Daily Record - June 15, 2007
IT'S TIME FOR ESTIMATED PAYMENTS AGAIN
By Mary M. Paul
Time and time again, we hear nightmares about estimated tax payments gone wrong. It’s hard to decide which is worse: the people who didn’t have any idea they needed to make tax payments for both income and self-employment taxes, or the people who set the money aside and then spent it on something other than their estimates. The problem with estimated payments is not only are they confusing, but the “right” way to make estimated payments depends entirely on your personality and your financial situation.
There are two types of people when it comes to making estimated payments: the Saver and the Spender. The Saver will want to pay the minimum amount necessary to avoid any underpayment penalties. The Saver may still have a big tax bill at the end of the year, so he or she needs to put something aside for that too.
The rules for avoiding underpayment penalty are pretty straightforward. If you meet any of the following criteria, you won’t be subject to an underpayment penalty.
- The amount due on your tax return is less than $1,000.
- You had no tax liability the previous year.
- Your estimated payments are 90% of your current year’s tax liability.
- Your estimated payments are 100% of last year’s tax liability (or 110% if your current year AGI is over $150,000 if married and $75,000 if single).
So the easiest way to avoid the penalty is to pay 100/110% of last year’s tax liability. If you think your AGI will be anywhere close to the $150,000/$75,000 limit, pay 110%. Reduce the prior year’s tax liability by any amounts that will be withheld for federal income tax on your W-2, and then pay 25% of that number on April 15th, June 15th (TODAY!), September 15th and January 15th. One caution: you may still have a large tax liability in April even though you’ve avoided any underpayment penalties.
If you’re a Spender, you will want to pay as much of your tax liability throughout the year as possible to avoid a big payment come April 15th. You also may not mind a bit of refund, because that will give just you some extra spending money.
The best idea is to set aside a portion of any income that doesn’t have some withholding for taxes. For instance, if you’re getting IRA distributions, interest income or alimony that doesn’t have withholding on it, or if you have income from a sole proprietorship, partnership, LLC or S-Corp that will end up on your 1040, then you’ll need to set aside something for Uncle Sam.
But how much to pay? If you expect this year to be pretty much like last year, your total estimated payments should be 100% or 110% of last year’s tax liability. If not, remember that different types of income are taxed are different rates, and these rates are subject to your income level and marital status:
1. Income that is only subject to ordinary income tax:
- Interest Income
- Short-term Capital Gains
-
S-Corp Income
-
Pension Income
-
RA Distributions
-
State Income Tax Refunds
-
Non-Qualified Dividends
-
Alimony Received
2. Income that is subject to ordinary income and self-employment tax:
3. Income that is subject to long-term capital gains rates:
-
Qualified Dividends
-
Long-Term Capital Gains
The mix of income types may influence your tax liability, and it’s important to know when you may be subject to paying Alternative Minimum Tax (“AMT”). Whether you’re a Saver or a Spender, you may be interested in IRS Publication 505, Tax Withholding and Estimated Taxes, which offers step-by-step instructions on how to make a more accurate estimate of your tax liability. The Publication also goes over the rules and exceptions for making estimated payments.
As always, it may be best to consult a qualified professional to help you determine whether you should make estimates and the amounts of the payments.
Mary M. Paul is a Small Business Specialist with Mengel, Metzger, Barr & Co. LLP and may be reached at mpaul@mmb-co.com.
