Pay Yourself First

Now that we’re well into the new year of 2009, if you’re anything like me, you are probably starting to gather all of your tax records together to file your 2008 tax return.

I got an ad in the mail today from Jackson-Hewitt. The eye-catcher was a statement that “9 out of 10 Jackson-Hewitt customers get a refund.” That might be true, but it says a lot about how ignorant the average taxpayer is when it comes to withholding.

I am retired, so I don’t have an employer to withhold taxes. I do request that taxes be withheld from my retirement pay and from my IRA withdrawals. I also pay quarterly estimates. As a result, I will owe $124 when I file my tax return on April 15th. That’s right, it is that close to being dead even, even though I have paid in about $4,500 for 2008.

The average tax refund last year (2007 tax year) was close to $3,000. It will probably increase this year, since it has done so almost every year for the past three decades. Did you know that many people who get those refund checks after filing their taxes believe that they didn’t owe taxes. Since they receive a refund, regardless of the fact that it isn’t a full refund of all taxes paid, they actually think they didn’t have to pay anything.

The tax refund of $3,000 per taxpayer is a free loan to the government, and it is wasted money. You’re likely asking yourself how it is “wasted” since you get it back. Well, it could be saved in an interest-bearing account, or it could be invested in some stocks or bonds. It could also be deposited in a retirement plan like a 401(k) or even an IRA. In any one of these instruments, it could do more for you than it does as a misnamed refund. It isn’t a refund, it is your money and it always was yours.

You might not recall it if you’ve worked for the same employer for several years, but when you were hired you filled out a Federal Form W-4. On it you told your employer either A) how many dependents you had at that time, or B) how much of each paycheck to hold back for taxes. If you are married, I can almost guarantee that you checked the box that reads, “Married, but withhold at higher Single rate.”

The reason I can make the above claim is that all the instructions on the W-4 intimidate you into thinking you might have too little tax withheld. There is no explanation of what happens if you do have too little withheld, but the implication is that you could suffer “penalties” for underpaying. Nothing could be further from the truth.

That last statement has nothing to do with the strange cases of Tim Geithner and Tom Daschle that have received so much publicity in the past few weeks. They probably should have paid both interest and penalties, based on the guidelines I will tell you about shortly. But I digress...

Another source of overpaying taxes is that very few people take the time and effort to submit a new W-4 when life events occur, such as birth or death of a dependent, divorce, additional job, or working spouse. Any of these events that take place after you have turned in the W-4 should trigger a new and revised one. However, you don’t even have to wait for one of these to happen. You can choose to revise your withholding for any reason.

My recommendation is for you to take every legal deduction you can on the W-4 so that the very minimum tax is withheld. That might cause a shortage in your withholding tax. You can correct that very easily by sending in a check with the Form 1040ES four times a year. Anyone can pay quarterly estimates, and there is no penalty for doing so.

The real advantage of using quarterly estimates is that it gives you the opportunity to check your tax status at least four times a year, and it is very quick and easy to accomplish the checkup. You might have to send a check for $100 or so, but at least you have the use of that money until it is due. I use the 1040ES to send in $400 every quarter, and there is no late penalty or interest due for my underpayment during the quarter or the year. The 1040ES is due on April 15, June 15, September 15, and then on January 15 of the following year.

If you can use a calculator and you keep track of your income and the tax that has been withheld, it is very easy to file your final tax return with a minimum deposit or refund. And those penalties and interest only come into play when you A) owe more than $1000 with your return, and B) paid in, or had withheld less than your tax liability for the prior year, or C) did not pay in fairly even installments for each quarter of the year.

How do I know all this stuff? I worked as a tax preparer for H&R Block for several years, and I had to take refresher courses every year. I think I know even more than I divulged to you today.

Please stop giving the government more of your money than you owe, just so you can feel like you don’t owe anything on April 15th. Most important is that you take an active part in determining how much of your money is being used by the government as interest-free loans.