NEWS AND RESOURCES

Financial Planning for February 2007

Waste Not, Want Not
When you hear the phrase "financial planning," what thoughts pop into your mind? Do you think about a savings plan - or perhaps following a monthly budget? Maybe retirement planning comes to mind - or building a college fund for your kids. To be honest, all of these things and more are part of financial planning, but sometimes what you waste can be even more important than what you save.

Most people waste money due to a lack of knowledge. It's not that they are incapable of learning the rules and regulations affecting their environment, but more that there are so many rules and regulations, it is nearly impossible for anyone to keep track of them. Such is the case with our overly complex tax system and the penalties for failure for the type of ignorance that is fostered by this system and its penalties for non-compliance. To assist you in avoiding federal tax penalties, this article discusses some of the more common ones.

Pay Me Now or Pay Me Later

For the vast majority of taxpayers, estimated tax payments do not come into play. If your income consists mainly of W-2 earnings as an employee, there's a good chance that your tax withholdings will cover your year-end tax liability.

For sole proprietors, partners and those who have significant income on which no tax is withheld, the story is a bit different. These people must make quarterly estimated tax payments to Uncle Sam and possibly their state tax authorities. The IRS is so adamant regarding your need to make these payments that you will be penalized if you don't pay on time. Presently, the penalty for failure to make timely payments is 8%.

So, what do you do if you can't make the estimated payments in a timely manner? If your flow of funds doesn't allow for paying timely quarterly amounts, you might want to investigate obtaining a home equity line of credit (HELOC). Though the interest rate on a HELOC might be slightly higher than 8%, that interest is deductible - and the penalty is not.

Also, make sure you give your tax preparer an accurate picture of how your taxable income is earned. If more of your income is earned near the end of the year, it may be possible to lessen or eliminate a penalty by basing your required estimates on something other than just of your final tax liability.

To File or Not to File

What happens if you get to April 17 and you're strapped for cash? Do you simply wait to file your return until you have the cash? You could, but the penalty bill you will get from the IRS would really hurt. Why is that? Did you know that the penalty for failure to timely file your tax return is 5% of the tax due for each month it is unpaid, up to a maximum of 25%? Not only will you pay a late filing penalty, you will also be hit with a penalty for late payment of tax that amounts to of 1% per month on the unpaid balance. If that's not enough, you will also be charged interest on the unpaid balance.

Instead of failing to file your return, let's discuss a few alternatives. You could extend your return on April 17. That way you can avoid paying the late filing penalty and, at 5% per month, the savings could be substantial. Another approach would be to file your tax return with no payment. Granted, you would still be hit with the late payment penalty and interest, but that's still a lot better than potentially paying a 25% penalty.

Do you have access to a home equity line of credit (HELOC)? Interest on the typical line is currently about 8% to 8.25%, while the interest rate on late tax payments is presently 8.0%. Add to that 8% the of 1% late payment penalty and it becomes apparent that it could be wise to borrow to pay your tax bill. Not only can you save money by borrowing against a home equity line, but the interest you pay will also be tax deductible. In a sense, the government will be helping you pay your tax bill.

You also have the option of paying your taxes with a credit card, but be careful. First, you pay a service fee for the privilege of using a credit card to pay Uncle Sam. Second, if you don't pay the bill off immediately, you will likely be paying a high interest rate on any unpaid balance.

Other penalties

Negligence or Intentional Disregard of IRS Rules and Regulations will cost you 20% of the underpayment of tax that results from intentionally disregarding tax regulations.


Substantial underpayment of tax (10% of the correct tax liability or $5,000, whichever is higher) will also cost you 20%.

Fraud related penalties can cost you up to 75% of the unpaid tax.

A Few Parting Thoughts

There is every reason to believe that you, the reader of this article, will never leave yourself open to any of the fraud-related or negligence penalties, but honest people sometimes inadvertently fail to properly report income. Whether from sloppiness in record-keeping or forgetfulness in the rush to file on time, mistakes can be made. If you are faced with a cash crunch at filing time or think you may have made a mistake on your return that could cause a heavy penalty, give us a call. We can't promise to keep you from being penalized for past errors, but we can promise to do everything in our power to minimize wasted dollars on tax penalties.

Have a terrific February.

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