IRS safe harbor after large capital gain

[Peter]

My understanding of the safe harbor rule is that no underpayment penalty will apply providing you pay at least 110% of last year's tax.

Is this true even if there is a large capital gain? I would prefer to underpay the tax due, until later in the year, when all other income has been finalized.

Seems too good to be true ... ?

 

[OldShooter]

AFIK it's true. We have been paying a safe harbor amount in December of each of the past few years, via 100% withholding of IRA distributions. I have heard nothing from the IRS.

 

[Sojourner]

You will get hit with an underpayment penalty if you don't pay enough quarterly estimated tax on the large CG. So, for example, if you realized the CG in February, then you'd need to pay sufficient estimated tax for that CG by the Q1 deadline (typically April 15), regardless of how much total tax you are paying throughout the year. That is my understanding, at least. The general idea is that it's a "pay as you go" tax system, so you must pay tax as you realize income throughout the year, otherwise you may be penalized.

 

[audreyh1]

My understanding of the safe harbor rule is that no underpayment penalty will apply providing you pay at least 110% of last year's tax.

Is this true even if there is a large capital gain? I would prefer to underpay the tax due, until later in the year, when all other income has been finalized.

Seems too good to be true ... ?

Yes!

I have done it a few times, no problem.

 

[Sunset]

You will get hit with an underpayment penalty if you don't pay enough quarterly estimated tax on the large CG. So, for example, if you realized the CG in February, then you'd need to pay sufficient estimated tax for that CG by the Q1 deadline (typically April 15), regardless of how much total tax you are paying throughout the year. That is my understanding, at least. The general idea is that it's a "pay as you go" tax system, so you must pay tax as you realize income throughout the year, otherwise you may be penalized.

Yep, unless you do the withholding from an IRA as it's considered throughout the year regardless of when done.

 

[audreyh1]

You will get hit with an underpayment penalty if you don't pay enough quarterly estimated tax on the large CG. So, for example, if you realized the CG in February, then you'd need to pay sufficient estimated tax for that CG by the Q1 deadline (typically April 15), regardless of how much total tax you are paying throughout the year. That is my understanding, at least. The general idea is that it's a "pay as you go" tax system, so you must pay tax as you realize income throughout the year, otherwise you may be penalized.

No.

As long as you pay prior years taxes (110% if above threshold) in 4 equal installments by the estimated tax payment quarterly deadlines, you will have no penalty, just a large amount of tax due the following April 15th.

No need to file form 2210 either.

That’s what safe harbor means.

 

[airborneFI]

You will get hit with an underpayment penalty if you don't pay enough quarterly estimated tax on the large CG. So, for example, if you realized the CG in February, then you'd need to pay sufficient estimated tax for that CG by the Q1 deadline (typically April 15), regardless of how much total tax you are paying throughout the year. That is my understanding, at least. The general idea is that it's a "pay as you go" tax system, so you must pay tax as you realize income throughout the year, otherwise you may be penalized.

This is not true.


OP's understanding about the safe harbor is correct. As long as he pays at least 110% of last year's tax, he will not owe any penalty.

 

[Sojourner]

No.

As long as you pay prior years taxes (110% if above threshold) in 4 equal installments by the estimated tax payment quarterly deadlines, you will have no penalty, just a large amount of tax due the following April 15th.

No need to file form 2210 either.

That’s what safe harbor means.

Right... I stand corrected. What I was thinking about were the times where I didn't pay the 100% (or 110%) safe harbor amount in particular years where my prior year income was MUCH higher than the current year's expected income. In those cases, you'd want to pay quarterly estimated taxes rather than paying (via safe harbor) far more tax than you'd likely owe.

 

[mrfeh]

My understanding of the safe harbor rule is that no underpayment penalty will apply providing you pay at least 110% of last year's tax.

Is this true even if there is a large capital gain? I would prefer to underpay the tax due, until later in the year, when all other income has been finalized.

Seems too good to be true ... ?

We're doing this very thing with our 2021 taxes. Had large cap gain early in 2021 and didn't pay all the taxes due, 'cuz why pay sooner than necessary?

 

[mrfeh]

No.

As long as you pay prior years taxes (110% if above threshold) in 4 equal installments by the estimated tax payment quarterly deadlines, you will have no penalty, just a large amount of tax due the following April 15th.

No need to file form 2210 either.

That’s what safe harbor means.

+1

This is correct.

 

[Peter]

Thanks everyone!

 

[OldShooter]

We're doing this very thing with our 2021 taxes. Had large cap gain early in 2021 and didn't pay all the taxes due, 'cuz why pay sooner than necessary?

