Calculating Estimated Taxes 2008, 2009

[Zathras]

Last year we had a cash sale of our BUD stock causing a large capital gains late in the forth quarter.
The IRS (so far) has had no problem with us making a larger payment in the 4th quarter. According to our accountant, it is not unusual.

[audreyh1]

Quote:

Originally Posted by RunningBum This is a helpful thread with some good info. But I'm not clear on the above statement. Is the IRS ok with you doing a large estimated tax payment on that big chunk in Q4, after smaller ones in Q1-Q3? It makes sense, but when I stop drawing a paycheck I don't want them coming after me and telling me my estimated payments should have been more even for each quarter.

YES. You don't have to pay taxes on income until you earn it. [In my case there is really no way to predict ahead of time what income I will have in any given "quarter" tax period.] You use the Annualized Income (AI) method for estimating your taxes. Then when you file your final return on Apr 15 of the following year, you must include the Form 2210 AI schedule to show how much income was earned in each quarter and the corresponding estimated tax paid. As long as you paid what you owed for each quarter according to the annualized income method, you are fine. No penalty.

The annualized income method is pretty funky. It uses a multiplier for each tax period (Jan-Mar, Apr-May, June-Aug, Sep-Dec) to "annualize" the income - i.e. guesstimate what your income would be for the year based on the income so far - and then you pay a prorated YTD percentage based on that annualized income.

The above probably sounds VERY confusing, but the 1040ES explains the AI method.

To be successful at using the AI method you need to be good at being able to find out what your income was each tax period and using a spreadsheet! When I first started this 10 years ago, neither Turbotax nor Quicken was able to compute this method for me so I had to figure out how to it myself. There might be software available now, I don't know.

Audrey

[ESRBob]

Envious of all you who've already filed and maybe even gotten a refund. I'm still waiting for one last &#@% K-1 from a limited partnership I'm in. I got into a bunch of exchange-listed pipeline master limited partnerships last year (I know, another dumb move, but I couldn't resist 10% dividends) and they've only got their K-1s to me a week or so ago.

[Nords]

Quote:

Originally Posted by ESRBob Envious of all you who've already filed and maybe even gotten a refund. I'm still waiting for one last &#@% K-1 from a limited partnership I'm in. I got into a bunch of exchange-listed pipeline master limited partnerships last year (I know, another dumb move, but I couldn't resist 10% dividends) and they've only got their K-1s to me a week or so ago.

I share your pain... I made a private-equity investment after reading about it in a popular ER asset-allocation book, and now I'm enjoying last-minute K-1 entries too!

[audreyh1]

Arrrgh! A new twist in my estimated tax calculations. I realized > $3000 in capital losses during the first quarter (selling bond funds to buy stocks in my January rebalance) and now I need to make sure I accurately compute my annualized income.

For those who aren't aware - You can only take $3000 in capital losses against ordinary income. The excess is then carried forward to the next year.

I expect this "problem" to resolve itself later in the year when I get more capital gains distributions.

Back to the drawing board on my spreadsheets.....

Audrey

[samclem]

Quote:

Originally Posted by audreyh1 Arrrgh! A new twist in my estimated tax calculations. I realized > $3000 in capital losses during the first quarter (selling bond funds to buy stocks in my January rebalance) and now I need to make sure I accurately compute my annualized income. Audrey

A dumb question from a tax-code neophyte: Is all this hassle really worth it? Do you have to recompute this each quarter? I was under the impression that you could simply estimate 100% (or 110% for higher income folks) of last year's taxes and make four equal payments. Done. There's no possibility that you can owe a penalty with this approach. The interest due on underpayments is just 4%, so hanging on to any extra money until you file costs almost nothing. Overpayment is a possibilty, but even that can sometimes have a silver lining. And, over time (years) the underpayments and overpayment can be expected to roughly cancel out, so doing this kabuki-dance annually instead of quarterly in order to minimize the "float" seems unlikely to have a significant cost. Sure, it helps to know how much is likely to be due so you can have the $$ available in a liquid account, but that (to me) is a heck of a lot easier and more error-tolerant than these quarterly recomputations.

