If you are like me and millions of other screwed Americans, you owe taxes by April 15. I used to think that it was always better to owe taxes each year, but that was when the 10-year yield and CDs were providing a healthy 4% annual return. Nowadays, you’re lucky to get a 2% return on either instrument. We won’t even talk about the average money market savings rates at 0.1-0.2%. As a result of such low risk-free opportunity costs, I’ve been an advocate of folks getting a small tax refund since 2009 when the world was ending.
After doing my own taxes for the 10th time this year and always getting a small refund, I will finally be sending in a check for a vomit inducing five figure amount on top of an already six figure amount in taxes paid for 2012. So what happened that caused me to make such an erroneous calculation since I should be an expert at doing my own taxes by now? I didn’t make a mistake. Instead, the government and the voters of California got me.
PROPOSITION 30 PASSES: IF ONLY EVERYBODY COULD PITCH IN
California Governor Jerry Brown floated legislation (Proposition 38) where everyone’s income taxes would be raised by 0.4-2.2% for 12 years to help pay for our public schools. I’m all for everyone pitching in together to help our state, especially if Prop 38 can raise $10 billion dollars per annum for our children. Unfortunately, Prop 38 was shot down because California already has some of the highest income taxes in the country at an average 8% for those making $38,000-$58,000.
What ended up passing was Proposition 30 where income tax rates would increase for seven years for only those making more than $250,000, even if the individual does not have children or does not have kids in public school. Seriously, what’s wrong with having parents pay for their own children? The top marginal state income tax bracket rises by 3% to 13.3% and raises roughly $6 billion extra per annum in tax revenues.
In other words, not everyone was willing to help pitch in to support our state’s youth which is why Prop 38 was rejected, even though Prop 38 would raise at least $4 billion more a year. Instead, the majority voted to raise taxes on the minority to pay for everything and not pitch in themselves. This is obviously not fair, but everyone needs to accept that the majority will always win in the end. Why work if more than 50% of our income will be taken away?
The worst part about the passing of Prop 30 (raising taxes on the minority) is that the law is retroactive starting January 1, 2012 to collect more taxes. I’ve never heard of a full 1-year retroactive law to claw back income from the public. All this time I’ve been carefully trying to manage my exit from society with the assumption that 2012 would be business as usual. I was wrong, and for my ignorance, I’ve got to pony up thousands of dollars to a state infamous for mismanaging funds.
I usually keep less than $10,000 in a liquid money market account because I hate having cash earn nothing. Furthermore, I have monthly positive cash flow that should continue into perpetuity. With my 2012 tax bill due on April 15 I don’t have enough money to pay my taxes. Perhaps many of you who’ve found this article on search are in a similar dilemma. Here’s what I did to solve my taxation problem.
UNDERSTAND THE PENALITES FOR NOT PAYING YOUR TAXES FIRST
1) There are no penalties for filing late if you have a tax refund. What a surprise! If you don’t want to claim your refund, the IRS has no problems letting you not claim your money. The IRS probably hopes you do your taxes wrong or simply forget to file in order to keep the billions of dollars in unclaimed refunds in their coffers.
2) Failure to file penalty. I guess there are people out there who don’t actually even file their taxes for some reason. If you fail to file, the penalty is 5% for each month the tax return is late, up to a total maximum penalty of 25%. The percentage is of the tax due as shown on the tax return. Let’s say I owe $20,000 in 2012, my penalty would be $1,000 a month up to a $5,000 penalty after five months.
3) Failure to pay penalty. Let’s say you refuse to pay your taxes by April 15. The penalty is 0.5% for each month the tax is not paid in full. There is no maximum limit to the failure-to-pay penalty. The penalty is calculated from the original payment deadline of April 15th until the balance is paid in full. In other words, you can have a failure to file penalty and then a failure to pay penalty which would really screw you over.
4) Interest payments. This is where the IRS really gets you as I’ve written in a previous example. The IRS charges daily interest on the taxes you don’t pay based on a rate of roughly 3-4% per annum. The rate adjusts every 3 months. Even though nobody can get a 3-4% return risk-free, the IRS rakes you over the coals with a super high interest rate.
5) Crushed credit score. If you decide not to file and not pay for over a year, a tax lien will be produced which will destroy your credit score by 100-150 points on average. It will then take anywhere from 2-7 years to get back to your original score.
