at the very least figure out how much money you need to save before April 15.
Tax Withholding and Penalties
My husband and I are subject to what I consider a marriage penalty, even though it isn’t really. Because we have a high joint income, but no kids or mortgage, we take a larger tax hit than a similar couple with either of those. If we weren’t married, we’d both qualify for the student loan deduction. Because we’re married, we don’t. If we weren’t married, we’d both be in the 25% tax rate. Because we’re married, we’re in the 28%.
Of course, this isn’t the kind of penalty that the IRS levies intentionally, it’s just the way our dear tax system is set up. There’s also another penalty you need to be concerned about: the underpayment penalty. If you don’t withhold enough from your paychecks or file quarterly taxes, you could be subject to a penalty. Fortunately, you escape the penalty if you’ve withheld at least as much as you owed in tax last year. That’s helpful for people who received raises or taxable windfalls, but didn’t correct their withholding. Most states also follow this policy, but make sure if you owe more than you withheld.
Strategies if You Owe More than Expected
Thanks to raises and the windfalls that allowed us to pay off our debt, our tax for the year has nearly doubled. Sadly, that doesn’t mean our income doubled. It means we have to pay self-employment tax on the windfalls.
Last year, we found that we’d underwithheld by accident, so we withheld my last two paychecks in their entirety to cover the difference. This year, we adjusted our withholding, but even that wasn’t enough. We’re again foregoing my paychecks in December, but we’ll still be on the hook for about $8,000 (Federal and State) come April. Here’s our plan to deal with that:
Accelerate deductible expenses. If you were putting off any deductible medical or business expenses, make those expenditures now to reduce your taxable income this year.
Delay bonuses and windfalls. Ask to delay the payment until January if you haven’t yet received the money and you know it will push you into a new tax bracket, like it did us.
Withhold extra now. If your cash cushion allows it, withhold more from your paychecks now. File a new W-4 with payroll indicating the extra amount. Just remember to give them a new form before January 1.
Start saving money. In addition to withholding extra now, we’re also going into mega-saving mode. We need to save $2,000 a month between December and March to cover our taxes. It’s doable, just annoying because it will delay our emergency fund plans.
Sell losing stocks. If you own stock in a taxable account, you’ve probably got some major losses. You can sell some of those stocks (the real dogs) to create a loss that will reduce your taxable income. If you think those stocks will recover, buy them again 31 days later.
There’s no two ways around it: taxes suck and have all sorts of hidden penalties depending on your financial situation. The best you can do is prepare now so you don’t have to charge taxes to your credit card or pay a tax penalty. The draft IRS forms can be found online. Your state may also have draft or final forms available.
