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A taxing question...
Old 08-16-2016, 05:29 PM   #1
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A taxing question...

I have a 1st class problem potentially.

I would classify myself as retired but my previous employers have requested my services on a short term contract basis occasionally. At the beginning of this year I had no contract and none to be expected.

In January I liquidated some positions and generated about a $35k LTCG. I figured I would end the year below 15% tax bracket so I figure no tax on the LTCG and moved on with life. So I never paid any estimated tax monies.

A month later a contract came up and I took it. I didn't expect to make enough to push me above the 15% bracket. The contract is over and I still expect to stay below 15% tax bracket.

As of today another contract is being offered. I will take it, but here is where some issues may arise.

1) I never did a payment of estimated taxes on the $35k ltcg. If by the end of the year I have made enough to push me above the 15% bracket will I get penalized for not paying estimated taxes through out the year or when the transaction occurred? If so, should I just pay all the taxes now and hope if #2 below is possible I just get a refund?

2) Are there some moves I could or can make to reduce my gross income so I have a chance to get back within the 15% bracket (e.g. IRA contributions, etc)?

Thanks,

Bob
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Old 08-16-2016, 05:49 PM   #2
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On the estimated tax, by Jan 15 of 2017, which is when the last quarterly payment is due, run and quick and dirty tax return.If you owe money send it in. Another thing to do is to make a payment now that equals last years tax liability plus one dollar. You might owe some interest when you file, but that will avoid a penalty.

They do enter your estimated payments by quarter and the computer works the magic the formula is above my pay grade.

You could do a regular IRA and a spousal IRA if you are married.
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Old 08-16-2016, 05:52 PM   #3
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If you make the estimated tax payment in Sept and in January, there is a place to explain why you did not make any for April and June. You can request a waiver of the penalty.
I had it happen when the funds declared unexpected LTCG at the end of the year. I explained there was no way I could anticipate the income.
From the IRS website:
Generally, taxpayers should make estimated tax payments in four equal amounts to avoid a penalty. However, if you receive income unevenly during the year, you may be able to vary the amounts of the payments to avoid or lower the penalty by using the annualized installment method. Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to see if you owe a penalty for underpaying your estimated tax.
The law allows the IRS to waive the penalty if:
  1. You did not make a required payment because of a casualty event, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
  2. You retired (after reaching age 62) or became disabled during the tax year or in the preceding tax year for which you should have made estimated payments, and the underpayment was due to reasonable cause and not willful neglect.
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Old 08-16-2016, 06:06 PM   #4
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Does your employer withhold taxes from your contract pay? You could also have extra withholding taken from your pay to cover what you owe for the capital gains.

Then there's no need to have to explain why you didn't make estimated payments in all four quarters.
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Old 08-16-2016, 06:09 PM   #5
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I believe that you would not owe a penalty if the tax due was under $1000.
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Old 08-16-2016, 06:15 PM   #6
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you can open a Vanguard self-401K plan, then you can contribute to it a lot:

- $24,000 for employees age 50 or older.
- plus 25% of the "net income" of the business (your 2 contracts)

The max you can put in, if you earn a lot is $59,000 for employees age 50 or older.

https://investor.vanguard.com/what-w...ndividual-401k

Even if you don't use it for reducing your taxes, you might want it as you can open one as a ROTH 401K and stash a bunch into your 401K ROTH, plus do your normal outside ROTH
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Old 08-16-2016, 07:25 PM   #7
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Thanks everyone. I will look in to putting an explanation in on the estimated payments. I need to do some estimations on how much I will make with this next contract first.

As for a self-401k I'm not sure it would work for me. When the contracts come up I am employed by a consulting firm that my previous employer then contracts with for my services. That contract dictates the length and rate of pay that I would get. So I'm not actually self employed.

The contract company does withhold taxes. I could increase the withholding. Would that actually eliminate the penalty possibility?

Can I do a spousal IRA if she doesn't earn an income? Would these contributions then lower my income?

