Oops! I Don't Have Enough Money to Pay Taxes!
Don't Get Caught by Surprise in April!
Taxes, to paraphrase the cliché, are one of the two only guarantees in life. Yet every year, millions of people fall short of the funds needed to pay Uncle Sam. How can you anticipate the government’s bill, and make sure you have enough on hand?
Here are some pointers that ensure you have enough to pay your income tax and property tax bills.
Set Aside 30 Percent of Each Paycheck
Most self-employed people are already in the habit of setting aside 30 percent of each paycheck for taxes.
But if you have a full-time job and you moonlight freelancing, consulting, teaching, contracting or doing other independent work for side income, you might be shocked by the income tax bill you receive the following year. (Your shock will be doubled if that bill is large enough that it includes penalties for unpaid quarterly taxes).
Avoid this shock by setting aside 30 percent of each self-employment paycheck that you receive. (Litmus test: if the paycheck doesn’t already have taxes taken out of it by the employer, then you need to set aside 30 percent). Put that into a bank account that’s earmarked specifically for tax payments.
Budget this money to pay estimated quarterly taxes, if applicable. Otherwise, use the money at the beginning of next year, when your tax professional calculates how much you owe Uncle Sam.
What if you don’t earn a side income, but you still get hit with an income tax bill each April? You may need to adjust your withholdings.
Conceptualize Your “True” Mortgage including Property Tax
Traditional mortgage lenders collect 1/12th of your property tax bill each month. They hold this money in an escrow account until it’s time to pay the government.
By doing this, the lender forces you to budget (to set aside a small amount each month to pay a major one-time expense). The lender ensures that the home’s taxes will be paid, and the property won’t get a hit with a tax lien.
But if you have a non-traditional mortgage, or if you own your home free and clear, you may not have the benefit of a lender that’s forcing you to budget for your property tax bill. Now the responsibility falls to you.
If you’re in this boat, mentally conceptualize your “true mortgage” to equal the cost of the loan payment, 1/12 the property tax payment, and 1/12 the homeowner’s insurance. In other words, rather than telling yourself “my mortgage is $700 a month, and I also pay $2400 a year in property taxes,” tell yourself, “my mortgage is $900 a month.”
If you own the house free and clear, imagine that you still have a “mortgage” of sorts. Conceptualize this “mortgage” to equal 1/12 the property tax plus 1/12 the insurance.
Side note: To maximize the effectiveness of the way that you budget for your house, set aside an additional 1/12th of 1 percent of the purchase price each month for the sake of home repairs.
For example: if you own a $300,000 home, set aside $3,000 a year, or $250 a month, or long-term repairs and maintenance. If you own a $200,000 home, set aside $2,000 a year, or $167 a month. You won’t actually spend this much each year. Some years you’ll spend next-to-nothing; other years you’ll drop $15,000 on a new roof.
Add this into your property taxes and insurance when you’re mentally conceptualizing your “real” mortgage. For example, you might consider your mortgage to be a monthly $1100 loan payment, $500 property tax payment, $300 insurance payment, and $300 repair/maintenance payment, for a total “real” mortgage of $2200 a month (double the $1100 loan payment!)