Q: How do you know when you’ve been at this too long?
A: When you you are halfway done on a post about how to underwitholding taxes without paying a penalty, only to find out you’ve already done it! Check out my post on April 23rd of last year – Maximizing My Tax… Bill? Underwithholding On Purpose. Let’s see if I can add to what I wrote already without too much overlap…
First, a quick summary from the IRS:
Generally, most taxpayers will have paid enough tax to avoid this penalty if they have paid at least 90% of the tax shown on the return for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
The easiest way is to use the 2nd option, taking 100% of the tax you owed from the prior year. That way you have a solid number to work with. Of course, this won’t help if your income drops. In 2004 we paid $8,600 in taxes. So $8,600 was the magic number. All we had to was make sure we at least withheld that much by the end of 2005, no matter what our income was.
To do this, we just raised the deductions on our W-4 forms to have less money withheld from each paycheck. Once it was about November, we checked in and hadn’t contributed enough, so we just did a one-time extra witholding request to payroll. We ended up paying a little over $9,000 in taxes, even though we owed a lot more. Still, no penalty, confirmed by Turbotax. We just have to pay up by April 17th.
Now, this didn’t really save us all that much money, it was really more of an experiment. Say we averaged $2,000 in savings over the year, that would have earned about $80 interest in a savings account. If you add in that you don’t have to pay up until April 15th, we’d net about $100. (Still, free money is free money.) But, if you got a huge refund this year, or plan to earn a lot more in 2006 than in 2005, this could be an easy way of Uncle Sam giving you an interest-free loan instead of the other way around.