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Time to Settle Up

Matt C. White

TAX DAY IS ALMOST here, and I have a feeling that some of you may be less than excited. The cash that changes hands every year around this time gets a lot of attention, but it tells an incomplete story. The size of the check you write—or the refund you’re receiving—doesn’t, by itself, say much of anything about your tax situation.

Back in the days before technology made transferring money so convenient, did you ever let a tab run both ways with a friend? Perhaps you were traveling and decided to take turns paying for meals, and then settled up any difference at the end of the trip. Just by looking at the cash that changes hands when it’s time to settle up, you wouldn’t know whether every meal had been a pricey fine-dining experience or gas station sushi. All you would know is whether you did a good job of taking turns paying and keeping the difference low.

Ditto for your tax refund or the sum owed.

Your total tax liability is a convoluted function of many factors—certainly the amount of income and the deductions that reduce it, but also the types of income, the corresponding tax rates that apply, and the credits that reduce your tax bill dollar for dollar. In many cases, the applicability of these factors depends on your income level—because some of them gradually phase in or out.

The big question is, how well have you been taking turns paying throughout the year with your friend, the IRS? How did you complete your Form W-4 Employee’s Withholding Certificate? How much withholding did you have on retirement plan withdrawals or annuity payments? If you had income from investments, asset sales or self-employment, did you make quarterly estimated tax payments and, if so, how much?

It’s tempting to look at the tax brackets, find your marginal ordinary rate and think that tells your tax story. But even tax brackets tell an incomplete story. The only way to know your true tax burden is to divide your total tax minus any credits (Form 1040’s line 24 less any credits included on line 32) by your taxable income (line 15). That’ll give you your effective tax rate.

April 15th—18th this year—is simply the one day each year that you settle up with the IRS. If the cash flow on this day is small, that means you accurately predicted how things would fall out. That’s great but not always possible. If it’s large, maybe there were surprises or maybe you chose to wait as long as possible to pay. My approach: I try to get my withholding reasonably close to my total tax owed. But I don’t sweat it.

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Ben Rodriguez
Ben Rodriguez
9 months ago

Same here. Sometimes I owe a little. Sometimes they owe me. This year I was happy to owe them due to how long they’re taking to pay up.

John Goodell
John Goodell
9 months ago

Simple, common sense approaches like this are the best ones. Great article Matt!

Matt Christopher White
Matt Christopher White
9 months ago
Reply to  John Goodell

Thanks, John! I’m definitely with you on that!

Thomas Taylor
Thomas Taylor
9 months ago

When I first started in public accounting some 30 years ago at a small local firm, we prepared the returns for retired partners if they wanted. As a joke or maybe as a hazing ritual, I was assigned to prepare the return of a retired partner who was also one of the founders. He could be intimidating but he became a very good mentor to me over the years. His take on tax day was always try to owe a little money to the IRS; refunds, particularly large ones, were a sign of poor tax planning and if they owed a lot of money, the clients will think it’s your fault, so try to avoid those situations as well. I wasn’t always successful with my clients, but I always try to owe a little money on my own return just as he taught me.

Matt Christopher White
Matt Christopher White
9 months ago
Reply to  Thomas Taylor

Thomas, I appreciate you sharing that story! It sounds like you were fortunate to have that relationship. I imagine that approach served you well. But–as you said–there will inevitably be things that come up that cause the Tax Day payment or refund to grow and get away from that planned amount, from time to time. Sometimes that’s just a sign of a taxpayer who is active and successful at whatever they’re doing, or perhaps one who is too busy enjoying life to remember to tell their CPA ahead of time about all the tax-relevant things they did that year!

Rick Connor
Rick Connor
9 months ago

Great article Matt. I like the analogy of a tax return being a “settling up” with the IRS. I tend to think of taxes as a somewhat complicated equation, with a variety of inputs and assumptions. The final answer is your total income tax bill. I monitor the equation throughout the year to try to have a final tax bill of a $1000 or so. I’m about to file and send my 2021 payment.

Matt Christopher White
Matt Christopher White
9 months ago
Reply to  Rick Connor

Thanks, Rick! Yeah, I’d say a Tax Day payment of about $1,000 would be just right if you can manage it.

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