Save and Pay as You Go

People wait in line at the post office in Racine, Wis., on Tuesday afternoon.
People wait in line at the post office in Racine, Wis., on Tuesday afternoon. (By Gregory Shaver/AP)
By Michelle Singletary
Thursday, April 17, 2008

I'll confess: I filed my tax return on April 15. This year the time just seemed to come up so fast.

But my husband and I have already talked to our tax preparer about our 2008 tax situation. You see, this is the time to begin looking at your taxes for next year. If you start now, you can make some changes throughout the year to help you save on your bill or at least put aside the right amount should you end up owing money.

I'm talking to the folks -- particularly small-business owners, freelancers and the self-employed -- who fall into two categories.

The first is people who didn't have enough money withheld during the year and thus got hit with an underpayment tax penalty.

Our tax system is pay-as-you-go, which means the government expects you to pay your taxes as you earn your income. You can comply by having money withheld from your paycheck. If you don't do that, then you have to make estimated tax payments. If you do not pay enough tax along the way, you may have to pay an underpayment penalty. Last year, about 7.7 million people were hit with a penalty for underpaying their taxes.

To avoid the penalty, you have to pay at least 90 percent of the tax for the current year, or 100 percent of the tax shown on your return for the prior year, whichever is smaller, according to the IRS.

The second group consists of people who had to borrow money -- sometimes on a credit card -- to pay their taxes or had to request an installment agreement with the IRS. If you are self-employed and you found yourself in this position with your 2007 return, make a promise to change the way you handle your money.

I know, times are tight and it's so tempting to use entire checks you receive from customers, clients or projects to pay for current expenses. But this bad budgeting can be costly. In 2007, nearly 3 million installment requests were accepted by the IRS. Even though the IRS allows you to pay what you owe over time, penalties and interest will continue to be charged on the unpaid portion of the debt.

Let's say that as money comes in, you use it to pay your personal expenses. You intend to use further earnings you receive later in the year to cover any tax obligation.

But what if your business slows down? What if you lose a major client? You can't always count on future revenue, particularly in the current economy. The wiser financial move is to immediately set aside the money for taxes when you receive your income. There is no reason to be short of what you owe in taxes if you are doing proper tax planning.

Another tax planning tip for next year's return: Stop using large refunds as a forced savings plan. If again this year -- despite my repeated warnings -- you are getting a large refund absent a major change in your tax situation (got married, had a kid, bought a home), you probably need to increase the number of withholding allowances on your W-4 form.

One reader who participated in a recent online discussion with IRS spokesman Jim Dupree is already thinking ahead to her 2008 tax return.

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