How many of you met with your accountant this year on or before April 15 and were shocked by the amount due? How many of you did not plan in advance and had no idea what number you would end up with?
This is not a good feeling for anyone, and rest assured, there are ways to avoid this guessing game. Furthermore, in today’s challenging economic climate, cash flow planning is imperative. This includes planning for income tax payments (or refunds).
We have all heard about the under-payment penalties and interest that the Internal Revenue Service tacks on to your tax bill if you underpaid your taxes or did not pay enough early during the year.
You want to make sure that you have paid in enough in advance to avoid any of these penalties.
While these penalties and interest can add to your tax burden, nobody wants to overpay the IRS either. While the government charges penalties and interest if you underpay, they don’t pay you any interest if you overpay.
So, good cash flow management will mean that you pay just enough to avoid penalties, but not too much to create an interest-free loan to the government.
To find the right balance, you need to understand the estimated tax and withholding rules. This starts with making sure estimated tax payments and withholding combined meet the safe harbor amount as determined by the IRS.
There are two options for paying your safe harbor amounts.
The first option is to pay 100 percent or 110 percent (if your adjusted gross income is more than $150,000) of your prior year tax liability. This is usually done by making estimated tax payments and withholding consistently throughout the year.
Now, since most accountants are not fortune tellers, your tax accountant has likely provided you with a schedule of estimated tax payments on the first safe harbor mentioned above to keep you protected from underpayment penalties.
However, throughout the year, if it looks like things are not going as well as the prior year with your business, you can choose the second option, which is to pay in 90 percent of your current year tax liability.
You are probably wondering how on earth you are possibly going to know what 90 percent of your current year tax liability will be if you are only one quarter of the way through the year.
The great thing about this option is that you can annualize your payments. This means that you can look at the income that you earned each period and pay your taxes accordingly. This option allows for you to plan for your taxes in a dynamic fashion, adjusting throughout the year, which optimizes your cash flow.
Hence, you will not be giving Uncle Sam an interest-free loan throughout the year and you will be able to better manage your cash flow related to income taxes.
Of course, to do this requires that you talk to your tax preparer/adviser throughout the year. There is no way to plan for the future if you do not have open communication with your accountant. Hopefully, you still like that person after April 15.
Having these discussions frequently will allow you to discuss whether business is up or down this year and whether you should adjust your estimates.
Did you make any large purchases, are you planning to make large purchases, do you want to put a retirement plan in place, etc.? All of these things have the potential to greatly impact your tax liability, and the sooner you discuss these with your accountant, the sooner you can start planning for your income taxes.
This should also help you sleep better the first two weeks of April next year.
Alisha Williams is a certified public accountant at BiggKofford P.C. She can be reached at 579-9090 or firstname.lastname@example.org.