About this time of year many people start getting buried in tax paperwork.
I confess I am one of them, having procrastinated beyond my usual Jan. 15 deadline for having my federal income taxes all figured out.
For the 1997 return I’ll file April 15, 1998, that is.
The 1996 return, the one I’ll put in the mail this April 15, is done. All I need before I mail it with my check are some 1099 dividend forms I haven’t yet received but that will only confirm the numbers I kept track of all year long.
That’s the message I try to convey every year–that the federal income tax is not something that “happens” to us every spring, but a basic part of our year-long financial plan.
“An awful lot of taxpayers look at the tax forms when they are mailed to them and that’s the only time they think about taxes,” said W.E. “Bill” Williams, a former deputy Internal Revenue Service commissioner who is now assistant to the president of H&R Block, the nation’s largest tax preparer.
Despite the mind-boggling complexity of our 4,768-page tax code, figuring out how much we owe is a very simple task for the vast majority of American taxpayers.
And a task we can and should do in advance so we don’t end up owing a lot of money every April 15. Or worse, being due a refund, which is just our own money being returned to us after we lent it for a year, interest free, to the IRS.
Consider these numbers from Margaret Milner Richardson, IRS commissioner.
About 70 percent of taxpayers do not itemize but simply take the standard deduction–a figure that is known more than a year in advance. More than 80 percent of taxpayers are in the lowest 15 percent tax bracket or don’t owe any taxes at all–again, something they would know in advance by calling the IRS (800-829-1040) and asking for the tables on tax brackets.
That makes figuring out the tax for these taxpayers–or estimating future taxes–a breeze. Just take the amount of money you expect to make during the year after any 401(k) or similar tax-deferred contributions. Subtract any exemptions for yourself and dependents plus the standard deduction, and take 15 percent of what remains.
That’s it.
Let’s use the example of a married couple with one child. They expect to make $55,000 a year in 1997 and contribute $3,000 to a 401(k) plan. Let me emphasize, all the numbers I’ll give you are for the 1997 tax year.
From the $55,000 the couple would first subtract the $3,000 contribution. Then, three exemptions of $2,650 each (one each for the husband, wife and dependent child). Next, they would subtract the $6,900 standard deduction for married couples filing jointly.
That would leave a taxable income of $37,150. According to the 1997 tax brackets, anything up to $41,200 will be taxed at 15 percent.
Therefore, this couple’s total tax for 1997 would be 15 percent of $37,150, or $5,572.50. Why wait until April 15, 1998, to figure this out?
Fact is, even those of us with more complicated financial lives can make a pretty good estimate at the beginning of each year of how much tax we will owe for that year.
If we take the trouble to do that we can avoid the fate of most American taxpayers. Of the 118 million returns filed last year, 80 percent got refunds averaging $1,200.
In other words, four out of five taxpayers overpaid their taxes by $100 a month all year long, either through larger-than-needed estimated tax payments or overwithholding at work.
“The percentage of returns that get refunds has gone up in the past decade from 65 percent up to 80 percent,” Williams said. “What has happened is the Americans generally do not have the discipline to save money and they use the withholding system as a forced savings program.”
That’s a totally irrational decision, of course. Much better to pay only the taxes you owe and, if you are that intent in saving, direct $100 a month out of your paycheck automatically to a savings account.
That way your money is working for you, not the IRS.
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If you’d like to learn more about Humberto Cruz’s savings tips, the new newsletter, “Winning at the Savings Game with Humberto Cruz,” is now available. Mail $19.95 to Tribune Media Services, P.O. Box 4410, Chicago, Ill. 60680-4410 or call 800-788-1225.
