Tax on unexpected enormous year-end distribution

[sergio]

I am part owner of a small privately held C-corp. We do dividends in June and December.

I start the year by setting my withholding only based on salary. Then I adjust my June-Dec withholdings to cover the Jun dividend tax. Then I adjust my last two Dec paychecks to cover the Dec dividend tax.

This year's Dec dividend is a monster, and even if I withhold my entire last two paychecks, they will fall well short of covering the tax. I could cover either state or federal but not both.

I feel I am screwed due to poor planning. Any suggestions on how to proceed? Thanks!

 

[scrabbler1]

You may be in a "safe harbor" to avoid any underwithholding penalties. What you can do, however, is make an estimated tax payment for the 4th quarter of 2018, due mid-January of 2019. The below link defines a "safe harbor" and includes the means to determine estimated taxes and how to pay them.


https://www.irs.gov/pub/irs-pdf/f1040es.pdf

 

[Bir48die]

Enjoy the fact that you are getting a humongous check and pay the piper. Plan better for 2019 if in fact it is another banner year.

 

[RunningBum]

Make extra estimated taxes via EFTPS.

 

[sergio]

Enjoy the fact that you are getting a humongous check and pay the piper. Plan better for 2019 if in fact it is another banner year.

I have no issues paying what's legally due. In fact, I'm trying to do whatever I can to avoid any issues with underpayment ...

Make extra estimated taxes via EFTPS.

If my underpayment for 2018 is (for example) $5,000 because of this dividend (figured out using my spreadsheet), is it really just as simple as logging on and sending $5,000 to the IRS via EFTPS before the Q4 deadline?

 

[sergio]

You may be in a "safe harbor" to avoid any underwithholding penalties. What you can do, however, is make an estimated tax payment for the 4th quarter of 2018, due mid-January of 2019. The below link defines a "safe harbor" and includes the means to determine estimated taxes and how to pay them.


https://www.irs.gov/pub/irs-pdf/f1040es.pdf

Thanks scrabbler. So it's just as simple as sending the "shortage" to the IRS before mid Jan 2019?

 

[RunningBum]

If my underpayment for 2018 is (for example) $5,000 because of this dividend (figured out using my spreadsheet), is it really just as simple as logging on and sending $5,000 to the IRS via EFTPS before the Q4 deadline?

I think so. I never had to use EFTPS while I was working, only after retiring and having investment and Roth conversion income. It's possible you'll have to fill out form 2210 to show when the income was received and the Q4 payment wasn't due to underpaying taxes all year long.

 

[scrabbler1]

Thanks scrabbler. So it's just as simple as sending the "shortage" to the IRS before mid Jan 2019?

Depending on what your "safe harbor" is, you might not have to pay much, if anything, in estimated taxes by Jan ~15.

Back in late 2008, I received a huge, lump-sum payout from my company stock when I ERed and left the company. The total additional federal taxes due on it was about $49k. However, I paid only $4k in estimated taxes the following January (2009) because I had met a different safe harbor provision as defined in Form 1040-ES's instructions. The remaining $45k I paid in April (2009), after it had earned some interest sitting in a bond fund account for 3 months.

Bottom line: look carefully at the instructions and worksheet within Form 1040-ES. You may end up being pleasantly surprised, as I was, at what you learn, and what you owe sooner versus later.

 

[GravitySucks]

Following.
DM is getting an insurance buyout from her former employer and may run into a similiar issue.

 

[COcheesehead]

I am in the same boat. Big year of capital gains. I sent in a bid chunk of cash to the IRS earlier this year and I still ended up sending all of my last pay check in as well. As best I can tell I will be a little above what I paid last year so probably no penalty, but I know I will still end up cutting a big check in April too. Good news I have the money, bad news is I have to send a lot of it to the government.

 

[sergio]

What I'm going to do is send most of my last two paychecks to the state department of revenue so my withholdings cover the state tax. That should reduce the amount of stress by half since I don't have to deal with them.

Then I'll read up on quarterly payments, underpayments etc. this weekend and figure out how to make this go off without a hitch. I'm okay with just paying the full federal tax due on Jan 15 for the sake of simplicity since the money sitting @ 2% for 3 months isn't going to make or break my budget.

Honestly, I just want to write a check and be done with it. I abhor spending time filling out these forms, googling, posting for advice etc.

The worst part is that all the safe harbor rules are in limbo since I'm changing from Single to MFJ this year and I withheld way less than in 2017 since my wife isn't working. I may just end up paying a few $100 and talking this thru with a tax advisor.

 

[cathy63]

For the Federal taxes, just pay the total amount due as best you can estimate it by January 15. You can send in 1040ES with a check, or you can use the online EFTPS system.

Since your income is "lumpy", and you're making a large payment in January, you may need to file Form 2210 with your return to show that you don't owe an underpayment penalty. This form calculates the taxes due according to how much you earned in each quarter, and it's designed for situations such as the one you're facing.

