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April 2012 Tip of the Month

Tips for People Who Pay or Should Pay Estimated Taxes

You may need to pay estimated taxes to the IRS and one or more states during the year if you have income that is not subject to withholding. This depends on what you do for a living and the types of income you receive.

Here are ten points we at Abo and Company would at least like you to consider regarding your estimated taxes and how to pay them.

  1. If you have income from sources such as self-employment, interest, dividends, alimony, rent, gains from the sales of assets, prizes or awards, then you may have to pay estimated tax. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension or other income is not enough.  Estimated tax is used to pay income tax and self employment tax, as well as other taxes and amounts reported on your tax return.  
  2. As a general rule, you must pay federal estimated taxes in 2012 if both of these statements apply: 1) You expect to owe at least $1,000 in tax after subtracting your tax withholding (if you have any) and tax credits, and 2) You expect your withholding and credits to be less than the smaller of 90 percent of your 2012 taxes or 100 percent of the tax on your 2011 return. If your 2011 Adjusted Gross Income was more than $150,000 ($75,000 if Married Filing Separately) substitute 110% for the 100% requirement.  
  3. For Sole Proprietors, Partners and S Corporation shareholders, you generally should make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return.  
  4. To figure your estimated tax, include your expected gross income, taxable income, taxes, deductions and credits for the year. You can use the worksheet in Form 1040-ES, Estimated Tax for Individuals, for this. You want to be as accurate as possible to avoid penalties. Also, consider changes in your situation and recent tax law changes. Many a client will have us prepare tax projections for them and even have them updated as the year progresses.  Your call.  
  5. The year is divided into four payment periods, or due dates, for estimated tax purposes. Those dates generally are April 15, June 15, Sept. 15 and Jan. 15 of the next or following year.  This year we get a bit of reprieve to April 17, 2012. As you can see, estimated tax payments are made in four quarterly installments and can be based on a regular tax method or an annualized income installment method.  
  6. The disadvantage to utilizing the annualized method as opposed to the regular method is that the calculation of your estimated tax payments may be more complex and time consuming.  Additionally, your estimated tax payments must be recalculated at the end of every quarter.  If you make an estimated tax payment using the annualized income method for a quarter, you may change to the regular method for a subsequent quarter but you must recapture the difference between the annualized income installments and the regular installments by adding the amount of the differential for all previous periods to the regular installment for the next payment period. For example, if you estimated a tax of $1,000 under the regular method, $250 would be due each quarter.  If you used the annualized method for the first quarter and paid $100, and then shifted to the regular method for the second quarter, the second quarter installment due would be $400 ($250 for the second quarter plus $150 unpaid for the first quarter).  
  7. An underpayment penalty is imposed on each underpayment for the number of days it remains unpaid.  A penalty may be applied if you did not pay enough estimated tax for the year or you did not make the payments on time or in the required amount.  A penalty may even apply if you have an overpayment on your tax return.  As we pointed out in an earlier email alert, the rate imposed is currently at 3% per annum.  Not necessarily the worst.  
  8. With April 17th filing deadline around the corner, if you only have so much in funds available to pay the balance of your 2011 tax liabilities as well as 2012 estimated tax payments, our vote is generally to pay the 2011 amounts due IRS and/or the states.  The 2012 underestimated tax penalty at 3% per annum at least does not have the additional "late payment of tax" penalty applied to it as you would with 2011 tax paid after April 17th.  
  9. Estimated taxes should be calculated for all states for which you will be filing individual resident or nonresident tax returns.  For purposes of calculating estimates for most states, either the regular installment or annualized income installment method may be used. 
  10. Many of our clients have called asking why we've included 2012 estimated tax vouchers with their 2011 tax returns.  When there is a material balance due on their federal or state 2011 return, we may often produce such safe-harbor estimates if we are unsure if you will be having similar balances due this time next year.  After discussing with us, clients often consider increasing their withholdings to so avoid the need for paying such estimates.  Again, your call.