TAX DAY IS ALMOST here, and I have a feeling that some of you may be less than excited. The cash that changes hands every year around this time gets a lot of attention, but it tells an incomplete story. The size of the check you write—or the refund you’re receiving—doesn’t, by itself, say much of anything about your tax situation.
Back in the days before technology made transferring money so convenient, did you ever let a tab run both ways with a friend? Perhaps you were traveling and decided to take turns paying for meals, and then settled up any difference at the end of the trip. Just by looking at the cash that changes hands when it’s time to settle up, you wouldn’t know whether every meal had been a pricey fine-dining experience or gas station sushi. All you would know is whether you did a good job of taking turns paying and keeping the difference low.
Ditto for your tax refund or the sum owed.
Your total tax liability is a convoluted function of many factors—certainly the amount of income and the deductions that reduce it, but also the types of income, the corresponding tax rates that apply, and the credits that reduce your tax bill dollar for dollar. In many cases, the applicability of these factors depends on your income level—because some of them gradually phase in or out.
The big question is, how well have you been taking turns paying throughout the year with your friend, the IRS? How did you complete your Form W-4 Employee’s Withholding Certificate? How much withholding did you have on retirement plan withdrawals or annuity payments? If you had income from investments, asset sales or self-employment, did you make quarterly estimated tax payments and, if so, how much?
It’s tempting to look at the tax brackets, find your marginal ordinary rate and think that tells your tax story. But even tax brackets tell an incomplete story. The only way to know your true tax burden is to divide your total tax minus any credits (Form 1040’s line 24 less any credits included on line 32) by your taxable income (line 15). That’ll give you your effective tax rate.
April 15th—18th this year—is simply the one day each year that you settle up with the IRS. If the cash flow on this day is small, that means you accurately predicted how things would fall out. That’s great but not always possible. If it’s large, maybe there were surprises or maybe you chose to wait as long as possible to pay. My approach: I try to get my withholding reasonably close to my total tax owed. But I don’t sweat it.
This article originally appeared on HumbleDollar.com
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