Using Financial Forecasting to Plan Your Taxes

Financial forecasting is slightly different from financial budgeting. With budgeting, you are using actual earnings and fiscal information from previous years or months to determine your expenses in the coming months or years. With forecasting, you are estimating new potential earnings, or loss of earnings in some markets, to estimate what your tax burden will be in the coming year. This is especially important for small business owners or independent contractors who must determine their quarterly contributions.

Pay as You Go

It is important to understand that the United States tax system operates on a "pay as you go" basis. This means you have to make contributions each quarter toward the money you owe in a given tax year. Most employers help employees with this step by contributing taxes for them through paycheck withholding. When you work for yourself or own your own business, you will be responsible for making your contributions each quarter. Payments are due by April 15, June 15, September 15 and January 18 of each year. These exact dates are subject to change. Make sure you know the dates required in a given year because you can be penalized for missing a quarterly contribution even if you make your year end payment.

Forecasting Tax Burden

You will have to make quarterly contributions based on the estimated salary you anticipate to earn in a given year. To determine the tax bracket that will apply to you, download and fill out a sample Schedule C from the IRS. This document is a basic form that tells you what your tax liability is likely to be, and you will have to fill one out at the end of the year regardless of whether you use one for planning. The Schedule C takes into account your business expenses, which can be deducted from your annual income to reduce your tax burden. Once you know your taxable income based on this sheet, simply research the tax brackets for the federal and state tax authorities to see the average tax for your bracket. You can ask an accountant for assistance on this part.

Saving for Tax Payments

If you simply save money for taxes based on your estimated budget, you may not end up saving enough. This is why forecasting is critical. You can save more than you think you will need to contribute. An employee who makes regular contributions to his or her tax burden through paycheck withholding typically contributes more than necessary. At the end of the year, this individual will receive a refund. Of course, some individuals structure this differently and receive a smaller refund or no refund at all. However, most will prefer to err on the side of contributing too much rather than too little. The same mentality can apply to you. Then, at the end of the year, the excess funds you have in your tax savings account will take the place of your refund. A good idea is to contribute these funds to an IRA or other savings account to further reduce your tax burden in the coming year.

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