Thanks again.
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Old 08-16-2016, 07:30 PM   #8
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Can I do a spousal IRA if she doesn't earn an income? Would these contributions then lower my income?
Yes you can, but the limit is $5,000 under age 50, $6,000 if 50 or over. Yes it would reduce your income, but you have to file MFJ.
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Old 08-16-2016, 09:09 PM   #9
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Quote:
Originally Posted by SoReady View Post
....I never did a payment of estimated taxes on the $35k ltcg. If by the end of the year I have made enough to push me above the 15% bracket will I get penalized for not paying estimated taxes through out the year or when the transaction occurred? If so, should I just pay all the taxes now and hope if #2 below is possible I just get a refund?...
No problem, as others have mentioned, you can use the annualized installment method to pay your taxes and compute any underpayment penalties and interest. I have done this for years since most all our income is in the 4th quarter.

You essentially do a tax calculation as of different points in the year and if you owe taxes based on what has happened thus far then you make estimated payments. Since through 5/31 and presumably 8/31 you do not have a tax liability (from what you wrote) then no estimated payments were due.

If you take it then from what you wrote you will need to make an estimated payment by 1/15/2017 for your tax obligation arising from income received after 8/31/2016 and you'll need to file Form 2210 when you file your 2016 taxes in 2017.
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Old 08-16-2016, 09:20 PM   #10
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I got caught in this same trap with state income taxes some years ago. I/we retired 7 years ago, and I do some part-time consulting for a start up design engineering company. They carry me on their payroll and withhold Fed/State on that income. Work pops up very sporadically (similar to your scenario). Will go quarters w/o work sometimes. Money is very good for as little as I work and all is from home office.

I estimate income and have been manipulating it to stay within the Affordable Care Act subsidy (two more years of this for wife, as I don't qualify being VA). I only draw divs off taxable accounts (pay on LTCGs as well, but don't normally take them for income). I don't have to pay estimated state as income normally under amount requiring it (very similar to Fed scenario).

I decided one year back then (market conditions) that it was advantageous to rebalance our taxable accounts for the long run to a 50/50 stock/bond portfolio for the long haul (no Fed taxes). I did this in June and the realized LTCGs state taxes were paid that quarter as annualized (uneven) income - similar to Fed as I understand it. Paid the third quarter, and filed year end B/4 year end due date.

Here's where I got in trouble. Thought I was Ok as earnings in 1st qtr were only work income where taxes were withheld/paid by employer. Other quarters were paid in full (what was owed by me on taxable accounts - Vanguard won't withhold taxes on any taxable accounts unless your state mandates as I understand it)

Received notification that I owed taxes and penalties for the 1st qtr - what State assumes work income earned was spread evenly over all quarters, and assessed taxes penalties accordingly. I had sent documentation (paper filing) showing uneven income pattern, but somehow that was lost by the state. Took me from 2nd qtr of the following year to the last qtr to win my case and get my refund (I had overpaid as a just in case). They got it down to a dollar difference and I gave up - would cost more to refile.

In all my struggles - I came to realize that it's a catch-22 when you do something to change your tax exposure during the year where you now owe estimated taxes on previous quarters where none was originally estimated/paid. You cannot go back and pay taxes for income that was originally estimated then at under the requirement for estimated taxes. The warning here is to be aware that uneven yearly income can create scenarios where you could get caught not having paid taxes in a timely manner. Send in documentation (with your tax filings) of uneven income earned to protect yourself. I do pay my own version of estimated taxes quarterly even though worksheets don't require it. They haven't questioned my income since that year. FYI - I have buried earned income in deductible IRAs over the years to adjust income for ACA/ state taxes manipulation.
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Old 08-16-2016, 09:41 PM   #11
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Originally Posted by SoReady View Post
.............................
The contract company does withhold taxes. I could increase the withholding. Would that actually eliminate the penalty possibility?

................................
If you withhold enough........withholding seems to be better (than paying estimated taxes) because the timing is assumed to be correct (regardless of when you withhold) ; in contrast estimated taxes are clocked in and are credited when paid so timing is important. In addition, to demonstrate that you have paid lumpy estimated taxes in a timely fashion, you have to complete Sch AI of F2210 which is kind of like doing your taxes 4 times. No such effort is needed if you withhold.
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Old 08-17-2016, 07:52 AM   #12
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As for a self-401k I'm not sure it would work for me. When the contracts come up I am employed by a consulting firm that my previous employer then contracts with for my services. That contract dictates the length and rate of pay that I would get. So I'm not actually self employed.

