Financial Smarts and Taxes

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Update: Ok, so it turns out that Federal Taxes are pay-as-you go, which means they are due when you earn the income. Most employers do this for you. If you’re self employed, you can pay estimated taxes quarterly. But You can’t not pay until the end of the year. Bummer. This IRS article says a bit more on the subject.

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Ok, like most people I have my employer withhold taxes each year, and I usually get a small return. And I was thinking, because Jeremy is having to do his own withholding because he is currently freelancing, how much money am I loosing by giving my cash to the government early instead of late?

Lets run some numbers. Say you have a decent job and make 50K a year. Now, if you make 50K a year, then you are probably going to owe about 18% of that in state and federal taxes, barring unusual situations where you have a huge amount of deductions.

If you took the money you would normally withhold each month on a 50K salary paying about 18% in taxes, you would owe $9000.00 in taxes. If you took the $750 and put it into a savings account like ING Direct which earns 4.5% interest compounded monthly, you would, after 12 months, have $12,120 saved, which means you would earn $3119 in interest you would get to keep.

3K is a nice bit of change. So, what are your thoughts? It takes discipline to not touch that money throughout the year and end up in a bad situation later, but still, there’s that 3K to look forward to. 

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I have been writing on the web since 2000. I am a christian , a photographer, an occasional poet, a recovering dreamer, an occasional philosopher, a software developer, an autodidact, and i resemble the INFP personality type.

13 Comments

  1. are those figures accurate, or for the sake of the conversation?

    also, does that figure for someone with a job or like Jeremy a freelancer? Freelancers are considered self-employed and have to hold out twice the taxes (your employer pays half yours).

    it sounds cool

  2. Tell Jeremy that he needs a corporation set up for himself (consult a lawyer for the best entity type). That way he can take a FICA taxable salary and non-FICA taxable “distributions” (still subject to income tax). Just a thought.

    Also, 18% sounds kind of low. We don’t have state income tax down here and I think I am paying more than 18%.

  3. Sean: 18% is what I pay in just State and Federal after I figure my deductions into the picture, and if you assume a single status. That doesn’t include FICA/Medicare/Social Security deductions which I don’t have the option of not withholding.

    Read: If you were making 50K, the rest of the numbers are accurate.

    The best thing to do is log onto the IRS site and your local state site and find the withholding calculation form, so you can find out how much you personally will need to withhold for a year. It will differ from person to person.

  4. If you are personally speaking, do what ever possible to save money, and tithe. You will need it for future time. I always encourage a disciplined budget at any age, especially in childhood. Usually, people who have budgets stay out of debt.

    In most cases, its easy to save money:
    My favorite quote
    *a dollar a day, save $365.00 a year!

    Deplete unnecessary things:
    *movies
    *cigarettes
    *candy
    *unplanned driving routes
    *over spending on kids and/or others
    *restuarants, etc.

    I’m not in favor of the words, “I can’t save money”!!

  5. A) It is illegal to underclaim withholding by a large amount. It can be done by claiming a large number of exemptions. But, the amount withheld should be close to amount owed, or the amount paid last year, for no penalty.
    B) self employed persons, must pay quarterly, on estimated earnings. And from personal experience in 1995 I paid a penalty for under estimating my income. The out from this is If you paid an amount equal to last years taxes there is no penaltly. So in other words you make money by not paying, Monthly, or Qrt. But, you will pay a penalty, (usually balances out, with the penalty being a little more.

    Hire a CPA they are worth it. Uncle Riley

  6. We’re getting it all worked out, Uncle Riley. We know a few other people with their own businesses and they are helping us to think about how much to put aside and to find a CPA. We’ll be putting a certain percent of what he makes into a savings account specifically for that so it won’t get used until we need to take it out every few months to pay our taxes. Thanks for your concern and advice.

  7. did not know we were into real life, A quick and dirty method to keep out of IRS trouble.
    Take the amount of Taxes paid last year. and if you think you your earnings will be about the same, divide last years taxes by 4, and remit every 3 months. If throug the year you find your self making more/less adjust accordingly. Paying the same amount as previous years taxes will avoid the penalty if you owe more. (Within 10% I think-).

    Or better yet fill the out the estimated tax form from the IRS. Uncle Riley

  8. Uncle Riley: Thanks! This information really helps. I reran my numbers, and if you save your money and do it quarterly, you’ll end up with $1028.00 at the end of the year.

  9. I have a $10000 CD at a local Bank paying 5% and I get some 500 + in interest annually. Are the banks in St. Louis paying more than 12%

  10. I don’t know… The interest is higher because my savings account is compounded monthly. When I have a moment, I’ll post the calculations.

  11. Uncle Riley: After further investigation of the way the interest is calculated, it seems my numbers were pretty far off. ;)

    The interest isn’t compounded monthly exactly, its calculated Annually (per year), and added to your account. You earn interest on the interest you accrue each month, but not on the principle. *sigh*

    So instead of 4.5% you earn just a smidge more, like 4.8% for the year.

  12. This is in fact real life for me and Julie since I’m now freelancing full time until other opportunities arise. Wasn’t exactly my preference at the time but it’s going ok for now. Thanks for the hint about that form Uncle Riley. I’ll be checking that out while I look for a good CPA.