For those making estimated tax payments (and for those who should), the dates of April 15th, June15th, September 15th, and January 15th usually don’t ring in the joyous changing of the seasons, but instead the due dates for payment of estimated taxes. Keeping in mind the following rule throughout the year will ensure that you pay enough, but not too much. Paying too much, or leaving too much on account from the prior year, will cost you the forgone rate of return you could have earned. Not paying enough will accrue a penalty of 7%. Year after year, the savings, or conversely, the costs, compound quickly.
The basic rule is that total payment 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 Adjusted Gross Income (AGI) was more than $150,000. The total tax amount includes any AMT, self employment tax, and household employment taxes (Nanny tax), but is reduced by any foreign tax credits and other credits.
Those who receive income unevenly throughout the year may be able to use the “annualized income installment” method. Under this method, tax liability is calculated on a cumulative basis through March 31st, May 31st,August 31st and December 31st, then annualized and applied on a pro-rata percentage due, after subtracting payments made to date. This requires that deductions be calculated, as well. If you receive a bonus late in the year, a required minimum distribution (RMD) from your retirement or IRA, exercise stock options late in the year, or receive capital gain distributions late in the year, this method might be the one for you.
Under the two methods discussed above, income from flow-through entities must be included on the same basis as the underlying calculation. If using the basic method, income from these entities must be included on a pro-rata basis. If using the annualized income method, the actual income during the specified cumulative period must be used. If you’re a beneficiary of a trust, you must include the income on a current basis if you have a right to the income currently (i.e., QTIP or other current income beneficiary). If you don’t have a right to current trust income, you don’t have to include the income in your estimated tax calculation until you receive a distribution.
You are permitted to treat your wage withholding as having been paid pro-rata throughout the year, or when it was actually withheld. Accordingly, you could have a year-end bonus paid in the 4thquarter withheld at a higher percentage to meet what would have otherwise been an 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 the year, also provide another excellent tax withholding opportunity to ensure that only the required amount of estimated tax is credited to your tax accounts.
With a little planning in timing transactions, remembering the rule, and noting in your calendar when to make payments, untapped returns may be in your future.
________________________________
John D. South, CPA, MST is a sole-practitioner in the Northern Virginia area who specializes in tax,business accounting/consulting, and estate/succession planning for closely-held businesses and their principals, as well as high net worth individuals. 703-625-4454.
Maximizing Returns on Tax Payments
December 12, 2008
For those making estimated tax payments (and for those who should), the dates of April 15th, June15th, September 15th, and January 15th usually don’t ring in the joyous changing of the seasons, but instead the due dates for payment of estimated taxes. Keeping in mind the following rule throughout the year will ensure that you pay enough, but not too much. Paying too much, or leaving too much on account from the prior year, will cost you the forgone rate of return you could have earned. Not paying enough will accrue a penalty of 7%. Year after year, the savings, or conversely, the costs, compound quickly.
The basic rule is that total payment 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 Adjusted Gross Income (AGI) was more than $150,000. The total tax amount includes any AMT, self employment tax, and household employment taxes (Nanny tax), but is reduced by any foreign tax credits and other credits.
Those who receive income unevenly throughout the year may be able to use the “annualized income installment” method. Under this method, tax liability is calculated on a cumulative basis through March 31st, May 31st,August 31st and December 31st, then annualized and applied on a pro-rata percentage due, after subtracting payments made to date. This requires that deductions be calculated, as well. If you receive a bonus late in the year, a required minimum distribution (RMD) from your retirement or IRA, exercise stock options late in the year, or receive capital gain distributions late in the year, this method might be the one for you.
Under the two methods discussed above, income from flow-through entities must be included on the same basis as the underlying calculation. If using the basic method, income from these entities must be included on a pro-rata basis. If using the annualized income method, the actual income during the specified cumulative period must be used. If you’re a beneficiary of a trust, you must include the income on a current basis if you have a right to the income currently (i.e., QTIP or other current income beneficiary). If you don’t have a right to current trust income, you don’t have to include the income in your estimated tax calculation until you receive a distribution.
You are permitted to treat your wage withholding as having been paid pro-rata throughout the year, or when it was actually withheld. Accordingly, you could have a year-end bonus paid in the 4thquarter withheld at a higher percentage to meet what would have otherwise been an 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 the year, also provide another excellent tax withholding opportunity to ensure that only the required amount of estimated tax is credited to your tax accounts.
With a little planning in timing transactions, remembering the rule, and noting in your calendar when to make payments, untapped returns may be in your future.
________________________________
John D. South, CPA, MST is a sole-practitioner in the Northern Virginia area who specializes in tax,business accounting/consulting, and estate/succession planning for closely-held businesses and their principals, as well as high net worth individuals. 703-625-4454.