If you file estimated tax payments, you’ve got a double tax deadline to meet on April 15.
Estimated tax filings are due the 15th (unless it’s a weekend or holiday) of each January, April, June and September. The one due April 15 is the first payment for 2010 and covers untaxed earnings collected in the first quarter of this year.
Estimated tax payments are the bane of an increasing number of Americans. They are expected from people who make money on investments, run their own businesses or get any extra cash that has not yet been taxed.
Time-consuming? Yes, nobody really likes doing taxes more than once a year.
Confusing? Sometimes, especially if you’re earning income from several different sources at different times.
Necessary? You bet, or you could end up owing Uncle Sam penalties and interest.
The reason behind estimated taxes
Most people meet their tax obligations through paycheck withholding.
If you’re self-employed, either as your main job or as a sideline, you must get the taxes on this money to the IRS yourself by filing Form 1040-ES. Estimated taxes also are due on interest and dividends, profits from investment sales, alimony, rental income and prizes or awards.
The estimated tax system was designed to ensure that taxpayers who have a lot of nonwithholding income pay into the tax system regularly. This evens things out between these taxpayers and wage earners who lose a chunk of money each paycheck to taxes.
The problem, says Linda Durand, a certified public accountant with Drolet & Associates PLLC in Washington, D.C., is too many folks who have a windfall get excited about the extra cash and immediately spend the proceeds without any thought to the tax implications. Even people who earn a steady stream of money that isn’t taxed upfront put off filing estimated taxes because they want or need the cash now. They figure they’ll make it right with Uncle Sam come April 15.
That’s not a good idea. If you end up owing $1,000 or more in April, you might have underpaid your tax bill. That would open the door for the IRS to add penalties and interest for not paying tax on your earnings as you got them.
Instead, Durand recommends setting aside a portion of the new cash for the taxes. And get ready to send it in before the spring tax deadline, she says, because “the IRS wants people to be paying their taxes during the year.”
Estimated filing schedule
To meet the pay-taxes-as-you-earn goal, the IRS has set up an estimated tax timetable calling for the filing of a 1040-ES voucher four times a year. If you prefer, you now can pay electronically with a credit card or by enrolling in the tax agency’s Electronic Federal Tax Payment System, or EFTPS.
Although the payments are commonly called quarterly, they don’t coincide with the calendar quarters.
|Estimated tax due||For income received|
|April 15||Jan. 1 through March 31|
|June 15||April 1 through May 31|
|Sept. 15||June 1 through Aug. 31|
|Jan. 15||Sept. 1 through Dec. 31|
|If the due date falls on a Saturday, Sunday or legal holiday, you have until the next business day to make the payment. The filing is considered on time if it is postmarked by the due date.|
The IRS prefers that you figure the total amount of estimated tax you’ll owe in April, divide it by four and send in equal payments according to the schedule. There’s a work sheet with the Form 1040-ES package to do exactly that.
Meeting the IRS requirement
Eva Rosenberg, an enrolled agent and the Web’s TaxMama, offers an easier alternative to the IRS paperwork if you expect your taxable income to be the same or higher than it was last year.
All you need is last year’s tax return and statements showing current tax withholding.
|Look at Page 2 of your last 1040, specifically the “total tax” entry. Let’s say it was:||$10,000|
|From that, deduct any withholding you expect to have from any sources (wages, unemployment). For this example, let’s use:||$3,000|
|That gives you the total amount to be made up by estimated tax payments:||$7,000|
|Divide the result by 4, and that’s what you’d pay each IRS quarter in this scenario:||$1,750|
Rosenberg’s method works even if you expect to owe substantially more in taxes this year than you did the previous one. This is because the IRS considers estimated taxpayers compliant as long as they pay either 90 percent of their eventual tax bill or a “safe harbor” payment based on a percentage of the tax owed the previous year.
Many taxpayers opt for the safe harbor payment of 100 percent of their prior year’s tax bill because it gives them a specific number to work with. Even better, it protects them from penalties and interest regardless of how high their upcoming final tax bill goes.
Some safe tax harbors tougher to navigate
The safe harbor is a little choppier if you make a lot of money, however.
If your previous year’s adjusted gross income was more than $150,000 (for married couples filing jointly and single taxpayers; $75,000 for married taxpayers filing separately), and you want to base your estimated tax payment on the prior year’s amount, you’ll have a higher safe harbor percentage to meet.
For 2010 estimated payments, the safe harbor target for a high-earning taxpayer is 110 percent of the filer’s 2009 tax bill. That means, if your adjusted gross income on that previous return was $150,000 and you ended up with a $30,000 tax bill, the IRS expects you to pay $33,000 — $30,000 plus 10 percent — in 2009 via estimated and withholding taxes to guarantee you don’t encounter additional IRS charges in penalties and interest.
“With both (partners) in a couple earning or people holding multiple jobs, the salary cap is not as out of reach as it may seem, especially if they had a good investment or sold a piece of investment property during the year, too,” says Durand.
Paying only when you earn
A large estimated tax bill can take a big bite out of even a wealthier earner’s wallet, in spite of being spread out in four payments.
But the tax pain can be postponed, if not avoided.
Although the IRS will always take your money early, you don’t have to make estimated tax payments until you have income on which you will owe the tax.
If most of your untaxed income comes in one quarter (such as stock dividends paid at year’s end) or if you operate a business where income fluctuates throughout the year, you should consider paying your estimated taxes under the annualized income system.
“The annualized method allows you to take a look at each quarter independently and pay the tax in the quarter that you earned it,” says Durand. “Say your job is one where most income is in the summer, such as landscaping, rather than the winter; you want to pay the taxes when you have the money.”
With this approach, your required estimated tax payment for one or more periods might be less than the amount figured using the four-equal-payments method. To find that out, you’ll have to complete a work sheet, found in IRS Publication 505, Tax Withholding and Estimated Tax. Sole proprietors need another work sheet found in IRS Publication 505 to determine annualized self-employment taxes that are included with the estimated payments.
And you’ll need to file Form 2210 with your annual return to explain why you didn’t send in the expected equal payments, says Durand. This will keep the IRS, which assumes you earned the money equally during the year, from charging you an underpayment penalty and interest for not paying enough in a particular filing quarter.
“It is a little more complicated,” Durand says. “But for cash flow, it’s better, and it puts the tax in the quarter when it is earned.”
A way to avoid estimated filing
Does the prospect of struggling through work sheets and filing even more tax returns make your head spin? There is an alternative.
If you have wage income in addition to untaxed earnings, file a new W-4 at work and ask your boss to start taking out more payroll taxes to cover any shortfall. This strategy also works for couples who file jointly, but where only one spouse has wage income subject to withholding.
Your take-home pay will be a bit lighter, but you’ll be off the hook for estimated tax payments.
But if you make the withholding change now rather than waiting until the very end of the year, the per-check tax bite won’t be as big since it will be spread over four months.