The contract company does withhold taxes. I could increase the withholding. Would that actually eliminate the penalty possibility?

Can I do a spousal IRA if she doesn't earn an income? Would these contributions then lower my income?

Thanks again.
If you are not self-employed and will get a W-2, then YES, you can increase withholding and that would eliminate any possible penalty.

Yes, your spouse can contribute to an IRA if either of you have earned income to support it. You all will need to determine if it is deductible or non-deductible because of income limits, but it seems like it would be deductible from the info presented in this discussion.

If you will get a 1099 from your contract company, then an individual 401(k) is the way to go. I have one with TDAmeritrade.
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Old 08-17-2016, 08:08 AM   #13
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I get a 1099 for my pension and have adjusted withholding to the point where I only get a few dollars deposited into my checking each month. This covers taxes for most of my investment/rental income so I don't pay or file quarterly returns. DW always has extra money withheld when she exercises options, so there's no need to explain the unequal income from that.


Enjoying life!
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Old 08-17-2016, 08:41 AM   #14
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If you withhold enough........withholding seems to be better (than paying estimated taxes) because the timing is assumed to be correct (regardless of when you withhold) ; in contrast estimated taxes are clocked in and are credited when paid so timing is important. .

Withholding is deemed to be equally distributed throughout the year regardless of when it was actually received by the IRS. So you could have aggressive withholding in the last months of the year to cover your taxes and avoid late payment penalties.

You could choose to use the safe harbor method where your total withholding in 2016 is equal to your total federal tax liability in 2015 to avoid penalties.
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Old 08-17-2016, 09:28 AM   #15
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Thanks everyone, this has been helpful.

I now have some options to consider. I like the aggressive deductions from upcoming paychecks as plan A. This is a part time gig so it is hard to say how far I'll go over the 15% line, but plan B is to look at IRA contributions to reduce reported income.

Thanks again!
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Old 08-17-2016, 09:31 AM   #16
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Keep in mind that the under witholding penalty for the year, I believe, is only about 2% of the amount of taxes that were under withheld.

If your tax balance due on Apr 15 is only a few thousand dollars then the penalty would only be a few 10s of dollars.

I know that I hate to pay penalties/fees in any part of my life but when I realized it was a fairly small amount, I no longer loose sleep over the possibility of being under withheld. (Truthfully I still over withhold so it is not an issue for me either way).

-gauss

p.s. If you contract company can jack up your W-2 withholding significantly for the rest of the year then this still may be the cleanest/easiest/lowest cost way to address this.

pps Don't forget about any state income tax that may be due in your case. My particular state has very onerous penalties, dwarfing the federal ones, for this type of problem.
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Old 08-17-2016, 10:41 AM   #17
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Thanks.

I got burned last year on state tax penalties. So I already been paying estimated taxes on the LTCG for state just to be sure for this year.
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Old 08-19-2016, 05:27 AM   #18
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Whew! I think you just talked me out of picking up any contract work next year after I ER in November!

Sent from my SM-G900V using Early Retirement Forum mobile app
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Old 08-19-2016, 10:28 AM   #19
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Usually I ignore the estimated tax thing and recently did a quick pro-forma of federal and state. I knew I was "much better than fine" with federal, since I pulled from a 401k and they kept 20% (that, and my tax liability is near zero, not counting credits). But I thought I should have been doing estimated tax payments for state. Alas, not a problem, they held 4% of my 401k withdrawal. So, as much as it urks me, I've made an interest-free loan to both federal and state authorities. Next time, the 401k pull will be in December and I'll file right away...no need in letting them keep my money any longer than needed.
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Old 08-19-2016, 03:22 PM   #20
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I had consulting and W2 income last year, and full time employment in the last quarter. The consulting income started taking off unexpectedly, so I recalculated etimated payments as I went along. I think I had a small penalty.

This year W2 income will be the most I've ever made. So I am making higher estimated payments, and have W2 withholding at 0 deductions. Also have spouse at 0 deductions.

At the end of this month I'll probably open TurboTax and check things once again, before the Sept 15th estimated payment.
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