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January Tip of the Month (2 of 2)

Don't say we didn't warn you: The same tax question asked four times in the last two days is worthy of an Abo and Company alert

Here's another inquiry we at Abo and Company have been getting a lot of nervous inquiries about the last few days with a January 15th fourth quarter payment due for many - Estimated Taxes.

The purpose of this advisory is to provide you with an overview of the varying methods of calculating your estimated tax payments.  Not just about the payment that might be due tomorrow but also the first quarter 2015 estimate that may be due in three months by April 15th. Still, if you need more information, do what we Abo and Company does - double check what we're saying by going to the IRS Publication 505 (revised March 2014) entitled "Tax Withholding and Estimated Tax".  Or....just read on.


In general, estimated taxes must be paid on any income which is not subject to withholding, including taxable income from self-employment, interest, dividends, alimony, gambling winnings, unemployment compensation, social security, rent, and gains from the sale of assets.  You also may have to pay estimated tax if the amount of income tax being withheld from your salary, social security, 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 personal tax return. If you do not pay enough tax, either through withholding or estimated tax, or a combination of both, you may have to pay a penalty.  You may be charged a penalty even if you are due a refund when you file your return. Estimated tax payments are made in four quarterly installments and can be based on a regular tax method or an annualized income installment method.


If you choose not to use the "Regular installment method", the annualized installment method allows you to compute your estimated tax based on actual income earned in each of four specific periods.  This is not always an easy task and certainly much more time consuming.  As a result, tax on income which is seasonally earned will not effectively be paid until the period in which it is earned.  For example, if a significant percentage of your income is earned in the last quarter of the year, then utilizing the annualized income installment method will allow you to defer the payment of tax on this income to the final quarter as opposed to paying the tax on this amount in equal installments throughout the year.


In general, under the regular installment method, the required annual payment which is paid quarterly through estimated taxes (if no tax is withheld) is the smaller of 1) 90% of the current year's total expected tax or 2) 100% of the tax shown on the prior year return. Note that if your last year's Adjusted Gross Income was over $150,000 ($75,000 for married filing separately); the safe harbor is 110%.  Adjusted Gross Income refers to all taxable income less certain deductions (not itemized deductions) such as your SEP/IRA/Other Retirement Plan contributions, alimony payments, deductible health insurance premiums paid (for self-employed individuals), moving expense deductions, deductible tuition, student loan interest and fees,  self-employment tax deductions, etc..


Timing of Payments, Penalty for Underpayment


The year is divided into four payment periods for estimated tax purposes.  Each period has a specific payment due date.  Note that if you do not pay enough tax by the due date for each period, you may be charged a penalty through the date any underpayment remains outstanding even if you are due a refund upon filing your income tax return.  The penalty is equal to the interest rate charged on tax deficiencies (3% per year as of the writing of this alert, January 13, 2015) on the amount of the installment underpayment from the date the installment is due until the earlier of the date the underpayment is made up for April 15th of the next year.  Thus, generally the penalty for underpayment of an estimate is equivalent to paying the IRS non-deductible interest.  Still, considering credit card interest rates exceeding 12%, 15% and upward, the effective borrowing from the IRS is not the worst as long as you're properly monitoring.


The specific due dates for estimated tax payments are as follows:

Period

Due Date

January 1 - March 31

April 15

April 1 - May 31

June 15

June 1 - August 31 

September 15

September 1 - December 31 

January 15 of following year

      
     
State Tax Estimates


Estimated taxes must 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.


Tax Projections - A Good Thing (we think)


Clients often wish to set up appointments during the year, even after tax time, to go over several tax and financial planning issues we suggest and even consider preparing tax projections to at least see what tax planning strategies, if any, can be implemented before year end.  We usually leave it up to the individual whether or not they wish to incur such professional fees but we just dread having to possibly say even as far away as next April 15th "...this is what you could have done".  At this point, with December 31st behind us, 2014 is effectively fate accompli, but while we’re addressing the preparation of your 2014 returns, what better a time to consider what’s up for 2015.


While estimated tax payments have become the bane of an increasing number of our clients and the taxpaying public, here are tips even the IRS agrees are worth considering about estimated taxes and how to pay them.

  1. As a general rule, you must pay estimated taxes in 2015 (yes, we said 2015) 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 credits, and 2) You expect your withholding and credits to be less than the smaller of 90% of your 2015 taxes or 100% of the tax on your 2014 return. There are special rules for farmers, fishermen, certain household employers and certain higher income taxpayers.
  2. For Sole Proprietors, LLC Members, Partners and S Corporation shareholders, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your return. 
  3. 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 1040ES, Estimated Tax for Individuals for this, just use the blank tax forms, tax programs or confer with us, your CPAs. You want to be as accurate as possible to avoid penalties. Also, consider changes in your situation and recent tax law changes. 
  4. The year is divided into four payment periods, or due dates, for estimated tax purposes. Those dates generally are April 15, June 15, September 15 and January 15. 

Form 1040ES, Estimated Tax for Individuals, provides all you'll need to pay estimated taxes. This includes instructions, worksheets, schedules and payment vouchers. The easiest way to pay estimated taxes, however, is electronically through the Electronic Federal Tax Payment System or EFTPS. You can also pay estimated taxes by check or money order using the Estimated Tax Payment Voucher or by credit or debit card (albeit we don't particularly advise the use of credit cards due to the expensive service charge).