Again, this probably just reflects my ignorance of the requirements or my laziness.

[audreyh1]

Quote:

Originally Posted by samclem A dumb question from a tax-code neophyte: Is all this hassle really worth it? Do you have to recompute this each quarter? I was under the impression that you could simply estimate 100% (or 110% for higher income folks) of last year's taxes and make four equal payments. Done. There's no possibility that you can owe a penalty with this approach. The interest due on underpayments is just 4%, so hanging on to any extra money until you file costs almost nothing. Overpayment is a possibilty, but even that can sometimes have a silver lining.

I outlined my reasons earlier. My income year to year fluctuates wildly. Some years I have more than twice the income of other years. It all depends on what I do with investments in a given year. After a high income/high tax year I could easily overpay by 2.5 to 3X the next year if I used the simpe "safe harbor" method. So, if I expect to pay much lower taxes in a given year compared to a prior year then, yes, it is well worth it to me to do the AI calculations.

Audrey

[Nords]

Quote:

Originally Posted by samclem A dumb question from a tax-code neophyte: Is all this hassle really worth it? Do you have to recompute this each quarter?

It used to be worth a lot more when money-market accounts were paying 8%.

The amount of text it takes to describe the process makes it seem a lot harder and more time-consuming than it actually is. Once the spreadsheet is set up then you're tweaking a few minutes at a time.

If you paid a monster tax bill last year then the following year you don't want to have to pay monster estimated payments just to save the effort of Form 2201AI. With huge swings of investment income, it can easily add up to $10K or more in state/federal/local taxes.

[samclem]

Quote:

Originally Posted by audreyh1 I outlined my reasons earlier. . . So, if I expect to pay much lower taxes in a given year compared to a prior year then, yes, it is well worth it to me to do the AI calculations.

Okay, sorry.

[audreyh1]

Well, after some hard work on the spreadsheets it looks like we owe about half our 2008 refund for Q1 2009 estimated taxes, so I decided to apply the refund to this years taxes after all. I probably won't have to fork over any new $$ until Sept 15 - yeah! It was a few hours work, but fortunately the effort is only required every few years.

BTW - our Q1 estimated taxes are about $10K less than that estimated using the "simplified" method based on last years taxes.

Audrey

[calmloki]

IRS code - how you gonna simplify it and cover everything:

Tax Topics - Topic 357 Tax Information for Parents of Kidnapped Children

[Zathras]

Quote:

Originally Posted by calmloki IRS code - how you gonna simplify it and cover everything: Tax Topics - Topic 357 Tax Information for Parents of Kidnapped Children

OMG
I thought you were joking.
This is just rediculous

[ERD50]

Quote:

Originally Posted by calmloki IRS code - how you gonna simplify it and cover everything: Tax Topics - Topic 357 Tax Information for Parents of Kidnapped Children

Quote:

Originally Posted by Zathras OMG I thought you were joking. This is just rediculous

Isn't it crazy? Like the first thing that should go through a parent's head if they were to discover that their Child (children?) were kidnapped, is:

Honey, is this a taxable event?




-ERD50

[skyline]

I'm not sure accurately computing estimated taxes is all that useful - I guess at a fairly low amount (low enough to ensure underpayment, as I have no interest in providing free loans to the govt), and pay the underpayment penalty when I do my taxes. It rarely seems to be punitive in any sense (and often is favorable to me). This year, for example, I owed a combined $6K fed+state on my tax return, but only paid about $40 in penalties, fed+state. Prior years, I've owed more and paid more in penalties, but it never adds up to all that much (rarely more than a few percentage of the amount due).

Give it a shot - if you're using TurboTax or similar, go back through your return and run a scenario where you reduce the stated estimated taxes paid by a couple grand per quarter, and see what the computed penalty is.

I'd love to see what others are seeing (to confirm that I'm not just in some special tax situation)...

[audreyh1]

I think your special case is that you only pay $6K in income taxes! LOL!

Audrey

[RunningBum]

skyline, there's not enough info in your post to know why you only owed $40 in penalties and interest.

