Estimated tax payments are required on income that is not subject to withholding. The most common types of income that results in estimated tax are earnings from self-employment, interest, dividends, alimony, and rental income. Here are some basic tips related to estimated tax obligations.
Calculate your estimated tax payments
Many taxpayers have difficulty predicting what their actual income from self-employment and other sources (rental properties, investments, etc.) will be from year to year. Form 1040-ES is the form that is used to calculate required estimated tax payments. Use this form to calculate estimated taxes. Unless you anticipate significant changes in income, it is generally a good idea to make estimated tax payments based on 100% of the previous year’s tax liability. By choosing this option you will simply divide the total amount of tax you paid in 2008 by 4. There is an exception to this rule if your 2008 income was $150,000 or greater. Rather than being able to base estimated payments on 100% of last year’s total tax, higher income taxpayers are required to base payments upon 110% of last year’s total tax.
Review your income tax plan regularly
Staying current with estimated tax payments requires a plan. Review your actual income and tax payments on a regular basis if you are subject to estimated taxes. This is especially important if you anticipate significant fluctuations in your income. A little planning can avoid significant headaches and surprises when the next tax filing deadline arrives. In my professional experience I have seen many tax problems arise as a result of the lack of planning.
Avoid estimated tax penalties
A penalty may be applied if you do not pay enough estimated tax for the year. Estimated tax penalties may also apply if you do not make payments on time or in the correct amount. The Internal Revenue Service recently announced that interest rates for the calendar quarter beginning July 1, 2009, would remain the same. The rate for underpayment of taxes is currently 4 percent. The best way to avoid estimated tax penalties is to consistently track income and tax payments throughout the year. While this rate is currently rather low, any penalties that can be avoided will put more money in your pocket and eliminate unnecessary penalty payments to the IRS.
Plan ahead for events that may result in an estimated tax
Be prepared if you have an unexpected event occur (e.g., loss of job, divorce, early retirement, family emergency, major purchase) that requires a taxable distribution from a retirement plan or other investments that are subject to taxes. Taxpayers are frequently overwhelmed with dual focus on meeting cash flow needs and satisfying tax obligations. During uncertain economic times or when faced with a cash flow crisis, it can be very tempting to ignore basic tax obligations. Proper income tax planning can help prevent problems during both good times and bad financial times. Any potential tax event should be discussed with your tax advisor or financial planner.
Stay current with your payments
Estimated taxes are due by the 15th of April, June, September, and January. It is important to keep in mind that these are not exactly “quarterly payments”.
If needed, try making weekly, bi-weekly, or monthly payments. This will reduce the impact of the sticker shock related to quarterly payments throughout the year. A significant amount of discipline is required to make sure that funds set aside for estimated tax payments are actually available when needed. If you are routinely struggling to identify funds for estimated tax payments you should strongly consider establishing a separate bank account (e.g., checking, savings, money market) specifically for estimated taxes. Never commingle funds designated for taxes with monies that are being used to meet basic living expenses.
Use the Electronic Federal Tax Payment System
Paying taxes electronically can eliminate the need to write checks and streamline the process of paying estimated taxes. Using the EFTPS system is the easiest way to pay federal taxes for individuals as well as businesses. Taxpayers have the ability to make all federal tax payments including federal tax deposits, installment agreement and estimated tax payments using Electronic Federal Tax Payment System (EFTPS).
Showing posts with label Estimated tax. Show all posts
Showing posts with label Estimated tax. Show all posts
Wednesday, July 22, 2009
Tuesday, July 21, 2009
The Basics of Estimated Taxes
If you are self-employed you are responsible for paying the self-employment tax. Any individual who is self-employed, retired, laid-off, or disabled, is responsible for filing and paying Federal estimated quarterly taxes and in states having a state income tax, for filing and paying State estimated quarterly taxes. This can be very different from the taxation that takes place while you are employed.
First of all, the term “estimated quarterly taxes” is not exactly accurate. The IRS publishes a schedule that jumps around a little. The first payment for a tax year is due April 15. The second payment is due June 15, and the third payment is due September 15. The last payment is due January 15 of the next year. So the payment schedule is more like 3½ months, 2 months, 3 months and 4 months in making up the Federal estimated quarterly tax payments. The intent, however, is each payment represents ¼ of what you will owe for the year.
