When my husband came to find me a few weeks ago after putting together our taxes, I could tell from the look on his face that things weren’t good.
“How much?” I asked, assuming right off the bat we were looking at owing money. Well, I won’t share the exact amount — mostly because it pains me to even put it in writing — but let’s just say we somehow managed to underpay the federal government well over $2,000 and as a result found ourselves dipping deeply into our savings account to come up with the funds we owed.
A Good Thing or a Bad Thing?
The funny thing about owing money on taxes is it’s not necessarily a bad thing. Although nearly eight out of every ten people get federal tax refunds each year, some accountants will tell you that getting money back means you overpaid throughout the year and therefore essentially gave the government an interest-free loan.
On the other hand, there’s the psychology of the refund to consider. Many people who get refunds don’t necessarily expect to receive money back from the government, and although they’ve technically paid more than they needed to up front, they’re able to enjoy their newfound money once it comes in. Along these lines, those who owe money unexpectedly often have the opposite experience — that they’re suddenly being robbed of money they thought was rightfully theirs.
Regardless of where you tend to side in this debate, one thing’s for sure: You don’t want to owe so much money that you’re forced to pay a penalty. Usually you can avoid this if you:
• Owe less than $1,000.
• Paid at least 90 percent of the taxes you owed for the current year, or 100 percent of the taxes you paid last year.
Avoiding the Situation in the Future
Unfortunately, if you’ve discovered you owe money this year, it’s pretty much a lost cause. But there are steps you can take to avoid owing money next year.
• First, check your withholding status — that’s the amount your employer is taking out of your paycheck. Did you claim too many allowances? You may need to correct your W-4. You can also try using the IRS’s estimated tax calculator to see if you’re paying enough and then adjust your withholdings accordingly.
• Next, review other sources of taxable income. Did you earn a lot of money from a savings account or Certificate of Deposit? Did your investments pay dividends that propelled you into a higher tax bracket? Growing your money is never a bad thing, but if it causes an uncomfortable situation come tax time, you may want to rethink your current strategy.
• Finally, if you’re worried about owing but don’t want to overpay and lose out on interest, you can leave your W-4 as-is but create a separate savings account designated for tax money — money that, in your mind, isn’t really yours. You can then put in money each month so that it accumulates over the year. If, come tax time, you see that you owe money again, you can simply dip into your special account to pay the government, as opposed to having to tap into your savings. And if you find that you don’t owe on your taxes, that money is yours to keep, and you’ll have earned interest on it as well.
Filing our taxes was a major wake-up call for us. Although it was a lousy way to learn our lesson, we’re already taking steps to get smarter and avoid a collective panic attack come April of 2017.