Family tax advice

When it comes to giving family members tax advice, my general rule is DON'T!

If you help them out, they'll never quit coming back for more help. And if you can't keep the IRS out of their pockets, you'll never hear the end of it. That said, I must thank my cousin J.B. for a question he posed after reading my post about the annual holiday letter my husband and I send. After he got over his shock that our letters contain some, uh, exaggerations, he pulled himself together enough to pose a personal tax query. He's always been resilient that way.

A little background. He's got a working-for-the-man job, regular hours, regular paycheck. His wife has her own business, meaning she has to take care of all her own administrative and tax tasks. As 2005 winds down, they want to make sure they've had enough withheld so that they don't get slapped with a big tax bill when they file their return next year.

It's a valid concern. Not only might they owe, meaning they'll have to find a way to come up with the cash to pay the IRS, if they owe too much, specifically more than $1,000, they could have bigger problems. Since the U.S. tax system operates on a pay-as-you-earn basis, the IRS figures you haven't been doing that (or at least not doing it properly) when you owe a lot and it can hit you with an underwithholding penalty.

The one grand mark is the usual trigger for closer IRS examination of your return. But they've got a few options.

Whenever anyone works for him- or herself like my cousin-in-law, or gets any other income that doesn't have taxes withheld, they need to make estimated tax payments throughout the year, one a quarter. This is the IRS's answer to payroll withholding for self-employed (SE) taxpayers.

The IRS prefers the payments to be in four equal installments, but if you find at any time you're coming up short, you can adjust the next payment to reflect that. This often happens when income sans withholding isn't regular.

The final 2005 estimated tax payment is due Jan. 16, 2006, so she can make up the shortfall there. It would help if she legitimately shows (via more paperwork when she finally files her tax return) that she paid more in the fourth quarter because she had substantially more income in that period.

Even when you don't have more income and are just adjusting an estimated tax miscalculation, it's not necessarily a bad idea to go ahead and make up the difference, or as much as you can, with payment number four. Basically, the IRS just wants its ( i.e., your) money as soon as it can legally get its hands on it.

Another way to reduce underwithheld taxes is to reduce such income. If my cousin-in-law is able, she might want to delay receipt of any still outstanding receivables. Having clients pay her on Jan. 2 will at least push that taxable income into 2006, giving her time next year to set up system to avoid a repeat of this year.

Finally, since my cousin has payroll withholding and they file a joint return, his businesswoman wife can take advantage of taxes paid from his checks to help cover any underpayment she might have. To account for the extra they need, he can adjust his withholding for the remainder of the year by filing a new W-4 with his pay administrator. He can either reduce allowances to have more taken out or ask that a specific dollar amount be withheld from each of his final 2005 checks.

Either way, he needs to undo those changes in early 2006 or the extra cash will still be coming out then. And that would not make for such a happy new year!

Comments

[The Unknown Professor]

Nice post, and good advice. I've given up on answering investment-related questions from friends and family in all but the most general way, withlots of disclaimers. It's a lose-lose situation.

[Holdie Lewie]

A long, long time ago, when I was a teen lad -- OK, we're talking the Carter administration, but don't do the math -- I was a connoisseur of cannabis, and a wise stoner told me: Never, ever, roll a joint for someone at a party. Either you'll do it poorly and everyone will think you're a dweeb, or you'll do it well and you'll be expected to be the house roller for that and all subsequent parties.

Sorta like ... uh ... what were we just talking about? Oh, yeah, taxes!