It takes discipline to plan and set aside funds for tax payments throughout the year, especially when the individual or married couple is managing their own income. If sufficient funds are not set aside as income is earned, then the individual or married couple will be put in a situation where some assets might have to be liquidated in order to come up with enough money to pay the taxes. An easier method is for the individual or married couple to know what their approximate Federal and State tax rates are and to apply those rates to income as it is earned. The calculated taxes should be set-aside in a separate interest bearing account until it is time to pay the estimated tax payments.
The IRS allows for two basic methods of calculating estimated taxes. An individual or married couple (if filing jointly) can either elect to pay an amount based on the total taxes paid in the previous year or pay at least 90% of the estimated taxes that will be due in the current year. Remember, in either situation, the amounts paid are only for estimated taxes and the actual tax due will probably differ from the total of estimated taxes actually paid. If electing to pay based on the prior year, the IRS allows you to calculate your amount and to then spread that amount into four equal payments, paying them on the estimated tax due dates.
Example: A married couple filed a joint return and the previous year’s total income was $160,000. The IRS formula is 100% of the prior year income if the income is less than $150,000 or 110% if greater than $150,000. If the couple paid Federal taxes of $42,000 last year on income of $160,000, this year’s estimated taxes would be $42,000 X 1.10 = $46,200. The estimated quarterly tax payments would be $11,550 due on each estimated tax installment date.
If you to pay at least 90% of the estimated tax due during the current year, then you must keep track of income received during the year and make sure the total estimated taxes paid by the time the last installment is paid equals 90% of the actual tax that will be due at filing time. (This should be easy to do, even if the first three installments were insufficient, as the last installment date is January of the next calendar year. This allows you to adjust the last payment for any unexpected income.) Failure to pay at least 90% of the tax due will result in a penalty being assessed on the amounts failing to meet the 90% level. Keep in mind, the 90% option is just that, 90% of the actual tax that will be due by the April 15th filing date. If you just meet the 90% amount, then the remaining 10% due will have to be paid with the final filing.
One surprise people discover when electing the 90% option is that the date of the first payment due in the next year and the annual filing from the last year coincide. Thus, not only is the estimated quarterly payment due for the current year, but any remaining balance owed from the prior year, such as the 10% not paid due to electing the 90% rule, will be due with the year end filing for the prior year. If funds were not set aside coming up with the monies to pay these taxes can be challenging. Keep in mind, these rules apply to both Federal and State taxes if your state has an income tax.
First of all, the term “estimated quarterly taxes” is not exactly accurate. The IRS publishes a schedule that jumps around a little. The first payment for a tax year is due April 15. The second payment is due June 15, and the third payment is due September 15. The last payment is due January 15 of the next year. So the payment schedule is more like 3½ months, 2 months, 3 months and 4 months in making up the Federal estimated quarterly tax payments. The intent, however, is each payment represents ¼ of what you will owe for the year.
It takes discipline to plan and set aside funds for tax payments throughout the year, especially when the individual or married couple is managing their own income. If sufficient funds are not set aside as income is earned, then the individual or married couple will be put in a situation where some assets might have to be liquidated in order to come up with enough money to pay the taxes. An easier method is for the individual or married couple to know what their approximate Federal and State tax rates are and to apply those rates to income as it is earned. The calculated taxes should be set-aside in a separate interest bearing account until it is time to pay the estimated tax payments.
The IRS allows for two basic methods of calculating estimated taxes. An individual or married couple (if filing jointly) can either elect to pay an amount based on the total taxes paid in the previous year or pay at least 90% of the estimated taxes that will be due in the current year. Remember, in either situation, the amounts paid are only for estimated taxes and the actual tax due will probably differ from the total of estimated taxes actually paid. If electing to pay based on the prior year, the IRS allows you to calculate your amount and to then spread that amount into four equal payments, paying them on the estimated tax due dates.
Example: A married couple filed a joint return and the previous year’s total income was $160,000. The IRS formula is 100% of the prior year income if the income is less than $150,000 or 110% if greater than $150,000. If the couple paid Federal taxes of $42,000 last year on income of $160,000, this year’s estimated taxes would be $42,000 X 1.10 = $46,200. The estimated quarterly tax payments would be $11,550 due on each estimated tax installment date.
If you to pay at least 90% of the estimated tax due during the current year, then you must keep track of income received during the year and make sure the total estimated taxes paid by the time the last installment is paid equals 90% of the actual tax that will be due at filing time. (This should be easy to do, even if the first three installments were insufficient, as the last installment date is January of the next calendar year. This allows you to adjust the last payment for any unexpected income.) Failure to pay at least 90% of the tax due will result in a penalty being assessed on the amounts failing to meet the 90% level. Keep in mind, the 90% option is just that, 90% of the actual tax that will be due by the April 15th filing date. If you just meet the 90% amount, then the remaining 10% due will have to be paid with the final filing.
