Kiss Surprise Tax Bills Goodbye. How to Start Saving for Next Year (and Earn Interest)

If you were hoping for a tax refund this year, finding out you owe the IRS money instead might have been an unwelcome -- and expensive -- surprise. 

Tax returns and payments are due on April 15 this year, so if you don't already have money set aside, you have just a few paychecks left to save up for your bill. If you can't afford your tax bill, you can sign up for an IRS short-term installment plan to pay off your balance in the coming months. 

If you usually get hit with an outstanding balance when filing your taxes or expect to owe a bill going forward, there are some steps you can take now to make sure you're prepared next year.

I talked with Lanesha Mohip, an accountant, founder of Polished CFO and CNET Money Expert Review Board member, to find out what you need to consider when saving for a tax bill. 

Make a savings plan for your taxes

The best way to stay on top of an upcoming tax bill? Plan ahead.

"If you know your income or tax situation won't change drastically, then you already have a foundation to plan from," Mohip said.

For instance, if your tax bill is usually around $3,000 every year, and you want to make the payment by April 15 next year, you may save $250 per month to make sure you're ready by the deadline. "Whatever is budget-friendly for you," Mohip said. "It's best to make a plan to comfortably set aside the money over time while balancing other goals."

Freelancers and side hustlers can use accounting software or work with a tax professional to make sure they put aside enough money throughout the year. If you're not sure how much you need to save, most experts suggest setting aside 30% of your earnings each time you get paid. 

Self-employed workers will need to pay estimated taxes throughout the year to avoid IRS penalties, so make sure you stay on top of your calendar. (Tip: Your first payment for 2024 earnings is due on tax day, April 15.)

If you earn money from an employer that taxes are pulled out of, something as simple as adjusting your withholding or setting aside $25 to $50 each paycheck can help. And while you're saving, put that money to work for you in a high-interest bank account to earn even more. 

Once you have a plan to save for the full amount, you'll have peace of mind knowing that you need only to set a reminder of when the balance is due to pay it, Mohip said. 

Stash your money in a high-yield savings account or CD

If you regularly owe taxes every year or expect to owe taxes next year, make sure you earn some interest on the amount you're saving.

Mohip recommends keeping your money in a high-yield savings account if you want to earn a competitive interest rate. You can even have a percentage of your money automatically moved from your checking account each time you get paid. Some savings accounts are offering 5% APYs or more right now, so it's an easy way to earn a little extra on your funds.

If you're worried savings rates will drop, you could consider investing that money into a short-term bond or a certificate of deposit, depending on your timeline. "At that point, your contribution to the account is earning a little bit of gain," Mohip said. But if you're on the hook for estimated taxes throughout the year, this might not be a good solution, since you'll forfeit a percentage of your interest if you need to withdraw your funds before the CD term expires.

Don't forget that interest is also taxable

The IRS treats the interest you earn on money in a savings account as taxable income -- and some states may tax you on interest earnings too. So, you'll need to include it on your tax return.

That's not a reason not to earn interest, though. Unless you're earning thousands of dollars in interest each year, the amount of interest you accrue is unlikely to bump you up into the next tax bracket. But you may pay a little bit more in taxes overall. 

If your tax bill is higher than you expected, don't panic

Even when you set out with the best intentions, sometimes you miscalculate. Maybe you earned more than you planned on or accidentally pulled from your tax savings account. As soon as you know you'll be short money for your tax bill, figure out your options. If you can't save for the full amount in time for tax day, Mohip recommends paying what you can and setting up a payment plan with the IRS for the balance. Not doing so before the tax filing deadline could cost you. 

"It could lead to daily penalties and daily interest that you don't want to accumulate," she said. "That money you're paying in interest and penalties could be going towards something else in your budget, like a student loan payment."