Powerful tax combo move can help you avoid a 'hefty tax bill' on your 2020 return — and again in 2021

Making these tax moves now can square things away for this year and optimize your taxes for 2021.


If you want to get an idea of what you'll owe in 2020 taxes, and at the same time seize control of your 2021 tax bill in advance, there's one key move you can make. Check and update your withholding — the amount you instruct your employer to set aside from each paycheck to put toward the taxes you owe.

"You're supposed to pay the tax liability you owe throughout the year. You don't just write a big check on April 15," explains Jeffrey Levine, a certified public accountant and chief planning officer at Buckingham Strategic Wealth in Garden City, New York. "It's important to check your withholding, because sometimes when you figure out how close your guess is to reality, it can be off. And you could owe a substantial amount or be owed a substantial refund."

To see what you will likely owe, or what your refund may be, enter information from your most recent pay stub along with information about any credits or deductions you expect to receive into the IRS Tax Withholding Estimator tool.

Here's how to use this information to your advantage for 2020 and 2021.

Consider paying estimated tax if you'll owe on 2020

If the amount you had withheld from your paycheck last year falls well short of what you actually owed, you'll likely have to pay the difference to the IRS on Tax Day and you may owe an underpayment penalty as well.

As a rule of thumb, you avoid paying the penalty — which equates to about 3% of your underpayment, a percentage that gets reduced the sooner you pay it off before April 15 — if you owe less than $1,000 or have paid at least 90% of taxes owed, says Lisa Greene-Lewis, a CPA and editor of the TurboTax blog. You're also in the clear, even if you owe a substantial amount, if the amount you had withheld this year is equal to your tax liability from last year (or at least 110% of it if you made more than $150,000 as a single filer).

"Say you hit the lottery for $500 million this year, and you paid $15,000 in taxes last year," says Levine. "If you pay $15,000 in taxes this year, you'll owe a hefty tax bill when it comes time to file your taxes, but you won't owe a penalty."

For most people, whose tax situation doesn't vary much from year to year, that means you're unlikely to have to pay a penalty, even if you owe a big bill, says Levine. But if your tax situation changed drastically (say, because you landed a new job) and you find you'll owe enough tax to trigger the penalty, you should make an estimated tax payment sooner rather than later, he says.

"The sooner you pay, the sooner you stop allowing the penalty to accrue," he says.

Tax credits vs deductions: Here's the difference

Video by Stephen Parkhurst

If you picked up a side hustle or freelance work this year, this may be especially relevant. Income from such work, classified as 1099 income, doesn't have tax withheld, and you'll typically need to pay quarterly taxes to cover that obligation.

You can calculate and pay your estimated tax via IRS Form 1040-ES. The final deadline for 2020 estimated tax payments (which can be made online) is January 15, but this deadline is waived if you file your return by February 1 and pay the entire balance due with your return.

How to pay taxes as a freelancer

Video by David Fang

Avoid giving the government 'a tax-free loan'

Ideally, you want the number the IRS calculator shows — be it a refund or a bill — to be as close to zero as possible. Wait a sec, you may be thinking, don't I want a fat refund? Well, seeing as you can no longer adjust what you had withheld in 2020, it certainly beats a big bill. But this year, your goal should be to get as little money back as possible, says Levine.

If keeping the same withholding for the upcoming year will result in either a big refund or a bill, adjust your withholding by filling out a form W-4 (which comes with worksheets that help you fill it out) and submitting it to your employer's payroll department.  

"If you've overpaid, you've been giving the government a tax-free loan of your dollars — they're not going to do that for you in reverse," he says.

Allowing the money to sit in government coffers can have a serious impact on your finances. "Say you got a $5,000 refund," he says. "If you have credit cards with a 15% interest rate, that's $750 in interest that you could have avoided had you had the money to pay on time."

More from Grow: