Question re: Estimated Tax Payments for Retirees

[EngineeringMyFinances]

This question is for someone else I know who has been retired for some time. He was not a big saver, but he has a paid-off house, a small pension and some real estate investments with variable income. He and his wife have gotten by comfortably mostly on Social Security and in the past few years his income has been so low that he hasn't even had to file a return.

For 2006, his real estate investment had enough income that he had to file and pay about $100 of federal taxes. He's expecting another real estate deal to go through by the end of the year that may produce sizable income, short-term gains maybe in the $80k range. And then he'll owe some significant taxes.

I have urged him to set up withholding for the taxes at least equal to the small amount of his 2006 taxes so the IRS won't even consider applying a penalty to his 2007 taxes for under-withholding. But he interprets the estimated tax worksheet as allowing him to get by without any penalties even though he has no withholding. Maybe he's correct (provided he makes an estimated tax payment by Jan 15, since the windfall is late in the year). But I think that even if he gets by without a penalty, it will be because he makes a trip down to the IRS to explain why he shouldn't have to pay one. Personally, I'd withhold the small amount to avoid the risk of a trip even if I knew absolutely for sure that no withholding was needed.

Does anyone have an experience with a similar situation?

Also just in case I can talk him into going the withholding route, does the SSA have any provision for state withholding? Looking at their website, it appears that all they'll setup for is federal withholding.

-----------------------------------
EMF's Personal Finance Blog
​

 

[Nords]

But he interprets the estimated tax worksheet as allowing him to get by without any penalties even though he has no withholding. Maybe he's correct (provided he makes an estimated tax payment by Jan 15, since the windfall is late in the year). But I think that even if he gets by without a penalty, it will be because he makes a trip down to the IRS to explain why he shouldn't have to pay one. Personally, I'd withhold the small amount to avoid the risk of a trip even if I knew absolutely for sure that no withholding was needed.
Does anyone have an experience with a similar situation?

Yep-- if he's worked through the estimated-tax worksheet in IRS Pub 505 (especially for annualized income) then he's probably OK in his insistence that he doesn't owe estimated taxes before 15 January. And it's possible that his only requirement for this tax year would be to pay as much estimated tax as his tax bill was last year. Take a look at pages 18-20.

Also just in case I can talk him into going the withholding route, does the SSA have any provision for state withholding? Looking at their website, it appears that all they'll setup for is federal withholding.

A good point here is that he may owe estimated state income tax, as well as locality. A lot of taxpayers (me included) are all over the federal rules and forget to consider the other tax impacts.

I'm not aware of any federally-provided witholding system for the states, and I bet the states like it that way. He'll have to work it out with the state.

 

[EngineeringMyFinances]

his insistence that he doesn't owe estimated taxes before 15 January

Actually the January 15 issue was my takeaway from having read the IRS Pub you linked. I don't think that part's sunk in. Not only will he have to pay his taxes by January 15 instead of April 15, he will have to get the necessary data from his accountant by January 15, and then have fill out a bunch of worksheets to figure out his estimated tax payment. Even if the IRS doesn't bill him for a penalty, or call him in for an audit. Which could all be avoided for a small amount of withholding.

But I expect he'll pay his taxes when he files in April, and at a minimum get hit with 3 months worth of penalty. And then he'll gripe about it.

Thanks for the answer on the state withholding issue. I suggested that he look into having withholding from his pension payments to cover both federal and state.

 

[GoodSense]

My understanding on small business owners' taxes is as follows:

- Estimated taxes are due four times a year: Jan 15, April 15, June 15, and September 15 (strangely, not all 3 months apart)

- As long as his payment of estimated quarterly taxes equals or is greater than 1/4 of his tax bill for the previous year, he is OK, even though this year his income (therefore taxes) may be higher than last year.

- So on Jan 15, 2008, his payment due is 1/4 of his total tax bill of 2006.

- If he has an S-corp, he will need to file his taxes by March 15. Any taxes he hasn't yet paid as of Jan 15 will come due then.

- If he is a sole proprietor, all the taxes for the previous year he has not yet paid as of Jan 15 will become due on April 15, along with his estimated taxes for the first quarter. That's why April 15 is a killer for sole proprietors.

- Depending on his situation, he should meet with his accountant before March 15 (or April 15 for sole proprietors) to figure out taxes owed for the previous year. No need to pay everything by Jan 15.

- Meeting with the accountant and filing should probably happen earlier rather than later, so he can figure out how much to contribute to his SEP-IRA or if he is eligible for Roth or traditional IRA, if that makes sense.

This is just what I've been doing. So far, no visits from or to the IRS yet.

 

[trirod]

Your friend's underpayment of estimated tax penalty will be based on the lower of current year and prior year tax - this will be the $100 of prior year tax. In theory he should have paiid in at least $100 in equal quarterly estimates, but even if he hasn't the penalty on that will be miniscule.

The tax will be due April 15th (doesn't need to make a 1/15 estimate).

Of course for 2008 he won't have that nice prior year exception, so he'll have to make estimates if he expects to have taxable income in '08.

 

[EngineeringMyFinances]

Thanks for your input, trirod. I was reading it as the penalty would be computed on the higher tax bill.

So his penalty for 2007 would be on the order of $5.
But it would be a wakeup call that next year's could be much higher.

 

[old woman]

I would have him pay at least $75 on Sept 15 and $25 on Jan 15. A little more if his tax wasn't exactly 100. He already missed the April 15 and June 15 dates. If he had a job even a minor job where he earned more than last year/s tax and withheld more than last year's tax he would be assumed to have earned evenly. He could have something withheld from his gain and that would help with the minor penalties. He can annualized his income to compute his penalties and probably get out of them.