6) Say hello to jail. Finally, if the IRS catches you evading taxes for much more than a couple years, you could face jail time, depending on how much you owe. You’ve got to evade or cheat on more than the cost it takes for them to prosecute and house you, so this shouldn’t be a problem for the majority of us.
SOLUTIONS TO PAYING YOUR TAXES WHEN YOU’VE RUN OUT OF MONEY
Now that you know the downside of not paying your taxes, here are some plausible solutions to help feed the government.
1) Ask family or friends for a bridge loan. I hate asking friends or family for money, but when it comes to defending oneself against more government tax penalties, one shouldn’t be too proud to ask. Family and friends should be more understanding that you need to borrow money to pay the IRS vs. borrow money to go buy some extravagant car or purse you don’t need.
2) Adjust your withholding allowances. Check with your company payroll to see what your current withholding allowance is. I usually put 0, which means my employer takes out the most in taxes so I have to pay the least come tax time. Adjust your witholding allowances higher if you need more cash flow, but that might mean a higher tax bill later on.
3) Call the IRS and ask for an extension. You can always call the IRS and ask for an extension by April 15 due to hardship. Depending on how bad your hardship is, a grace period may be granted for a certain period of time. The IRS really are a bunch of nice people contrary to how they are portrayed in the movies. They realize the tax code is ridiculous and the people who work at the IRS are on your side. It’s just the politicians who aren’t because they are being lobbied by tax firms and need a complicated tax system to retain power.
4) Borrow from your 401(k). Borrowing from a 401(k) is discouraged because it takes money out of your investments which may grow. If the world is detonating, then it’s not so bad to pay for a vital liability. However, there are some borrowing fees to pay, and a high interest you pay yourself to pay back your loan.
5) Sell some unnecessary belongings. Here’s a great chance to sell your crap that’s been piling up in your basement. There’s no better feeling than decluttering your house, making money, and using the proceeds to pay off the IRS!
6) Get a temporary second job. If you do your taxes soon enough (Jan), you should be able to work a second part-time job for a month or two to cover your tax liability. This is when you will really start to hate the government for all it taxes you, because you’ll be trying to make more money that’s taxed to pay taxes. Bad jobs develop character, so look on the brightside.
7) Ask your employer for an advance. This is a tricky one because you don’t want to let your employer know you don’t have enough money. They might translate your mismanagement of money as a work flaw which could lead to a lack of promotion and future pay. That said, plenty of people owe taxes every year which they can’t afford. If you have a legitimate excuse, such as the out of the blue retroactive Proposition 30 bill I discussed, then your employer should be understanding. You never know until you ask.
8) Withdraw interest from your CDs or ROTH IRA. The interest you earn from your CDs can be withdrawn penalty free. It’s only the principal that is affected by penalties if you decide to cut the CD duration short. You can also withdraw your original contributions of your ROTH penalty free, but you will have to pay a 10% penalty on earnings before 59.5.
PAY YOUR TAXES ON TIME AND SAVE YOURSELF THE HASSLE
Paying taxes bites the big one. It’s a large part of the reason why I removed myself from the system in 2012. There’s too much discrimination, waste, and persecution. Nothing really bad is going to happen if you don’t pay your taxes as you’ve read above. You’ll just have to pay penalties. It’s only if you try and evade on hundreds of thousands or millions of dollars where you get into big trouble. The IRS goes after big fish and generally leave the rest of us alone.
I am able to pay my five figure tax bill with some fortuitous timing. One tranche of my deferred compensation hit my E*Trade account recently so I liquidated my holdings to pay the IRS. If I didn’t get my deferred comp, I would have withdrawn the interest earned from my CDs penalty free. For 2013 and beyond, I shouldn’t have a problem with unexpected tax bills b/c my deductions are the same and my income is much lower.
If you’ve got a tax bill that’s too high to comfortably pay, definitely look into adjusting your withholdings down for the following year. The easiest tax shield available to everyone who buys a house is mortgage interest. After that, things get much more complicated and you’ll probably want to speak to an accountant to lower your taxes further.
Recommendation To Build Wealth
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Tax Savings Recommendation
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Updated for 2017 and beyond. Income taxes are set to come down under President Trump. As a result, those who contributed to their Roth IRA or Roth 401k and planned on retiring in 2017 – 2021 had wrong tax expectations.