Two IRS Tax Payment Tips

I recently mentioned a couple of tax tips to a friend which he found useful so I thought to share them here as well. As always, do your own research or consult with a tax advisor before implementing any changes.

Withhold Taxes From Paycheck Near Year’s End

Taxes are required to be paid quarterly which is why we have them withheld from our paychecks. Self employed people should be manually paying in their taxes each quarter.

Interestingly, taxes withheld on your paycheck are considered by the IRS as having been withheld evenly throughout the year. And so instead of having taxes withheld on each paycheck, you can have them all withheld on your final few paychecks and it will be considered as if you paid all along the way. (Obviously this will depend on how amenable your employer is to changing around your tax withholdings throughout the year.)

I wouldn’t recommend this trick to everyone; most people will budget better by having their taxes paid evenly. A disciplined person who is looking to maximize their savings might want to keep this trick in mind. For example, someone can keep the extra funds in a high yield savings account to earn interest throughout the year, and only have to pay into the IRS in December. Again, not a huge moneymaker, but something interesting to be aware of.

I’m not sure if this trick works for state taxes.

I once had this ‘trick’ work against me: I had $2,500 in taxes withheld on my paychecks for each of the first three quarters of the year. In the fourth quarter I set it up that no taxes would be withheld since I planned to pay in $2,500 manually (to meet a credit card spend requirement). Although I paid each quarter exactly the $2,500 owed, the IRS hit me with interest for late payment.

See, they considered the payments from the first three quarter as having been paid out evenly across all four quarters. And so they saw my four perfect $2,500 quarterly payments as if I had paid in $1,875 each of the first three quarters, and $4,375 in the fourth quarter. It’s the same $10,000 result, but they saw it (incorrectly) as if I had paid late. And so I got hit with interest for the delayed payment.

Pay Q1 Taxes Toward Prior Year

The other tip I’ll mention is mainly relevant for someone who is doing an extension on their tax return beyond April 15th. I always do an extension and have my taxes done later in the year. Since I don’t yet know exactly how much tax I’ll owe, I’m left guessing how much to pay in before April 15th. (Even when getting an extension, you still need to be fully paid up by April 15th or you’ll get hit with penalty and interest.)

A tip I learned is to make my Q1 estimated payment amount as payment toward the prior year’s taxes instead. (Instead of making a first-quarter estimated tax payment, I pay that amount toward my prior year’s extension payment and do not make the first-quarter payment at all.) This way, even if I guessed wrong on my estimates for the prior year, I have the Q1 payment padding the prior year’s balance.

In case I end up owing more than my guess, that extra payment will cover the prior year to avoid penalties. I’ll then have to worry about how to satisfy the current year’s tax liability (e.g. I can use the first trick mentioned in this post to pay it backwards). If my tax estimates for the prior year were, in fact, accurate I can always have the overpayment applied toward the current year.

This tip should work for both federal and state taxes.

Hopefully I didn’t lose everyone with my ramblings here. I find tax law interesting, hopefully some readers do too. 🙂