Give yourself a tax-related raise

Times are tough, so squeezing every cent you can out of your paycheck is critical. So why are you letting Uncle Sam hold onto some of your hard-earned money?

That's what way too many folks do every year by having their employers overwithhold payroll taxes. You know that nasty line item on your pay stub that shows how much of your money doesn't make it into your hands.

It's a necessary evil. This collection process is in place because our tax system is pay as you earn. Uncle Sam has found that it's the best way for him to get our due taxes throughout the year, rather than waiting for everyone to fork over lump sum tax payments at the end of the year (like that would happen!).

Ideally, your withholding amount comes pretty darn close to the taxes due amount that you calculate when you fill out your Form 1040. If that eventual tax amount is more than you withheld, you owe Treasury the balance. If it's less, you get a refund.

But that refund possibility actually could be a problem.

Overpaying the IRS, by accident and choice: Some people overpay their withholding taxes throughout the year simply because they miscalculate how much to have taken out.

Other times, there's a change in their lives -- they have a baby or buy a home -- that will affect what they'll ultimately owe but they don't account for it when it happens during the year. That's not necessarily wise tax planning, but it's understandable.

What is unfathomable to me, though, is folks who intentionally overwithhold so that they'll get back a big refund each tax season. What the heck are you thinking?!?

People, you are giving Uncle Sam an interest free loan when you do that! Yes, given our growing federal deficit, he does need the money. But so do you! (If you don't, drop me an e-mail so we can talk about how you can share it with me!)

And true, savings and investment vehicles are offering minimal returns and interest right now. But that little bit is better than nothing. Plus, you still get some power of compounding.

Forced savings? Grow up! OK. I hear you. By letting the feds hang onto your cash for a year, you won't be tempted to blow it on frivolous expenditures.

Well, that's not always true. A lot of folks let the IRS collect the excess and then when they finally get their money back, they then blow it on a big screen TV or something else they want rather than need.

Hey, as I said, it is your money. But if you're old enough to earn it, you should be responsible enough to manage it throughout the year.

You can change your withholding amount -- all it takes is filing a new W-4 with your payroll office -- and then when your next bigger paycheck arrives, put the extra cash into an emergency fund or a special account.The IRS even has an online withholding calculator to help you figure out just the right amount to have taken out of your checks.

If you don't trust yourself, have the amount taken directly from your pay and put into the account before you get your check. It's just like the IRS collection process, but it's going to you now.

Jumpstart YOUR Economy! This post was inspired by the blog series Jumpstart YOUR Economy underway this week at Money Life Network.

That group of personal finance bloggers is posting about fiscally smart moves each of us can make to get 2009 started on sound financial footing.

There are some good ideas at the MLN blog, so check them out.

Comments

[laureyssens]

well,well, I like when the expert talk about if you have a $ to much put him in a special account.but the reality is there are no $ to much the government took it all ourdream,savings,nesteggs,home,job,the bread out the month of our children to spend it on wallstreet,war.etc.The states,counties,cities,schoolboards are short it is NORMAL this happen.Our officials are used to fill their pockets big time,but now the coffers are empty it is time to trim the fat because there is no more.to bad if you are also on the streets,you will experience which life we lived now more than one year because of your greed,arrogance and incompetence

[TC]

This is my first year of having to face the idea of owing money as my financial situation changed drastically in one year.

I agree that everything you have just said makes SENSE, but honestly, until looking at that calculator, I never have any idea to figure out how many allowances to claim, so I always claim the minimum to make sure that I don't owe money.

I would much rather lend that money to Unle Sam for a few months than have to scrape a bunch together in April of the following year to pay him off.

[Dooney]

I saw this on tv on the Suzy Orman show and it makes all kinds of sence if you put the money away in another bank account.

[taxrascal]

It makes much more sense to do direct deposit or automatic investment, rather than letting the IRS hold on to the money. But I guess it could be a willpower thing; you might pull cash out of CD early, but you can't get the IRS to give you back your money early no matter how hard you try.

[Pete]

Great post! Thanks for adding your entry to the mix. It is now included under our "user submissions" section.

[Robert D Flach]

KB-

I agree with you in principal – and try to advise my clients about the errors of a big tax refund. But knowing many of them as I do, and they will all admit this, if you have an extra $100+ in their weekly paycheck they will spend it foolishly and not save it. Considering the poor return on brick and mortar bank savings accounts (less than 1%) it is truly their forced vacation savings plan.

What I like to suggest is that instead of getting a big refund at tax time they change their withholding accordingly and have the difference directly deposited into a credit union or other money market account – so they do not actually see the extra 100+ in their takehome pay.

To be honest, there is also a psychological boost to getting a big refund, as opposed to breaking even (the best outcome) or owing. I would certainly prefer to tell a client he gets a $5,000 refund instead of telling him he owes $5,000.

And regardless of how stupid it is, clients will judge the performance of a tax preparer by the amount of refund - and not by the amount of actual tax liability (or by the competence and accuracy of the return).

TWTP