Tax Season Advice

I cannot pass up this opportunity, which only comes at this time of year. It is, of course, “tax season.” For some it falls between January 31–about the earliest you can get copies of all the documents needed to file–and April 1. For others, it starts on April 1 and can run up to midnight on April 15, the last deadline to file taxes without penalties for dollars you owe to the IRS.

Kiplinger Magazine states that approximately 110 million taxpayers received an average refund of $2,735 for the 2008 tax year. This year it is anticipated that the $3,000 level will be reached. Those people fall into the early category above, because they want to get that huge lump-sum payment from Uncle Sam ASAP. (I’ll get back to that lump sum later)

The latter group, those who file at the last minute, do so because they either owe some additional taxes, or they have a very modest refund coming. I am in that group, and I am going to tell you why we should all be in that 15-day filing window.

If you divide $2,735 by 12 it gives you a quotient of $228. That is the average amount of money taxpayers “lend” to the federal government each month with no possibility of growth in interest or dividends. To my way of thinking, that is very poor investing.

A better way to pay taxes is to estimate how much you will owe on April 15 and then have the correct amount withheld periodically as it is earned. The goal is to try to be within $100 of you total tax liability when you file.

If your income is mainly derived from a paycheck that you receive from an employer, you can easily change your withholding by filing a new W-4. Just ask your employer for the form, or you can download one from the IRS Website: http://www.irs.gov and then turn it over to your payroll department when you complete it.

There is an easy way to calculate the optimum number of allowances on the W-4. Go to the Kiplinger Website: http://www.kiplinger.com/tools/withholding/index.php
and follow the easy steps. You might want to read the entire set of pages there as well, since Kiplinger gives excellent advice on the subject.

Even if you were to miscalculate (under-estimate) your optimum withholding amount, you can always file quarterly estimated taxes to catch up without penalty. The 1040ES form and instructions are also available at the IRS Website to help you.

The 1040ES is the same form you should use to file quarterly estimates if your income is from other sources, such as self-employment, pension, Social Security, interest or stock and bond dividends.

Now, back to that huge lump sum that so many people seem to desire… If you are one of those, you can still get that “refund” but with more bang for your buck.

Instead of making an interest-free loan to the government every payday, take the amount you have saved by decreasing your withholding and put it in interest-bearing bank or credit union accounts. Most employers have a thrift plan that allows automatic deposits to be made from your periodic pay. You still want an instant refund? Make a big withdrawal from that bank account on the same day you send in your tax forms.

I have an even better idea for you. Use that $228 per month to fund a 401(k) or Roth IRA. You won’t be able to withdraw it until you are at least 59½ years old, but it will grow at an astonishing rate to fund your retirement. The beauty of it is that you won’t even miss it while you’re funding your possible early retirement.

You might possibly be my age, and you can no longer fund a retirement program, but you probably have kids and grandkids who would really benefit from this advice. I urge you to forward it on to all your relatives and friends.