One surprise people discover when electing the 90% option is that the date of the first payment due in the next year and the annual filing from the last year coincide. Thus, not only is the estimated quarterly payment due for the current year, but any remaining balance owed from the prior year, such as the 10% not paid due to electing the 90% rule, will be due with the year end filing for the prior year. If funds were not set aside coming up with the monies to pay these taxes can be challenging. Keep in mind, these rules apply to both Federal and State taxes if your state has an income tax.
Friday, July 17, 2009
Do you Owe Estimated Taxes?
It is often emphasized by financial planners that tax planning is a year round effort. For most people the April 15th filing deadline is at the center of their tax planning concerns. However, most financial planners and tax professionals agree that tax planning begins well before the due date of a personal income tax return. The implementation of an effective tax and financial plan throughout the course of the year can help one minimize the impact of taxes and make smart financial decisions. If you owe estimated taxes to the IRS the importance of having an income tax plan in place is magnified.
Do you owe the IRS or State estimated taxes?
Estimated tax is the method used to pay tax on income that is not subject to withholding. The most common examples of income resulting in estimated taxes includes self-employment income, investment income (dividends and interest), alimony, rental income, gains from the sale of assets, prizes and awards. If the amount of income tax being withheld from your salary, pension, or other income is not enough you also may have to pay estimated tax.
Who Must Pay Estimated Tax
If you had a tax liability for 2008, you may have to pay estimated tax for 2009.
General Rule
You must pay estimated tax for 2009 if both of the following apply.
1. You expect to owe at least $1,000 in tax for 2009 after subtracting your withholding and credits.
2. You expect your withholding and credits to be less than the smaller of;
- 90% of the tax to be shown on your 2009 tax return, or
- 100% of the tax shown on your 2008 tax return. Your 2008 tax return must cover all 12 months.
Many taxpayers get into trouble with tax debt due to the failure to stay current with their estimated tax payments. Some of the most common triggers of tax problems are related to major life events. These life changes may include loss of employment, business cash flow problems, and unexpected medical expenses (to name a few). Self-employed individuals are at a huge risk for estimated tax problems. I see a great deal of people who are transitioning from being a W-2 employee to self-employment struggle with making estimated tax payments. Keep in mind that the ultimate trigger of tax problems is often the lack of a holistic tax and financial plan.
The failure to make accurate and timely estimated tax payments can lead to major tax problems. If you are required to make estimated tax payments you need to follow a tax and financial plan that will prepare you for this tax obligation. Good organizational skills and budgeting is an excellent form of prevention.
Next week I will present some basic tips to help taxpayers subject to estimated tax payments stay current with their tax obligations and prevent tax problems.
Do you owe the IRS or State estimated taxes?
Estimated tax is the method used to pay tax on income that is not subject to withholding. The most common examples of income resulting in estimated taxes includes self-employment income, investment income (dividends and interest), alimony, rental income, gains from the sale of assets, prizes and awards. If the amount of income tax being withheld from your salary, pension, or other income is not enough you also may have to pay estimated tax.
Who Must Pay Estimated Tax
If you had a tax liability for 2008, you may have to pay estimated tax for 2009.
General Rule
You must pay estimated tax for 2009 if both of the following apply.
1. You expect to owe at least $1,000 in tax for 2009 after subtracting your withholding and credits.
2. You expect your withholding and credits to be less than the smaller of;
- 90% of the tax to be shown on your 2009 tax return, or
- 100% of the tax shown on your 2008 tax return. Your 2008 tax return must cover all 12 months.
Many taxpayers get into trouble with tax debt due to the failure to stay current with their estimated tax payments. Some of the most common triggers of tax problems are related to major life events. These life changes may include loss of employment, business cash flow problems, and unexpected medical expenses (to name a few). Self-employed individuals are at a huge risk for estimated tax problems. I see a great deal of people who are transitioning from being a W-2 employee to self-employment struggle with making estimated tax payments. Keep in mind that the ultimate trigger of tax problems is often the lack of a holistic tax and financial plan.
The failure to make accurate and timely estimated tax payments can lead to major tax problems. If you are required to make estimated tax payments you need to follow a tax and financial plan that will prepare you for this tax obligation. Good organizational skills and budgeting is an excellent form of prevention.
Next week I will present some basic tips to help taxpayers subject to estimated tax payments stay current with their tax obligations and prevent tax problems.
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