If, for example, in 2007 you're final tax liability was $20K, and in 2008 you initially paid $19.8K and owed an additional $6K, the penalties and interest is only going to be on the $200 you were short from the previous year.

But if in 2008 you had only had $14K initially withheld, you are going to get hit with interest and penalties on the full $6K.

You really need to understand what you need to pay with respect to the previous year to avoid large penalties. And if you're not going to make as much in a given year as you did the previous year, you're going to get hit with the penalties+interest on anything you owe at the end.

I understand the desire to not give the govt an interest free loan by overpaying estimated taxes or withholding, but paying the penalty+interest if you underpay is probably going to cost you a lot more than whatever you made on that money during the year.

[mickeyd]

Don't fogret that the first $2400 of umployement comp is tax free in 2009.

[skyline]

Quote:

Originally Posted by audreyh1 I think your special case is that you only pay $6K in income taxes! LOL! Audrey

Sorry, I should have been more clear in my post (now I read it, I see why it's confusing).

Audrey - In 2008, I had underpaid a total of $6K in taxes, not that my total tax was $6K. My actual total taxes due for the year was about $67K. So I usually expect a hefty fine when I do my taxes, but it never seems to come...what's also odd is that California usually penalizes me more than Federal - although the total taxes are proportionately lower, the absolute amount of the penalty is usually higher for California. Go figure.

RB - yes, I know the penalties are heavily dependent on the prior year's tax liability. I admit that this year's data point is extreme, but my income fluctuates quite a bit up and down (as much as $50-$100K change year-over-year). But over the last 7 years or so following this strategy, the worst penalty was about 5%. That was back when interest rates were a lot higher so even that wasn't all that bad.

I've been trying to figure out if I've just hit some lucky streak in terms of my tax situation and that's why the penalties are low, so I'm interested to see if anyone else has had a similar experience (or follows a similar lazy strategy)

[audreyh1]

Thanks for the details skyline. I'm afraid that paying up to 5% extra due to penalties sounds unappealing to me. To each his own!

In the past 10 years I only had one quarter in which I paid a penalty because I forgot to include some $3000 of interest income from one account. I guess the penalty seemed hefty enough and annoyed me enough that it made me more careful.

In the past 10 years I only had two years with a refund - both large. One year was in 2003 (for the 2002 tax year) where I paid the using simplified estimated taxes based on prior year's taxes and ended up way overpaying - getting over half the estimated taxes back! This was a situation like Nords' and other's where I realized some capital losses in late 2002 by switching some mutual funds and upgrading my portfolio. But I still continued to pay based on the simplified schedule, not realizing what a huge effect the realized losses in Q4 would have on our taxes owed until April of 2003. I certainly learned my lesson after that and check the annualized income method each quarter.

The second time was this year when I realized I had let my spreadsheets go on way too long without revision. The refund was more like 10% of what we had paid in estimated taxes.

Under normal circumstances by Jan 15, I have usually paid 92% to 95% of my taxes for the year and so owe a bit more by April 15. Because the estimates are conservative because I don't have all the information to be more accurate, I always end up paying a bit more than the 90% required by Jan 15. It doesn't really bother me that I might have paid 2 to 5% more taxes than I really had to before April 15 and thus given the government a "free loan" of 2 to 5% of my taxes for 3 months.

Once I have my estimated tax spreadsheets in place (on which I only make major revisions every 3-4 years), the process of gathering the information from various bank/brokerage websites and plugging in the numbers and evaluating the results is usually less than 1 hour. Not a whole lotta effort IMO.

Audrey

[audreyh1]

A discussion of estimated taxes would not be complete without mentioning the Electronic Federal Tax Payment System (EFTPS) https://www.eftps.gov/eftps/. You set up an account online and then make your quarterly estimated tax payments and your final annual 1040 payments electronically. You use the website to schedule the withdrawal amount from a bank account. You can view your tax payment history as well. This has been tremendously convenient - no concerns about checks getting lost in the mail. It sure made my life a lot easier once we had that set up.

Audrey