In my reading this morning I came across an article that sent chills down my spine and made me cry out “No, no, no!” According to Smart Money, you can give yourself a short term loan by not sending in one of your estimate payments when due. But before you do that, please finish this post.
In theory, the article is correct. When you are self-employed or have income from sources other than wages, you can prepay your tax by making estimated payments on a quarterly basis. If you don’t pre-pay enough and have a balance due when your tax return is prepared, you could be subject to the Underpayment of Estimated Tax Penalty. It’s not a large penalty, currently it’s 3%. So, even if you skip a payment the penalty will be less that the interest on a comparable loan. This is especially true if you can make it up on the next quarter’s payment.
That’s the theory but the real world is what scares me.
- One “estimate as loan” leads to a second or third and the client has a big balance due come April 2012. If they can pay it then, they are still getting their low 3%. But if they can’t, then failure to pay penalty and the regular interest rate start to add on to the balance due and underpayment penalty.
- They forget they didn’t make all the payments and tell me they did. That brings an IRS notice and tracking through bank statements looking for the payment they’re sure they made.
I live in the real tax world. I have clients who win big at the casino and call to see what they might owe on the win. Very seldom can I get them to make estimates. They decide to put it into the bank where it might draw interest. And then they spend it. It’s spent with the intention of putting it back before tax time but they never do.
If you do give yourself this kind of loan, please keep track of what you do and pay it back before the next estimate payment is due. That enticing low interest rate can change into a higher rate and penalty if you aren’t careful.