Tax filing season is well underway, April 15 is just around the corner, and with all eyes turned to the bottom line of refund or you owe, this month’s BFEC article focuses on three potential problem areas of income-tax withholding: individual withholding, tip-income, and self-employment income. It’s too late to make adjustments for 2013, but not too soon to review – or too late to fix – withholding elections to avoid unpleasant tax-time surprises next filing season.
In our pay-as-you-go system, most payroll withholding is based on the Employee’s Withholding Allowance Certificate (Form W-4) on file with their employer. However, even a correctly completed W-4 can leave someone owing at tax time if, for example, multiple jobs result in receipt of multiple W-2s, there was an event during the year such as a marriage or divorce, a change in child custody arrangements, getting or losing a job, or if funds were withdrawn from a retirement account. Conversely, one may have too much withheld. While a big refund may feel good and is a form of forced savings, it’s also an interest-free loan to the government that might do more good if it had been in your wallet all year, not Uncle Sam’s. Either way, a new Form W-4 can be submitted to make an adjustment in the amount being withheld. A handy tool to help individuals, self-employed, international taxpayers, military, seniors and retirees, and students figure out the correct amount of tax to have withheld is the IRS’s Withholding Calculator at http://www.irs.gov/Individuals/IRS-Withholding-Calculator.
Another often misunderstood area is tip income. Tips are taxable income and must be included in gross income regardless of whether they are received directly by the employee, charged tips paid by an employer, or allocated tips received under a tip-splitting or tip-pooling arrangement.
According to an IRS fact sheet, even the value of noncash tips, such as slot tickets, casino tokens, or other items of value, is considered income that’s subject to tax. And it’s not just restaurant workers who are taxed on tip income. Anyone who receives a paycheck and collects tips – cab drivers, hairdressers, club attendants, gaming industry workers – must do three things.
First, keep a daily tip record for reporting purposes and for later use as proof should the tax return ever be questioned. Second, submit a written report to their employer within 10 days of the end of the month so that the employer can withhold federal income tax, social security, and Medicare taxes, and can report the correct amount of the employee’s earnings to the Social Security Administration. Third, they must report all tips on their annual income tax return. Failure to do the first two (which can result in penalties in addition to the taxes owed) does not eliminate the need to do the third. People who don’t get a salary and work only for tips won’t have a boss to report tip income to, but the tax collector still expects them to be reported (as self-employment income, see below). Additional details on the IRS requirements of workers who depend on tips can be found in IRS Publication 531, Reporting Tip Income.
Most people meet their tax obligations through paycheck withholding. However, those generating income from self employment (or those receiving tip-only income from an employer) may have the additional obligation of making estimated tax payments. Estimated tax is the method used to pay tax on income that is not subject to withholding or to make up a shortfall if the amount of income tax being withheld from salary, pension, or other income is not enough. For estimated tax purposes, the year is divided into four payment periods; each period has a specific payment due date. The payment periods and due dates for estimated tax payments are as follows: on income earned between Jan. 1 – March 31, the due date is April 15; on April 1 – May 31 income, the due date is June 15; taxes on June 1 – Aug. 31 income is due Sept. 15, and taxes on income earned between Sept. 1 – Dec. 31 will be due Jan. 15, 2015. If enough tax wasn’t paid by the due date of each payment period, a penalty may be charged even if a refund is due at the end; however, a good faith effort to catch up (or a valid reason why it wasn’t paid on time) may mean no penalty at the end. For additional information on estimated tax, see IRS Publication 505, Tax Withholding and Estimated Tax.
Members of the Bitterroot Financial Education Coalition, a project of the Bitter Root RC&D, will present a monthly column about personal finances. If you would like to request a workshop on this topic or another financial topic, please contact Katelyn Andersen, 375-6611 or firstname.lastname@example.org
The Bitterroot Financial Education Coalition is a partnership of Ravalli County organizations working to improve lives and strengthen our community by providing access to financial education that prepares individuals for life-long success in problem solving, decision making, and personal financial competence.