 

[LOL!]

While EFTPS can be easy, I tried to set it up once and it took a few days, so I would have missed a deadline. However, DirectPay works and took a few minutes. So I just wanted to mention that you can use DirectPay as well.
https://www.irs.gov/payments/direct-pay

Do note that each payment has to be less than $10 million.

 

[pb4uski]

Two ideas.

1. If you are over 59 1/2, you can do a tIRA withdrawal and have it 100% withheld and the feds consider it as paid in over the year even if it is done in December.... I recently paid my 2019 estimated federal and state income taxes recently using that approach.

2. If you are under 59 1/2 or can't do 1, when you file your return and calculate your penalty you can use the annualized income method... essentially it looks at what your tax liability would have been as of 3/31, 5/31/ 8/31 and 12/31 and as long as withholdings and estimated payments exceed what you would have owed based on income through each of those dates then there is no penalty.

See https://www.irs.gov/publications/p505, https://www.irs.gov/publications/p505#en_US_2018_publink1000194674 and https://www.irs.gov/publications/p505#en_US_2018_publink1000194749

 

[OldShooter]

Our "income" goes up and down depending on what we draw from IRAs. I never worry about income taxes though.

1) I make sure we pay the safe harbor amount of 110% of last year's taxes to both Federal and state.

2) We pay the whole amount in December (just did it, in fact) by taking IRA distributions and having the necessary amount withheld for both Federal and State.
​

#2 is not an option for everyone, but I think #1 is. If we overpay a little bit, I just have it applied to next year's taxes. I could also get a refund check, which I may start doing now that interest rates are above zero.

 

[RunningBum]

Our "income" goes up and down depending on what we draw from IRAs. I never worry about income taxes though.

1) I make sure we pay the safe harbor amount of 110% of last year's taxes to both Federal and state.

2) We pay the whole amount in December (just did it, in fact) by taking IRA distributions and having the necessary amount withheld for both Federal and State.
​

#2 is not an option for everyone, but I think #1 is. If we overpay a little bit, I just have it applied to next year's taxes. I could also get a refund check, which I may start doing now that interest rates are above zero.

No,#1 isn't always a good solution. For example, it's a poor option for someone who alternates years of taking high income (conversions, withdrawals, whatever) with years of limiting income to get an ACA subsidy. I paid about $13,000 in income tax last year, and will probably pay less than $1000 this year. That may sound like an extreme example, but it's a real one. And it's just an example. Both numbers have been higher, but still far apart.

 

[sergio]

I did some digging during the lunch break - basically the key seems to be (1) pay the federal and state tax online as a quarterly payment by Jan 15 and (2) fill out a 2210 (and the state equivalent) when filing taxes - basically to show that the Q4 quarterly payment corresponded to a spike in Q4 earnings. Simple enough and I believe can be done thru TurboTax.

I could fiddle around with paying as little as possible now and paying the rest in April - letting the difference compound for 3 months @ 2%, but my situation is a bit complicated and I'd rather have the peace of mind, than deal with an actual underpayment down the road, all for $80-100 of interest. And if I pay someone to help me, there goes any interest I'd get on paying the taxes later.

I'll plan better for next year. Thanks again everyone for the great advice.

 

[cathy63]

I did some digging during the lunch break - basically the key seems to be (1) pay the federal and state tax online as a quarterly payment by Jan 15 and (2) fill out a 2210 (and the state equivalent) when filing taxes - basically to show that the Q4 quarterly payment corresponded to a spike in Q4 earnings. Simple enough and I believe can be done thru TurboTax.

I could fiddle around with paying as little as possible now and paying the rest in April - letting the difference compound for 3 months @ 2%, but my situation is a bit complicated and I'd rather have the peace of mind, than deal with an actual underpayment down the road, all for $80-100 of interest. And if I pay someone to help me, there goes any interest I'd get on paying the taxes later.

I'll plan better for next year. Thanks again everyone for the great advice.

Yes, TurboTax can do the 2210. It will prompt you to fill it out if you use the interview mode and it detects an underpayment penalty.

 

[audreyh1]

I did some digging during the lunch break - basically the key seems to be (1) pay the federal and state tax online as a quarterly payment by Jan 15 and (2) fill out a 2210 (and the state equivalent) when filing taxes - basically to show that the Q4 quarterly payment corresponded to a spike in Q4 earnings. Simple enough and I believe can be done thru TurboTax.

I could fiddle around with paying as little as possible now and paying the rest in April - letting the difference compound for 3 months @ 2%, but my situation is a bit complicated and I'd rather have the peace of mind, than deal with an actual underpayment down the road, all for $80-100 of interest. And if I pay someone to help me, there goes any interest I'd get on paying the taxes later.

I'll plan better for next year. Thanks again everyone for the great advice.

Yep.

