This weekend, Floyd Mayweather Jr. could make up to $400 million in the “Money Fight” against Conor McGregor. But about half of that will go to taxes, and there are reports that he still owes the IRS a large sum from 2015, the year he earned over $200 million fighting Manny Pacquiao.
Now, your tax issues may have fewer zeros, but you still don’t want to owe the IRS a large amount at end-year. For one, it hurts writing big checks to the IRS. But primarily, underpayment adds penalty and interest, which can be easily avoided. So how do you prevent this situation? Increase withholding or pay estimates:
Increase Withholding
If you just draw a salary and still owe money, you need to adjust your withholdings on file with your employer by submitting a new W-4. It’s not the most intuitive form, but just remember that the more allowances you claim, the less your employer will withhold—it’s an inverse relationship. So if you want to have more withheld, claim fewer allowances.
Another common issue with underpayment comes from traditional IRA, 401(k), and pension distributions. Some taxpayers mistakenly believe that these amounts are tax-free, but they are definitely not. And if they create a tax liability at year-end, you should update your withdrawal information to either have the custodian start withholding or increase withholding to avoid that situation.
Pay Quarterly Estimates
Those who are self-employed should be well aware of this process. When you file one year’s tax return, tax preparers will generally provide you with vouchers to pay tax estimates for the next year. When you’re self-employed, there’s no one to withhold tax payments, so you have to send them in yourself.
Current year estimates are usually based on income from the year prior, so if your business income is consistent, your estimates will be too. But if your income fluctuates wildly year-to-year (e.g. contractors, plaintiff attorneys, anyone in sales, etc.), you may need to do some mid-year adjustments.
Additionally, those with large investment portfolios, rental property, or side gigs should also make quarterly tax payments to ensure that no penalty and interest accrue as the result of tax underpayment.
Everyone hates dealing with taxes, so no one thinks about them until returns are due. But if you plan ahead, you can avoid the added sting of penalties and interest.
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.