Start planning now for 2008 income taxes

I’ll confess: I filed my tax return on April 15. This year the time just seemed to come up so fast.

But my husband and I have already talked to our tax preparer about our 2008 tax situation. You see, this is the time to begin looking at your taxes for next year. If you start now, you can make some changes throughout the year to help you save on your bill or at least put aside the right amount should you end up owing money.

I’m talking to the folks – particularly small-business owners, freelancers or the self-employed – who fall into two categories.

The first are people who didn’t withhold enough money during the year and thus got hit with an underpayment tax penalty.

Our tax system is pay-as-you-go, which means the government expects you to pay your taxes as you earn your income. You can comply by having money withheld from your paycheck. If you don’t do that, then you have to make estimated tax payments. If you do not pay enough tax, you may have to pay an underpayment penalty.

The second group is people who had to scramble to borrow money to pay their taxes – sometimes on a credit card – or had to request an installment agreement with the IRS. If you are self-employed and you found yourself in this position with your 2007 return, make a promise to change the way you handle your money this year.

I know, times are tight and it’s so tempting to use entire checks you receive from customers, clients or projects to pay for current expenses. But this bad budgeting can be costly. In 2007, nearly 3 million installment requests were accepted by the IRS. Even though the IRS allows you to pay what you owe over time, penalties and interest will continue to be charged on the unpaid portion of the debt.

The wise financial move is to immediately set aside the money for taxes when you receive your income. There is no reason to be short of what you owe in taxes if you are doing proper tax planning.

Another tax planning tip for next year’s return: Stop getting large refunds as a forced savings plan. If again this year – despite my repeated warnings – you are still getting a large refund absent a major change in your tax situation (got married, had a kid, bought a home), you probably need to increase the number of withholding allowances on your W-4 form.

One reader who participated in a recent online discussion with IRS spokesman Jim Dupree is already thinking ahead to her 2008 tax return. She wrote: “We are getting back too large of a refund this year partly because we had a child in 2007. The problem we have with most withholding calculators is we never know who should take how many allowances. Since my husband and I are both employed, should he take six and I take none? Should we each take three? Should the higher-paid one take most? It’s just really confusing.”

To find the correct amount to withhold, Dupree says use the calculator at www.irs.gov, which you can find by typing “withholding calculator” in the search field. Use the results to help complete a new Form W-4, which you then need to submit to your employer. And what better time to do it than this week, especially since you’ll need your most recent income tax return to fill out the fields on the IRS calculator?

You’ll have to enter information about your income and tax liability for the previous year and an estimate of your 2008 itemized deductions. Based on your responses, the calculator will tell you how many allowances to take. For spouses filing jointly, it will also break down how many allowances each of you should take.

If you find all the questions on the IRS calculator intimidating, try the withholding calculator designed by Kiplinger’s Personal Finance magazine at www.kiplinger.com/tools/withholding. It’s a quick and easy calculator in which you answer just three questions to come up the number of allowances you should take.