Creating Our Self-Tax Refund

tax refundWhile most people might love to receive a fat tax refund following tax season each year, it seems that personal finance nerds converge more on either owing tax on April 15 or getting very close to getting zero refund. Kyle and I seem to have split the difference for our 2014 taxes, gaining the pluses from each side of that argument while avoiding the minuses.

 

For the last few years before 2014, we managed to match our withholdings pretty closely to our actual tax owed. We generally had to pay a bit in federal tax (<$100) and got a small state tax refund (~$200) at the end of each year. How to accurately fill out a W-4 is still a bit of a mystery to me, but we managed to get our withholding so close to our actual liability by having slightly too much withheld from Kyle’s paycheck and slightly too little withheld from mine.

 

2014 was a big transition year for us with Kyle going from being a grad student to a postdoc and me going from being a grad student to a funemployed person (with some self-employment income), and we prepared as best we could tax-wise. Kyle didn’t change anything about his W-4 so we knew we were well-covered in terms of the withholding needed from his paycheck.

 

In terms of my self-employment income from the fall, we took a very simple approach. I often see self-employed people throw around seemingly random numbers like 25% as how much they set aside from their income for taxes. What we did, because we still had Kyle’s base of an income in place from which his withholding was taken care of, was assume that we would pay our marginal income tax brackets on my self-employment income plus self-employment tax. I understand that approach won’t work for people whose sole income is from self-employment because of our marginal tax bracket system, but it did for us as my income didn’t change which marginal tax bracket our income fell in.

 

The numbers work out like this: For every bit of self-employment income we took in, we set aside 15% for federal tax, 5.8% for state tax, and 15.3% for self-employment tax for a total of 36.1%. (This is one component of our percentage-based budgeting approach to all of our income. In addition to setting aside enough for taxes, we also give 10% of our gross income and save 15% into our Roth IRAs.) This money went into our designated Taxes savings account – one of the few that survived The Great Accounts Consolidation of last fall.

 

In January 2015, we checked whether we would need to file estimated tax for Q4 of 2014. We calculated that we would owe less than $1,000 in additional tax on April 15, so we did not need to file estimated tax for that quarter. When all was said and done, on April 15 we ended up paying $628 in additional federal tax and $114 in additional state tax.

 

So we did pretty well in terms of what personal finance nerds want out of tax season – we owed a bit, but we had prepared for it so it wasn’t a shock to our cash flow. The pleasant surprise, though, was that we managed to create a self-tax refund. We had $1,020.22 in excess funds in our Taxes account after we paid our 2014 taxes (above what we’ve saved into it in 2015). So we created a tax refund for ourselves, but one that we got to hold onto all year long instead of it being held by the government!

 

As best as I can tell, the tax refund probably came from Kyle’s withholding still being a bit too stringent. I think the assumptions we made about how much of my self-employment income we were paying in tax are still good. We could adjust his withholding down a bit, but I’m pretty happy with the rest of our system and how it worked out at the end of the year. This year, we are paying estimated tax up to 100% of our 2014 liability, but still saving into our Taxes savings account at the proper (marginal) tax rate. I think this system will hold up pretty well until my self-employment income bumps us up a tax bracket.

 

Have you ever given yourself a tax refund from your own tax savings account? How do you figure out how much to set aside for year-end or estimated tax payments?

 

photo by eFile989

 

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9 Responses to "Creating Our Self-Tax Refund"

  1. Fiby says:

    “So we created a tax refund for ourselves, but one that we got to hold onto all year long instead of it being held by the government!”

    This is something the average person just doesn’t seem to understand. Too many people think of tax refunds as somehow being “free money.” Or those who understand it’s an interest free loan to the IRS say “So? What am I going to do with an extra $1000 or $2000 during the year?” Uh well maybe…invest it? Stick it in an online savings account? Or have it on hand for emergencies? *sigh* It frustrates me to no end.

    I’ve never been self employed so I’ve never had to set up my own tax savings account. At the beginning of the year I project my income and calculate my withholding based on that (I’m not salaried so there’s some inherent guesswork). I can’t just rely on the questions on the W-4 because I do have a supplemental fellowship (which of course has no tax withheld) and I gather a lot from bank bonuses. The latter is harder to predict at the beginning of the year because I don’t know how many bank bonuses I will collect (I’ve collected $830 so far and am on track to collect another $1110). Oh and I guess I also have some dividends from investments, but they’re almost all qualified dividends and they’re not that much so they don’t have a profound effect on my AGI.
    Then near the end of the year, say November, I do another projection now that most of the year is over, and adjust my withholding based on that. I know I can always owe $1000 and pay no penalties, so that gives me a lot of leeway.

    1. Emily says:

      For us, the savings is just padding to our cash accounts for additional security. And even if it’s only getting a tiny bit of interest, better that it’s under my own control!

      It sounds like you have a solid system as far as adjusting your withholding goes, although I suppose in a very good year your November and December paychecks could get a bit lean. Does payroll get annoyed with you filing a couple different W-4s each year or is it no big deal?

      1. Fiby says:

        I can fill out my W-4 (and also my direct deposit settings for those sweet bank bonuses) online, so as far as I know I bother nobody (perhaps a human does have to look at my changes every time I make them, but I don’t think this is the case).

        It’s true I could have a lean November and December, but I spend less than my paychecks anyway, so it’s not a big deal. If I grossly underestimated my earnings and my paychecks aren’t enough, I could always draw from my Mango account which has $5k earning 6% (but has a $3/month fee).

  2. How did you start loving numbers, Emily? I myself used to hate numbers. The only time I fell in love with it when I had to be mindful of my expenses and savings which required me basic mathematics, but when it comes to taxes, I’ll let others do it for me.

    1. Emily says:

      Haha, I really don’t like math much, actually. I’ve taken so much higher-level math and I’m really a slow student in that area. Arithmetic is a nice break for me! I do like the certainty of numbers.

  3. […] also suspect that we’ll receive a decently sized tax refund between the IRS and emptying our Taxes savings account at year end (in the past we’ve withheld or mad quarterly estimated payments for within about […]

  4. […] a generous amount for taxes between Kyle’s withholding at work and our self-withholding […]

  5. […] a generous amount for taxes between Kyle’s withholding at work and our self-withholding […]

  6. […] We still haven’t received all our tax forms; the forms from our employers earlier in 2015 haven’t caught up with our move yet. (While we remembered to change our addresses on all our financial accounts and such, I didn’t update mine with my fellowship “employer” and the update Kyle sent his postdoc employer wasn’t processed.) I have a handle on my net business income and documentation (definitely the most complicated part), but we haven’t drafted our personal taxes yet. I’m pretty sure we’ll have to pay more to the federal government and probably North Carolina, but I’m hoping we’ll still be able to give ourselves a ‘refund’ from our self-withholding savings account. […]

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