The GYFG blog recently picked up a new reader (Sean), who finally asked the question I have been waiting for all summer. It was around how my taxes were so low on such a high income. It’s a good thing we have smart readers that ask good questions (someone has to keep me honest). It makes for nice opportunities to continue to provide full transparency. On other blogs I see many commentators get ignored when a question like this is asked.
Not here!!! Not us!!!
See his original comment below:
Although I was prepared to answer this question as taxes have been on my mind a lot lately, but I kept putting off finally building accurate tax calculations into my spreadsheet. I had been using the back of the napkin rate I calculated at the beginning of the year when I thought our income was going to drop in 2015 to about $180K (vs. $214K in 2014). So, without thinking anything of it I replied the following:
All of these points were valid and in alignment with my policy of full transparency. But then my alarm bells started going off when I was getting close to finishing my comment.
Notice the sentence about 2/3’s down the comment above where I say “I will also point out that our income has increased substantially this year and I expect I will have to cut a check to the IRS again. There is even a chance that we will be hit with a penalty. We never get money back from the IRS.” The good news is that we will not be hit with a penalty after all (but more on that below).
It was that particular reply that forced me to realize that I had not re-calculated my new tax liability for 2015 based on the extra income from my promotion and the additional income that my wife had been earning as she has been growing her business (and she has been killing it). Typically, the way I like to pay taxes in the current year is to pay as little as possible, and then back load the end of the year, that way we get to hold onto the money as long as possible.
If you read my September financial report (in the contributions section) you will note that I did call out the fact that taxes did go up as I reduced my withholding’s from 10 down to 2. But again this was based on the old plan (definitely a blonde moment and huge oversight on my part). Oh, and by the way I have black hair, so figure that one out 🙂
New Tax Calculations Indicate a $13,000 Gap
I immediately went to work finally building out a tax module in my spreadsheet to be able to calculate the following taxes:
- Federal Income Tax (Tiered tax bracket, see below)
- State Income Tax (Tiered tax bracket, see below)
- Medicare (1.45% on all income and increase by 0.9% for high earners, see Vawt’s link in comment below)
- Social Security (6.2% on income up to $118,000 per tax payer)
- CA SUI/SDI (0.9% up to a max of $7,000 per tax payer)
Although our total projected income for 2015 is $248K, our taxable income is around $150K after all tax deferred contributions and our estimated deductions. After building in detailed tax calculations into my spreadsheet, here is what I came up with:
You will notice that I have layered in a tax credit of $4,505 that we will be realizing in the 2015 tax year for going Solar (there is a post coming on this soon). I also layered in the FICA (Medicare and Social Security) savings for contributions made to our HSA.
WE HAVE A $13,000 TAX GAP!!!
Side Note: I had to take a few tums to relieve the heart burn after realizing we will our tax liability for 2015 was $52,080 (that’s how much I made during my first year out of college). Imagine what you could do with an extra $52,080…even worse, imagine how the government is going to waste that money. But such is life and it’s the PRICE WE PAY to live in this AWESOME USA.
Since making these calculations I went into our ADP portal and changed my personal deductions to ZERO and told ADP to add an additional $1,000 per pay period in additional tax payments. This should close the gap by $5,000 (give or take), but still leaves us with an $8,000 check to write to Uncle Sam come APRIL 15TH OF 2016.
As much as I hate writing a check to Uncle Sam, I like holding onto my money as long as possible. This move will ensure we don’t get hit with any penalties for underpayment.
Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and estimated tax payments, or if they paid at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller. – IRS website
The good news is that I won’t be caught off guard on this again next year. My master spreadsheet now has the tax model built into it, to allow me to keep close tabs on what our tax liability is going to be. The timing was good, because I had just started to take a first past at forecasting 2016, so that we could start setting our goals.
Taxes are never fun, but I always remind people that taxes are a good problem to have. It means you are making money.
Learn from my blonde moment and make sure you stay on top of your taxes, especially when you start making huge financial strides in your income.
-Gen Y Finance Guy