Why I hate income-tax refunds

Aim to withhold just enough

If I can't entice you with my "deal of the decade," what should you do?

Aim for the safe harbors. That's the minimum amount you have to pay during the year to avoid any interest and penalties. There's no interest or penalty if any of the following apply when you file your return on April 15:

• You owe less than $1,000.
  
• You've paid in at least 90% of your 2008 liability.
• You've paid in at least 100% of your prior year's total tax. On your 2008 return, that was Line 61. Go check it as you begin planning your 2009 return.

If your adjusted gross income (Line 37 on your Form 1040 for 2008) was more than $150,000, you need to pay 110% of your total tax, rather than 100%. So if my 2008 adjusted gross income was $160,000 and my total tax was $10,000, I'd need to pay 110% of that, or $11,000, during 2009 to hit that safe harbor. If I do that, there's no interest or penalty to pay, regardless of how much I owe on April 15, 2010.

If you're paying through withholdings, they are deemed to be paid evenly during the year, regardless of when they are remitted. I have some clients who have nothing withheld during the first 10 months and then meet their safe harbors with November and December withholdings.

If you're making estimated payments, they need be equal or, if your income varies substantially during the year, proportional to the income earned during each quarter. So on a simplistic basis, if I have $100,000 in income earned and $40,000 was earned in the first quarter, I'd need 40% of my tax paid in during that quarter. Technically, it's called the annualized income installment method, and it's a bit more complicated than my simplistic example.

See Form 2210 (.pdf file) for the required computations.

Video: Tax-filing audit triggers

If you expect to owe additional taxes April 15, it would be prudent to put those dollars into a money market fund until needed. At least that way, as opposed to increasing your payments to the IRS, you'll get the interest. Just make sure you hit one of the safe harbors.

And don't get any more big refunds. Refunds are BAD! BAD! BAD! Trust me on this.

Updated Nov. 24, 2009

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