Maximizing Returns on Tax Payments

For those making estimated taxpayments (and for those who should), the dates of April 15^th, June15^th, September 15^th, and January 15^th usuallydon't ring in the joyous changing of the seasons, but instead the due dates forpayment of estimated taxes. Keeping in mind the following rule throughout the year will ensure thatyou pay enough, but not too much. Paying too much, or leaving too much onaccount from the prior year, will cost you the forgone rate of return you couldhave earned. Not paying enough will accrue a penalty of 7%.  Year after year, the savings, orconversely, the costs, compound quickly. 

The basic rule is that totalpayment credits for the current year (withholding and estimated tax payments)must equal at least 90% of the current year's tax, or, if less, at least 110%of the prior year's total tax shown on the return if the prior year's AdjustedGross Income (AGI) was more than $150,000. The total tax amount includes anyAMT, self employment tax, and household employment taxes (Nanny tax), but isreduced by any foreign tax credits and other credits.

Those who receive income unevenlythroughout the year may be able to use the "annualized income installment"method.  Under this method, taxliability is calculated on a cumulative basis through March 31st, May 31st,August 31st and December 31st, then annualized and applied on a pro-ratapercentage due, after subtracting payments made to date.   This requires that deductions becalculated, as well.  If youreceive a bonus late in the year, a required minimum distribution (RMD) fromyour retirement or IRA, exercise stock options late in the year, or receivecapital gain distributions late in the year, this method might be the one foryou. 

Under the two methods discussedabove, income from flow-through entities must be included on the same basis asthe underlying calculation. If using the basic method, income from theseentities must be included on a pro-rata basis. If using the annualized incomemethod, the actual income during the specified cumulative period must beused.  If you're a beneficiary of atrust, you must include the income on a current basis if you have a right tothe income currently (i.e., QTIP or other current income beneficiary). If you don'thave a right to current trust income, you don't have to include the income inyour estimated tax calculation until you receive a distribution.

You are permitted to treat yourwage withholding as having been paid pro-rata throughout the year, or when itwas actually withheld. Accordingly, you could have a year-end bonus paid in the 4^thquarter withheld at a higher percentage to meet what would have otherwise beenan estimated tax obligation from income or a gain you had earlier in the year(employers are required to honor such requests). Required Minimum Distributions("RMD") from IRAs and Qualified Plans, typically received at the end of theyear, also provide another excellent tax withholding opportunity to ensure thatonly the required amount of estimated tax is credited to your tax accounts.

With a little planning in timingtransactions, remembering the rule, and noting in your calendar when to makepayments, untapped returns may be in your future.

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John D. South, CPA, MST is asole-practitioner in the Northern Virginia area who specializes in tax,business accounting/consulting, and estate/succession planning for closely-heldbusinesses and their principals, as well as high net worth individuals. 703-625-4454.