Taxpayer has $100,000 short-term capital loss carryforward, and $100,000 long-term capital loss carryforward. In the first quarter, he gets $200,000 in short-term capital gains. How much estimated tax should he pay? (Assume no other income in that quarter.)
If that's his only income for the year, his tax bill will be $0. But if he doesn't pay any estimated tax, and does have more income later in the year, he'll be underpaid and subject to a penalty. Is he really stuck between either potentially overpaying or potentially paying a penalty?
He owes no tax for the quarter so needn't pay ANY installment. Should he get income in later quarters he can pay an installment for the later quarter based on the Annualized Income Method for determining underpayments. If he did have other income later any installment indicated by the AI Method would be limited to the amount of last year's tax for the same number of quarters to date. By using the AI Method he will incur no underpayment penalties.
For instance, if he should have income in the third quarter and the cumulative annualized tax due (third installment with no payment in the first or second quarter) is $1,500 and his taxes last year were $400, and he paid no earlier installments becasue he had no earlier income, the AI computations would indicate $300 due on Sept 15 ( 3/4 of $400) , and regardless of the amount of any additional income later in the year, another payment of $300 on Jan 15 would be indicated for no penalties under the AI Method.
So what happens if he has a lot more income later in the year, including $100,000 of long-term capital gains (and, say, $500,000 consulting fees)? Would he have underpaid for the first quarter?
Assume his tax liability last year was very high (so that safe harbor is gone).
Using the AI Method he has no tx liability for earlier quarters with no taxable income, regardless of what happens in later quarters. If he has income in later quarters he will owe an installment for that quarter. Get IRS form 2210 and fill it in and see how this works. Or download a form 2210 tax calculator from the web that will do all the messy computations for you.
His tax liability for the first quarter was $0, and that's what he paid. So there's not any underpayment.
He'll want to be absolutely sure he does not end up underpaid for the year, and he'll want to be sure to file the Annualized Income page of the 2210 to let the IRS know he had no income in that first quarter. Remember though, that the IRS version of a quarter of a year isn't the same as yours or mine.
Safe harbor is never gone. Some of the bars may be higher, that's all.
The rules are complicated, but typically safe harbor depends on withholding or *equal* quarterly payments.
No. As mentioned by others, by doing mini-tax returns (via form 2210) for each IRS "quarter", he can pay what he needs to each quarter to avoid both penalty and overpayment.
If his capital gain sale is reported on a 1099-B, he could ask the broker to do withholding, which by default counts for the whole year no matter when it actually happens.
He could also make (over-)estimated state tax payments close to but before the end of the year to help smooth out some of the unevenness, although under the annualized method they will only count for the quarter in which they were actually made.
You might be asking, how are the capital loss carryovers allocated under the annualized method? I couldn't find a simple answer in the instructions for Form 2210 or Pub 505, but I suspect if you fill out the worksheets and forms, they get applied to the capital gain income as it occurs. Some credits, on the other hand, need to be allocated across quarters according to your proportional AGI for that quarter.
Mark: You are right. The carryovers are put in the first quarter and limited to a net loss of $3,000 , which gets annualized to $12,000, which is one of the advantages to the AI Method. If they are not offset in the first quarter thay are applied to any gains as they occur in any subsequent quarter and the excess (up to $3,000) carried forward though all quarters.. Credits are applied in whatever amount is allowable for the annualized taxes through each quarter. So they may be fully earned in the first quarter (typical for the Child Tax Credit). or partially earned in the first quarter and then fully earned in the second, third and fourth quarter.
In the OP's case they are fully offset with gains in the first quarter so there is no further carryforward.
It might be a good idea to make the charitable contributions that people typically make in December in the first quarter (Jan 1 to April
15) in order to lower the first quarter annualized taxable income -- ie. if you intend to donate 15k, if you do it in the first quarter it will be like donating 60k for the whole year. Sounds right?
His tax liability for the first quarter is $0 only by using up his entire capital loss carryforward. And note that he's using the long-term loss against a short-term gain (because that's all he has, it's allowed), though by the end of the year the long-term loss gets applied against a (later quarter) long-term gain.
He did have income in the first quarter: $200,000 in capital gains.
A few other tips to minimize initial quarters' installments whether calculating currently, or to reduce a penalty, and some tips to keep you out trouble with the IRS.
Make any deduction on 1040 lines 23 through line 35 as early as possible
Apply carry-over losses in the first quarter, and apply any limit at the incurred level befor annulizing,
Make any itimized deductions on Schedule A each quarter, including State Sale Tax (if reinstated) and Property Tax, even if you do not intend to itemize annually.
Take any Schedule C, D, E and F losses available as soon as possible. Their annulized effect is a 4-fold reduction in the first quarter.
Determine which dividends are Qualified Dividends and figure each quarters' annualized tax using an appropriate Schedule D worksheet.
DO NOT take any pension, RMD, IRA or taxable payouts before September
Calculate and include any credits in the earliest quarter you are entitled to them, particularly the Child Tax Credit.
Calculate AMT, phase-outs and credit limitations every quarter so you don't underpay any quarter.
Compute taxability of your Social Security income each quarter
Apply withholding to the quarter it is withheld . Don't use averaged withholding until year-end.
Include withholding (to reduce installments) through the 15th of the month following the quarter end.
Be sure to figure SE Tax, deduct 1/2 of it at 1040 line 27 and SE Health Insurance at line 29.
Download a 2210 tax calculator from the web to do all the calucations for you, and keep you legal
Calculate any RMD early and prepare to take the RMD in December and withhold up to the entire amount. Reduce any calculated quarterly installments by 1/4 of the expcted RMD. Check with you RMD administrator as to lead times, required forms, limitations etc. I phone TRPrice and verbally advise them of the current RMD and the amount to withhold. They have no limits or special requirements.
Very handy set of rules Ed, there is some logic to this after all :-)
Slightly off-topic: I had trouble understanding the logic of the word "annualizing". Since I did my from 2210 for 2007 after the fact, in an attempt to get rid of underpayment penalties, I felt like I was "quarterizing" my income rather that "annualizing" it.. However, after looking up the definition of the word it made some more sense.
Annualizing: Making calculations for a period of less than a year as if the period were a whole year. For example, if data existed for only one quarter, it could be annualized by multiplying by four.
So the word is used in the sense that I should do this during the year, and in each quarter/period annualize from data known up to the current time.
For example, I should use form 2210 on March 31 to determine a safe (penalty-wise) amount of estimated tax to pay`, I would annualize (predict the full year) from Q1 and then determine total/4 as the safe amount (modulo some
derk: Now that you know what wer're trying to do download a 2210 tax calculater from the web which will remove the PITA factor and save you some bucks.
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