How many PSL can you buy this fall? Estimate your tax liability to find out

As we welcome Q4 and you’re wondering how many pumpkin spiced lattes are too many to buy this season, I invite you to do the math on your taxes to give yourself a gut check on whether you’re in a refund or balance-due position with the IRS. Considering that bank interest rates are still 4.5% even after the September 2024 rate cut, this is no time to be prepaying the IRS if it’s unnecessary. That’s just too spooky!

At a high-level, the math is simple, “What do I owe for the year less what have I paid already?”, but the additional steps to reach ‘taxable income’ is where things get a bit trickier.

As of October, the year is in a lot of ways fully baked in terms of estimated compensation. Generally, companies pay bonuses and give raises at the beginning of the year, so at this point most salaried folks can estimate their total annual taxable income with some reasonable assurance.

Steps to Estimate Your Tax Position:

Step 1: Download your most recent paystub

Step 2: Calculate Year-to-Date (YTD) Taxable Income by subtracting pre-tax benefits from Gross Pay:

Gross Pay YTD (Includes salary, commission, bonus, imputed pay. Does not include non-taxable reimbursements)

-  401k deductions YTD

-  Medical, Dental, Vision deductions YTD

-  FSA/HSA deductions YTD

= YTD Taxable Income

Step 3: Calculate Remaining Pay Periods Taxable Income (same as Step 2, just for current pay period)

Taxable Income of most recent pay period (single pay-period)

x  # of remaining pay periods in year

= Taxable Income of Remaining Pay periods

(Most companies pay twice a month, but double check if you’re paid every two weeks or monthly to understand how many pay periods are remaining in the year)

Step 4: Calculate Estimated Annual Taxable Income

YTD Taxable Income

+ Taxable Income of the Remaining Pay periods

= Estimated Annual Taxable Income

Step 5: Use an Online Tax Calculator* and Input your Estimated Annual Taxable Income to find out your Federal Income Tax liability

Federal Income Tax amount from the calculator

- Federal Income Tax withholding on your YTD paystub

= Amount of Federal Income Tax you owe before year-end

(When looking at your paystub, ignore withholdings for Social Security and Medicare, those are not included in income tax calculations. Federal Income Tax is totally separate from social taxes.)

Step 6: Estimate Federal Income Tax you will pay in the remaining pay periods

Federal Income Tax withheld each pay period (from paystub)

x # remaining pay periods in the year

= Amount of Federal Income Tax you WILL pay in via payroll by year-end

If what you owe (Step 5) is less than what you will pay in (Step 6), you might be getting a refund.

If what you owe is more than what you will pay in, prepare for a balance due.

Side Hustles/Multiple Income Sources

Depending on if you’re a math/excel person or not, you could expand this exercise and add in your side hustle taxable income, bank interest, and dividends. Having multiple sources of income makes this tax exercise very important.

Remember that unless you have edited your company payroll settings to increase your tax withholding, your W-2 job is only withholding tax as if you only had that one job. If you have a side hustle, it’s a good idea to increase your W-4 form withholding taxes so that you can pay in more tax via payroll to cover the additional tax owed as a result of side hustles.

The advanced money-hack strategy is to pay in ONLY the required estimated tax and never overpay the IRS via withholdings (so the IRS owes you a refund). That means you just gave Uncle Sam an interest-free loan when you could be making interest on your own money. Interest rates on HYSA (high-yield savings accounts) are at 4.5% even after the September 2024 federal rate cut.

If all of this scares you more than a haunted house, then reach out to your CPA to do the math for you. These are of course estimates, but doing a Q4 tax check-in will help to relieve year-end anxiety around tax planning and give you a better idea of potential payments or refunds.

Notes

i) For simplicity, the equations above are only for Federal Income Tax estimates. Repeat this exercise with State Income Tax Calculators and paystub information to estimate your state liability.

ii) The IRS has an underpayment penalty safe harbor (no penalties) if you pay in at least:

• 90% of the current year liability OR

• 100% of the previous year liability (110% of previous year if you make more than $150k)

iii) The true money-hack strategy would be to stick to the minimum amounts to avoid penalties so you can maximize the cash in your HYSA. It’s important to always have cash set aside for taxes, but Uncle Sam doesn’t need to be holding your cash and making your interest if it’s not yet technically due. 

iv) This exercise assumes your paycheck will not change over Q4 (ex: you don’t change 401k withholdings or get a large year-end bonus). It’s also a good time to review your YTD 401k contributions and decide if you’d like to change it by year end. The 2024 401k employee deferral is $23k.

Glossary:

Payroll Withholding - ‘withholding’ refers to a tax amount being subtracted from your paycheck.

Payroll Deduction - ‘deduction’ refers to a benefit amount being subtracted from your paycheck (Health Insurance, Life Insurance, Transit funds).

Taxable Income - All income (salaries, bonuses, commissions, other imputed items like gift cards from your employer) less pre-tax deductions (401k, medical insurance, FSA or HSA health plan, Parking/Transit deductions). 

Imputed Income - These are things that your employer pays for you that the IRS sees as ‘taxable income’. Think of holiday gift card handouts, paying for gym memberships on your behalf, additional life/disability insurance.

This is not tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.