Many years I play the "safe harbor" rule and just make sure I've paid the prior years taxes times 1.1 for incomes above $150K - and pay those in four equal installments.

However, I do have some years with high income for various reasons, so for the following lower income year I pay estimated taxes for each quarter based on the earnings year to date using the Annualized Income (AI) method. This then requires that I fill out form 2210 to avoid penalty. Turbotax does take care this, although you do have to supply your income for each IRS quarter period.

Just to be clear - after a unusually high income year, using the easy safe harbor method using the prior year's taxes would have me way overpaying taxes during the year. That's why I switch to the more complex AI method and file from 2210.

 

[Golden sunsets]

I’ve always understood the tax code to mean that if your income increased dramatically from one year to the next, then as long as you have paid in 110% of your last year’s federal tax liability by 12/31, you’re fine and will not owe a penalty on the underpayment. I think that is PB’s #1 point. I think the actual rule is 110% of last years, OR, 100% of current years taxes. Obviously, if your liability for the current year is more than 110% of the prior year, then you would want to emsure that you fall under the 110% of the prior year rule.

 

[scrabbler1]

No,#1 isn't always a good solution. For example, it's a poor option for someone who alternates years of taking high income (conversions, withdrawals, whatever) with years of limiting income to get an ACA subsidy. I paid about $13,000 in income tax last year, and will probably pay less than $1000 this year. That may sound like an extreme example, but it's a real one. And it's just an example. Both numbers have been higher, but still far apart.

Yup. Using the prior year's tax liability as a safe harbor is good when your income rises sharply. It's not so good when your income drops sharply the year after. When that happens, you need to find another way to get into the safe harbor, and it is usually one less certain and perhaps more costly (but not as costly as the method you can't use).

 

[RunningBum]

I’ve always understood the tax code to mean that if your income increased dramatically from one year to the next, then as long as you have paid in 110% of your last year’s federal tax liability by 12/31, you’re fine and will not owe a penalty on the underpayment. I think that is PB’s #1 point. I think the actual rule is 110% of last years, OR, 100% of current years taxes. Obviously, if your liability for the current year is more than 110% of the prior year, then you would want to emsure that you fall under the 110% of the prior year rule.

No, the actual rule is 90% of current year, and 100% of the past year if under $150K income the previous year, 110% if over 150K.

And what happens if the next year your income drops back to the lower level? You really want to pay 110% of a large tax in the next year when you aren't going to have anywhere near that liability? I sure don't.

 

[bada bing]

No, the actual rule is 90% of current year, and 100% of the past year if under $150K income the previous year, 110% if over 150K.

And what happens if the next year your income drops back to the lower level? You really want to pay 110% of a large tax in the next year when you aren't going to have anywhere near that liability? I sure don't.

There is no obligation to meet the 100%/110% of previous years tax paid. That's just one safe harbor available in a year when income balloons. When/if your income drops, very likely you'll have 90% or better of tax due withheld for that year and will meet that safe harbor instead.

As a practical matter, I would avoid making an estimated tax payment if you qualify for a safe harbor and an estimated payment isn't required. I can say from experience that filing an substantial estimated tax payment will flag your return in the next couple years for scrutiny as to why no subsequent estimated payments were made. Don't do it if you don't have to.

 

[RunningBum]

There is no obligation to meet the 100%/110% of previous years tax paid. That's just one safe harbor available in a year when income balloons. When/if your income drops, very likely you'll have 90% or better of tax due withheld for that year and will meet that safe harbor instead.

I understand safe harbor, I listed all of it. What I was disputing was old shooters statement:

1) I make sure we pay the safe harbor amount of 110% of last year's taxes to both Federal and state.

2) ...
​

#2 is not an option for everyone, but I think #1 is.

As a practical matter, I would avoid making an estimated tax payment if you qualify for a safe harbor and an estimated payment isn't required. I can say from experience that filing an substantial estimated tax payment will flag your return in the next couple years for scrutiny as to why no subsequent estimated payments were made. Don't do it if you don't have to.

Some of us have no option but to make estimated payments. I'm not 59.5 so I'm not withdrawing from my IRA, and see no other way to do withholding. I haven't looked hard at all, because paying estimated taxes work fine for me. What I do is make at least a token payment every quarter. I had also heard that it's better to make some kind of payment rather than just skip, even if you owe nothing.

 

[sergio]

I’ve always understood the tax code to mean that if your income increased dramatically from one year to the next, then as long as you have paid in 110% of your last year’s federal tax liability by 12/31, you’re fine and will not owe a penalty on the underpayment. I think that is PB’s #1 point. I think the actual rule is 110% of last years, OR, 100% of current years taxes. Obviously, if your liability for the current year is more than 110% of the prior year, then you would want to emsure that you fall under the 110% of the prior year rule.

I got married this year and withheld far less in 2018 than 2017 when I was single (wife didn't work in 2018).