How Exactly to Handle Extra Taxes for Capital Gains?

[clobber]

Still working (W-2). Numbers are for illustration:

2019 - under-withheld and owed taxes ($5K) with small penalty
2020 - capital gains would increase tax liability by ~$12K more than 2018.
2021 - expect taxes to return to 2018 value.

My plan for 2020 was to withhold to 100% of my 2019 tax liability to avoid a 2020 penalty.

1) Am I correct that if I withhold to 100% of 2019 taxes, I will not owe a penalty in 2020 (even though I will owe $12K additional tax?)

2) Do I need to make estimated tax payments for the capital gains, or can/should I just increase my withholding for the rest of the year - to get me to the 100% of 2019 mark?

3) How do I ensure penalty free withholding in 2021? Clearly I do not want to withhold to 100% of 2020 taxes.

thanks in advance

 

[pb4uski]

1) Yes.
2) withholding is preferable since all withholdings are considered as done evenly throughout the year
3) you can't ensure penalty free withholding unless you meet the safe harbor... but if you monitor your situation and your 2021 withholding exceeds your 2021 tax then you'll be fine.

 

[cathy63]

If your 2019 AGI was over $150K, then you should withhold 110% of your 2019 tax liability in 2020, otherwise 100% is fine.

You could also pay estimated taxes, but I think it's easier to just have it withheld.

For 2021, you just need to withhold at least 90% of your tax liability for that year. If you can project your income, aim for 100% and then you'll have a little room for error.

 

[clobber]

If your 2019 AGI was over $150K, then you should withhold 110% of your 2019 tax liability in 2020, otherwise 100% is fine.

I saw that too. I'm struggling to understand that requirement. Why does it exist?

 

[statsman]

If your 2019 AGI was over $150K, then you should withhold 110% of your 2019 tax liability in 2020, otherwise 100% is fine.

We had a similar one-year spike in tax liability for 2018 (sold house with a good amount of taxable capital gains beyond the exemption). We couldn't withhold 110% of our 2018 tax liability in 2019. The best we could do was make sure we didn't owe when we filed for the 2019 tax year.

 

[cathy63]

I saw that too. I'm struggling to understand that requirement. Why does it exist?

I'm not sure there's a logical answer to most of the "why" questions about oddities in the tax law. I certainly can't explain this one.

 

[audreyh1]

I saw that too. I'm struggling to understand that requirement. Why does it exist?

Well, I always assumed they figured us bigger earners would make a lot more each year? LOL. But for most folks unless you get a big raise it doesn’t work.

You can start out filling the 110% of prior years taxes requirement but dial back to 90% of current years taxes after Q4 in Jan if it looks like you are going to overpay otherwise.

 

[scrabbler1]

Back in 2008, I had a monster cap gain from cashing out my company stock in November. It increased my income by a factor of 10, so there was no way I could adjust my withholding, especially because this happened after I left my job.


All I had to do was to make sure my total taxes paid in, by withholding or by estimated taxes, exceeded my 2007 (previous year) total tax liability. That got me to a safe harbor, so I paid the relatively small amount by 1/15/2009. I paid the rest in April.


Basically, I couldn't be punished for having a really "good" year in 2008, especially when the added income occurs in the 4th quarter.

 

[clobber]

Thanks everyone

 

[HI Bill]

2020 - capital gains would increase tax liability by ~$12K more than 2018.
2021 - expect taxes to return to 2018 value.

Wow! This describes me in 2020. I sold a bunch of equities just prior to COVID crash, realizing LTCGs. I had planned to keep my MFJ income to <$80K to keep the LTCGs tax-free, but due to COVID, have delayed FIRE, and am looking at $23K in federal taxes instead of my usual $15K. So, what I've done is added $500 of additional federal tax withholding and $450 in additional state tax withholding per pay period ($1K and $0.9K per month) for the remainder of 2020.

 

[Animorph]

If you don't mind doing your taxes quarterly you can handle a big unexpected capital gain at the end of the year with a matching fourth quarter estimated tax payment. No penalty as long as tax payments match tax liabilities for each of the IRS's tax "quarters", which are not calendar quarters. This was a pain for me to sort out, but it did save a few bucks in penalties.

 

[clobber]

Wow! This describes me in 2020. I sold a bunch of equities just prior to COVID crash, realizing LTCGs. I had planned to keep my MFJ income to <$80K to keep the LTCGs tax-free, but due to COVID, have delayed FIRE, and am looking at $23K in federal taxes instead of my usual $15K. So, what I've done is added $500 of additional federal tax withholding and $450 in additional state tax withholding per pay period ($1K and $0.9K per month) for the remainder of 2020.

I think this is what I am planning to do, but only to make sure I get over the 100% of 2019 tax liability. I don't "mind" writing the bigger check come 2020 tax time. I guess it is even physiologically better than reducing take home pay every check. Ha.

 

[Rex]

The penalty for not withholding is not that bad....of course, it's based on how much you did not pay Uncle Sam.

I've given up trying to pay quarterly payments and for years, we just roll with it and pay on tax day. It's not worth the hassle of figuring out the amounts as they vary from year to year and remembering to make quarterly payments. Plus, I never like to give Uncle Sam my money and earning zero percent interest for the amount I overpay.

Here is the penalty:

"For every month or part of a month that you're late in paying your taxes, you'll owe a penalty of 0.5% of your unpaid taxes."

 

[clobber]

The penalty for not withholding is not that bad....of course, it's based on how much you did not pay Uncle Sam.

"For every month or part of a month that you're late in paying your taxes, you'll owe a penalty of 0.5% of your unpaid taxes."

This is a good point. When I originally said "small penalty" I was shocked at how small it actually was.