Yup. We are too. In our case we withdrew a bunch from the IRAs to fund a house we're building. My rough estimate is that we'll owe around $60K fed+state on April 15. Paid safe harbor amount last year, so we're covered.

 

[Peter]

OP here again. I thought I'd better check to make sure this safe harbor rule applies to California as well.

It doesn't, if your AGI is over $1,000,000. Then you have to pay at least 90% of current year's taxes to avoid a penalty. And you can't wait until April 15th of the next year, either; amounts due are 30%, 40%, 0% and 30% for Q1 through Q4 respectively.

Well, at least the weather here is nice...

 

[mrfeh]

OP here again. I thought I'd better check to make sure this safe harbor rule applies to California as well.

It doesn't, if your AGI is over $1,000,000. Then you have to pay at least 90% of current year's taxes to avoid a penalty. And you can't wait until April 15th of the next year, either; amounts due are 30%, 40%, 0% and 30% for Q1 through Q4 respectively.

Well, at least the weather here is nice...

You could still follow the 110% rule for federal taxes.

 

[audreyh1]

Right... I stand corrected. What I was thinking about were the times where I didn't pay the 100% (or 110%) safe harbor amount in particular years where my prior year income was MUCH higher than the current year's expected income. In those cases, you'd want to pay quarterly estimated taxes rather than paying (via safe harbor) far more tax than you'd likely owe.

Yes, that also. In years where my taxable income drops (or I expect it to drop), and I want to avoid paying excess estimated taxes, I’ll use the annualized income method for calculating estimated taxes each quarter.

Mind numbing details follow.

I generally switch between the two methods:

1. After a lower than usual tax year, I use the 110% of prior year’s taxes in 4 equal installments.
2. After a higher than usual tax year, or expecting a major drop in income, I switch to the annualized income method. Most of my income is paid in Q4, so this also saves me paying way ahead.

And in average/usual years I may choose to start with method 1, but after Q4 I may switch to 90% of taxes owed to avoid overpaying taxes - so annualized income for Q4.*

The annualized income method is a lot of work, but I’m willing to do it to avoid overpaying estimated taxes. I really try to avoid refunds.

*Example: During 2020 I used method 2 because my income had dropped since I did some tax loss harvesting during the early 2020 market drop which lowered my 2020 taxable income quite a bit. For 2021 taxes, I started out using method 1 as I usually do after a lower tax year, but then in Q4 2021 we ended up doing some major charitable donations which lowered our taxes quite a bit - even more than 2020, so I switched to a bit over 90% 2021 taxes owed for the last Q4 installment, otherwise I would have way overpaid estimated taxes. 2022 - back to method 1 again!

 

[daver]

OP here again. I thought I'd better check to make sure this safe harbor rule applies to California as well.

It doesn't, if your AGI is over $1,000,000. Then you have to pay at least 90% of current year's taxes to avoid a penalty. And you can't wait until April 15th of the next year, either; amounts due are 30%, 40%, 0% and 30% for Q1 through Q4 respectively.

Well, at least the weather here is nice...

I believe you are correct...

CALIFORNIA INDIVIDUAL ESTIMATED PAYMENTS - SAFE HARBOR RULES
Generally, taxpayers can avoid paying California penalties for underpayment of estimated taxes by paying the lesser of the following:

1. 90% of the current year's tax
or
2. 100% of the preceeding year's tax

But high income taxpayers must meet some different standards as listed below:

1. When current year AGI exceeds $150,000 ($75,000 if married filing separately) but is less than $1,000,000 ($500,000 if married filing separately), they must pay in 110% of the prior year's amount to avoid the penalty.

2. Individuals with annual AGI of $1,000,000 or more must pay in 90% of the current year's tax to avoid a penalty.

And yes love the CA winters....

 

[statsman]

OP here again. I thought I'd better check to make sure this safe harbor rule applies to California as well.

It doesn't, if your AGI is over $1,000,000 ...

Sounds like a first-world problem.

We had a sizable post-exemption capital gain on the sale of our California house late October 2018, but we weren't over $1,000,000 AGI. For 2018, we just made sure of the safe harbor rules based on our owed 2017 Federal and California taxes (in our case, 110% of our 2017 California owed taxes). Sent them both whopping checks in 2019 when we filed for 2018.

 

[TheWizard]

2. Individuals with annual AGI of $1,000,000 or more must pay in 90% of the current year's tax to avoid a penalty.

As a side note, these higher income folks are now the new definition of Millionaires.

The old definition ($1M in net worth) expired at the start of the new millennium...