Estimated Tax Payments Many of our clients are required to pay estimated
taxes and it often comes to our attention that there may not always be a
clear understanding of the mechanics involved in determining how much they
are required to pay Uncle Sam during the calendar year. Anyone whose withholding and other tax credits
comprise less than 90% of their total tax liability (including alternative
minimum taxes owed), is required to make estimated payments during the
year. This general rule, however is subject to some important
exceptions. Estimates are not required if: a) the total
amount due after subtracting withholding and other credits will be less than
$1,000; or, b) your total withholding and other credits add up to at least
as much as the amount of tax you paid during the previous year.
So for example, if you have withholding on your
wages that you anticipate will cover your tax liability for the year (at
least up to 90%), you should not have to file estimated tax
payments. However, if during the year your spouse sells stock and incurs a $30,000 capital gain on that transaction, you will be
required to make an estimated tax payment to cover the anticipated tax
liability. That payment could easily be calculated at
$4,500 (the
$30,000 capital gain at a 15% capital gain tax rate). On the other
hand, if your spouse's gain was only $4,000, the anticipated $600 tax
($4,000 at 15%) would not trigger the need for an estimated payment since
it is less than the $1,000 minimum. Safe Harbor Rules You can always avoid paying estimated taxes if your
withholding and other credits are expected to equal the amount of tax shown
on your prior year tax return. The safe harbor rules also allow you to
avoid estimated taxes if you meet all of the following
requirements: a) you had no tax liability for the
previous year Using the same case as above, let's assume that not
only are your withholdings going to cover your anticipated tax for the
current year (before the stock transaction), but that your withholdings will
also equal or exceed your total tax owed during the previous year. No
matter what your spouse receives from the sale of his or her stock,
you would not be required to make an estimated tax payment to cover the
anticipated tax because you would fall under the safe harbor rule of paying at
least the amount of tax you owed during the previous year. You can exclude certain amounts such as the earned
income credit and social security tax on tip income when you determine the "total tax" on the
prior year's return, but most of these items apply to a fairly small percentage of
taxpayers. Safe Harbor Caveat There is one hitch to the safe harbor rule
described above. Taxpayers with adjusted gross income
above $150,000 on the prior year's return ($75,000 if married filing separately)
are required to use
a higher percentage of the prior year's tax when applying the prior year safe harbor.
That higher percentage can change but is generally around 110% of the
prior year tax. Calculating The Required Estimates Once we have an idea of the tax that you need to pay
in to be "safe" (90% of the current year's tax or
100% of the prior year's tax), we typically examine your withholding amount
to determine if it will meet or exceed the safe amount. The difference
between the safe amount and your anticipated withholdings and credits
determines the amount of your required estimated payments. Of course, it isn't always necessary that your
additional tax payments have to be made in the form of estimates.
You do have the option of simply increasing your withholdings to an amount
necessary to cover the shortfall. This is often the best alternative
for taxpayers who do not have the discipline to make quarterly estimated
payments. Please give us a call if you suspect that your current
withholdings or estimated payments will not meet a safe harbor
amount. The penalties for underpayment of estimated taxes are
excessive, but easily avoided with the proper planning. |
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