Calculating Estimated Taxes 2008, 2009

[samclem]

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]

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]

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]

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]

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]

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

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]

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

 

[W2R]

I am paying estimated taxes for 2009, for the first time. TurboTax divided my 2008 underpayment by 4 and printed out the estimated tax forms with that number filled in, so I blithely sent off the one for April 15th for that amount. It seems likely that I might have to pay a penalty next year, though my AGI for 2009 is difficult to estimate (too many variables).

Louisiana allows us to file our taxes up to May 15th, and I always enjoy that extra leeway and don't even think about state taxes this early. BUT - - it occurred to me this week that they probably require estimated taxes too, and mine for 2009 might be due on April 15th, and guess what? They are. So, I freaked and spent this morning doing my 2008 Louisiana taxes, paying the amount due, and tomorrow morning I will send one fourth of that amount to Louisiana for my April 15th estimated taxes. I might have to pay a penalty to Louisiana next year, as well.

(groan)

OK, so NOW my taxes are done (I think), at least until June. I feel like a battle-scarred veteran of estimated taxes by now.

 

[audreyh1]

I am paying estimated taxes for 2009, for the first time. TurboTax divided my 2008 underpayment by 4 and printed out the estimated tax forms with that number filled in, so I blithely sent off the one for April 15th for that amount. It seems likely that I might have to pay a penalty next year, though my AGI for 2009 is difficult to estimate (too many variables).

What do you mean Turbo tax used your 2008 underpayment divided by 4 for your estimated quarterly payments? How could it do that?

Turbotax takes the prior years taxes paid (multiplied by 110% for higher income earners) and divides that by 4 to compute the current year's "safe harbor" quarterly estimated tax payments. If you pay by this schedule you will owe no penalties no matter if your income ends up being way higher.

And if you think there was a mistake and have figured out how to correct it, it's not April 15 yet and you can probably send in another payment. Not sure of the exact protocol, but I'm sure there is one!

Audrey

 

[W2R]

What do you mean Turbo tax used your 2008 underpayment divided by 4 for your estimated quarterly payments? How could it do that?

I mean that it included the four filled out 2009 estimated quarterly payment forms when I told it to print out everything from my 2008 return. The amount TurboTax filled in for my quarterly payment for 2009 was 1/4 of my underpayment for 2008.

Turbotax takes the prior years taxes paid (multiplied by 110% for higher income earners) and divides that by 4 to compute the current year's "safe harbor" quarterly estimated tax payments. If you pay by this schedule you will owe no penalties no matter if your income ends up being way higher.

That sure takes a load off my mind. Thanks. I can see why it would not just use the underpayment for someone who is retired and paying most/all their taxes via estimated quarterly payments, though in my case I suppose the reason it used the underpayment is that I am still getting W-2's with withholding.

And if you think there was a mistake and have figured out how to correct it, it's not April 15 yet and you can probably send in another payment. Not sure of the exact protocol, but I'm sure there is one!

Earlier I did find a way to amend the quarterly payments, though I don't really know of any specific, correctable mistake. There are just a lot of unknowns here, so if the quarterly payments are not large enough then I will just have to pay the penalty.

 

[audreyh1]

That sure takes a load off my mind. Thanks. I can see why it would not just use the underpayment for someone who is retired and paying most/all their taxes via estimated quarterly payments, though in my case I suppose the reason it used the underpayment is that I am still getting W-2's with withholding.

Oh - OK, it's taking into account the W-2 withholding. You're probably OK then if this year is close to last year. If you have more income than expected in a future quarter, you might want to refigure your estimated taxes.

Audrey

 

[W2R]

Oh - OK, it's taking into account the W-2 withholding. You're probably OK then if this year is close to last year. If you have more income then expected in a future quarter, you might want to refigure your estimated taxes.

Audrey

Thanks for the tip!! That's a good idea.

 

[kaneohe]

Oh - OK, it's taking into account the W-2 withholding. You're probably OK then if this year is close to last year. If you have more income than expected in a future quarter, you might want to refigure your estimated taxes.

Audrey

Audrey,

Why the last statement? Didn't you say earlier that TT is using last yr as the safe harbor..........if you earn more than expected, don't you have more
withholding so at the end of the yr, you're even farther into the safe harbor?

 

[W2R]

Audrey,

Why the last statement? Didn't you say earlier that TT is using last yr as the safe harbor..........if you earn more than expected, don't you have more
withholding so at the end of the yr, you're even farther into the safe harbor?

Audrey knows a lot more about this than I do, but I should clarify that some, but not all of my income is subject to withholding. I claim 0 exemptions on my W-2 but the withholding still is nowhere near enough and this is why I have to do estimated quarterly taxes this year. Also everything is up in the air since I am in a state of transition right now.

In 2010, I plan to be retired and no more withholding. My income should settle down to something more predictable, too. That should solve that little oddity in my tax return.

 

[Lakedog]

Audrey knows a lot more about this than I do, but I should clarify that some, but not all of my income is subject to withholding. I claim 0 exemptions on my W-2 but the withholding still is nowhere near enough and this is why I have to do estimated quarterly taxes this year. Also everything is up in the air since I am in a state of transition right now.

In 2010, I plan to be retired and no more withholding. My income should settle down to something more predictable, too. That should solve that little oddity in my tax return.

Not sure if you realize that you can have an additional amount withheld from your salary (at least I did this when still working), and since you will collect a fed pension, you can have taxes withheld from the monthly payment (assuming the pension is enough to cover the total tax bill). I use this to avoid having to make quarterly payments.

 

[audreyh1]

Audrey,

Why the last statement? Didn't you say earlier that TT is using last yr as the safe harbor..........if you earn more than expected, don't you have more
withholding so at the end of the yr, you're even farther into the safe harbor?

Not if you don't have withholding. Those of us living off investments don't usually have withholding.

Audrey

 

[kaneohe]

Not if you don't have withholding. Those of us living off investments don't usually have withholding.

Audrey

ok, that makes sense. I guess I got confused bc your comment was made to
W2R who does have withholding for now.