Are you giving the IRS an interest free loan?

How is it already February 8? I feel like I just wrote an entry two days ago. Well, I want to thank everyone who sent suggestions for blog topics. I got lots of suggestions from clients, friends and through my email. The winner of the Kill-a-Watt energy monitor is Amy from CT. Congrats Amy. I’ll get it out to you ASAP.

On to more important matters. Now, I try not to get huffy on the blog but I think tonight I have to rant a bit. It’s tax time so not only am I preparing tax returns for my clients but a lot of people talk taxes with me. Friends, family, acquaintances, you name it. People talk money with me in general. It’s the nature of the profession. I know there are a lot of people out there who are struggling to pay their bills each month and are racking up credit card debt. Then there same people are getting THOUSANDS of dollars back in tax refunds. Are you kidding? Seriously? Why are you giving the IRS an interest free loan?

I get tons of different excuses. I can’t save on my own. I want to make sure I have enough paid in. I like getting that big check. Okay, we are going to solve all three problems right here and now and get some extra money into your budget. Let’s deal with the big check first. That big check is costing you interest each month. Even at 2.20% APY, which is what ING Direct is paying right now, if your refund was $4,000 for 2008 you lost $48 in interest that you could have earned instead of letting the government hold on to your money. More importantly, if you need that money, you cannot write to the IRS and politely ask them if you can have it back before the end of the year. You cannot request that money until you file your tax return. Do you realize that if you get paid twice a month, that $4,000 translates into approximately $165 per pay period? You are giving the IRS an extra $330 per month in the form of an interest free loan. Wouldn’t you rather have that money in your pocket?

That leads to excuse number two: I’m afraid I won’t pay in enough. Okay, we can deal with that one, too. The IRS comes out with withholding tables each year that instruct employers how much to take out of your paycheck each week based how many exemptions you put on your W-4 form, whether you claim married or single and how much you make. We are going to make those tables work for us now. Here is what I want you to do:

1. After you get your tax return filed, take your copy and open it to page two of the 1040. Look at line 61 of your 1040. If you file form 1040A or 1040EZ, you’ll need to find the line that states “This is your total tax”. Write down the amount on that line. This is the amount that the IRS is not giving you back; the amount the government keeps for income taxes.

2. Add a cushion amount to the amount you wrote on the piece of paper. Some people like a larger cushion than others. I think $500 is more than enough, but this is something you need to be comfortable with. The amount should not be more than $1,000. Try to stick to $500 though. If your total tax is $2,500 and your cushion is $500. The total amount you want withheld is $3,000.

3.  Take the amount you want withheld for the year and divide it by the number of paychecks you get each year. If you get paid every:

  • week – 52
  • every two weeks – 26
  • twice a month (15/30 or something like that) – 24
  • once a month – 12

Now, take out your W-2 and divide the amount in box 1 by the same number. If you and your spouse work, this is a bit trickier but completely doable. Take both your W-2’s and divide them separately. If you make $40,000 a year and want $3,000 withheld, getting paid every two weeks, your gross pay should be $1,538 and your target withholding should be $115 each pay period.

4. Go to IRS Publication 15. The withholding tables start on page 40. You’ll notice on page 40, the table is titled “Single persons – Weekly pay period.” The next table on page 42 is “Married persons – Weekly pay period.” Flip through the publication until you get to the table for your filing status and the frequency you get paid. In our example, we are using a single person who gets paid every two weeks. That table starts on page 44. Now that we have the correct table, we need to find our gross pay. The gross pay is in ranges. For $1,528, we are looking for the range $1,520 – $1,540. Notice there are 11 columns ranging from 0 to 10. We stated that we wanted to have $115 taken out each pay period. So move over to the amount closest to the amount you want withheld. It just so happens that $115 is the exact amount in one of the columns. If we wanted $118 withheld, we would use the next number, in this case $136. I was lucky with this example and $115 was actually the number in the column. Excellent! Now scroll up to the top of the page and see how many exemptions you would need to put on the form to have that much withholding taken out. For our example, the answer is four.

Now if you have two people working, you’ll want to split the withholding amount between the two of you. Pick the number of exemptions for each of you that gets you closest to the total amount you want withheld when you add the two figures together. If you need help with this, shoot me a comment and I’ll help you double check your figures.

5. Fill out a new Form W-4 and bring it into your employer. After the changes take effect, make sure to check your paystub to make sure the correct amount is being withheld.

If you are still worried that you are not having enough withheld, remember that you’ve had an entire month withheld at the old amount so you’ve got some extra money there, plus the cushion we added to your total tax. Also remember that if taxes go up, the withholding tables will also adjust and you’ll automatically have more money taken out of your paycheck. I know it seems like a lot of work but isn’t it worth it to have a couple hundred dollars extra each month?

Now, for the last excuse. I can’t save it on my own. How many times have we talked about automatic savings on the blog? That excuse is not allowed anymore. Open a savings account with ING Direct, HSBC Direct or another bank (I like the online banks because of the higher interest rates and the fact that it’s harder to access the money for impulse purchases) and have the extra money direct deposited into the account each time you get paid. If you don’t want to do that, set up your savings account to automatically pull the extra money from your checking out the day after you get paid. It’s automated so it forces you to save.

I want to hear from you. How much extra money are you going to have in your pocket each pay period? Post your number to get others inspired to do the same. Even a $1,500 refund could be an extra $58 every two weeks. That’s gas money, if you need it. It’s a great way to build up some savings if you can spare it.

Please note: I reserve the right to delete comments that are offensive or off-topic.