How to avoid a large tax bill at the end of the year? - Fix your payroll withholdings
February 27, 2011
Anyone who has a check to write on April 15 hates it. For some of my clients and a lot of people who ask my advice, the response is usually the same, "why does so and so get so much back on their taxes and I have to pay?". The reason is pretty simple for many and doesn't include any magic tax gimmick. "So and so" probably has their withholdings set too high. If you are writing a check right about now, chances are your withholdings need to be adjusted.
So should you fix it and how can it be done? The answer to the first depends on how big a check. If the payment does not have a penalty, then there is really no harm in paying taxes on April 15 instead of holding it all year. (Generally any payment under $500 and even some over that will not have any penalty.) Still many don't like to write a check and would like a reasonable surprise at the end of the year. The quickest way may be to simply have an extra amount added to your calculated withholdings. The amount in Box 6 will be added to whatever amount is calculated regularly. So, if you'd like your payment to be $600 less next April 15 and you have 12 payments left in the year, Filling in $50 in Box 6 will get it done.
Another way is complete all of the worksheets on the Form W-4. There are three sections on the form to help calculate the best estimate of withholdings and avoid any large payments at the end of the year. The "Personal Allowances Worksheet" is on the front and is the part most pay attention to. But specifics of your taxes like whether or not you itemize deductions or whether both you and your spouse work can impact your refund. The two job scenario is the one I see that causes the most unwelcome payments on April 15. These worksheets are on the back of the form. Filling them out will help you adjust that allowance number.
You can always ask your payroll department for help. Some don't like to do this, because they think the payroll people are "mean". Some may be, but others probably just have a hard time being yelled at all the time (think about it, when is the last time you called your payroll department to thank them for putting your paycheck in your account on time each and every payroll). Regardless, they can frequently run a calculation to let you know what your taxes and net paycheck would be by adjusting your W-4 to help avoid that payment. Some companies will have calculators on the web. There are also some free calculators such as paycheckcity.com
One last option is to make estimated payments. Some people have income from sources other than their paycheck. Rather than trying to adjust on a W-4, estimated payments can be the best way to allow for the taxes on this income and avoid that penalty. Estimates are sent in using form 1040-ES.
Just remember. Writing a check on April 15 may be unpleasant. But many times it just means you had the money all year in your account instead of the government's. But in those cases where the payment includes a penalty, you should probably shrink it a little.
Philip Laube is a CPA in Ohio and the Assistant Vice President for Business & Finance at Muskingum University. He presents and writes about personal finance issues for college students. He can be followed at twitter and on his web site