Estimated taxes?

Hi, a couple questions about estimated taxes. I know it's kind of late, but I just realized I may need to look into this.

Question #1) Was I supposed to pay estimated taxes for 2010 to avoid penalties, given this scenario? .....

In 2009, I had work income of $22K (from which taxes were automatically taken out of my paycheck). I also had $5K income from dividends. And $1K from business income (for which I did not pre-pay the tax). Being an idiot, I didn't plan ahead, and almost incurred a tax penalty because the extra $6K in income almost caused me to not pre-pay at least 90% of my tax liability for the year.

NOW.... for 2010, I will make about $14K from work income in the FIRST

6 months (taxes already taken out of paycheck). I will also make about $3K in dividends in the first 6 months. BUT in the LAST 6 months of 2010, I will have work income of $100K (from which taxes will automatically be taken out of paycheck). In the LAST 6 months of 2010, I will also have $3K in dividend income.

Was I supposed to be paying estimated taxes? As I said, in 2009, I almost incurred a penalty because of the extra $6K I made in dividends/ business. But, if I read correctly, since I obviously will pay in

2010, way more than my tax liability in 2009, I won't have a penalty?

Question #2) If you're calculating estimated tax payments, I know you need to consider predictable income from the previous year, such as regular dividends, since they don't automatically get taxes withdrawn. However, what if one quarter, you happen to hit the jackpot... say you buy a penny stock that skyrockets and you make a $500K profit in just a few days (this is just hypothetical). Then obviously your estimated tax for that quarter will be way off. Are you supposed to disregard the estimate for that quarter, and more precisely calculate your tax liability due to the unanticipated $500K income?

Question #3) Kind of related to question #1. So what if I realized I DID need to be paying estimated quarterly taxes. Well obviously I already missed the 1st quarter. Would I have to figure out my penalty and pay it in the 2nd quarter, or do I pretty much have to just wait passively until the end of the year and then pay one big penalty?

Reply to
martin lynch
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  1. Becaue of the large withholding in the second half of the year you average that over all 4 quarters and then have no penalty because the average is more than 1/4 of last year's tax. If you didn't know about this, yes, you should hav e been paying estimates so each quarter is at least as much as 1/4 of last year's tax or 1/4 of 90% of this years final tax (whichever is lower).
  2. Again, most likely the 1/4 of last year's tax "safe harbor" will prevail. You then ignore any large gains in later quarters.
  3. Any penalty is figured when you pay your tax next year (April). You use form 2210, and if annualizing helps, its' Schedule AI. If you realize you underpaid a previous quarter the sooner you "catch up" the less the penalty will be. In your case the 100K of salary with withholding more than makes up any underpayment in the first or second quarter.

You mention "dividends" but if they are "qualified"( which they probably are) there is no tax on some amount of them and / or long term gains in 2009 and 2010. You don't mention it, but you probably had SE tax ini 2009 and 2010.

Download an IRS form 2210 and fill out the first page with your hypothetical values to see how this works, and even the Schedule AI . In either case it benefits you to average withholding over all 4 quarters.

There's a spreadsheet at

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to do the calculations for you.

ed

Reply to
ed

  1. Becaue of the large withholding in the second half of the year you average that over all 4 quarters and then have no penalty because the average is more than 1/4 of last year's tax. If you didn't know about this, yes, you should hav e been paying estimates so each quarter is at least as much as 1/4 of last year's tax or 1/4 of 90% of this years final tax (whichever is lower).
  2. Again, most likely the 1/4 of last year's tax "safe harbor" will prevail. You then ignore any large gains in later quarters.
  3. Any penalty is figured when you pay your tax next year (April). You use form 2210, and if annualizing helps, its' Schedule AI. If you realize you underpaid a previous quarter the sooner you "catch up" the less the penalty will be. In your case the 100K of salary with withholding more than makes up any underpayment in the first or second quarter.

You mention "dividends" but if they are "qualified"( which they probably are) there is no tax on some amount of them and / or long term gains in 2009 and 2010. You don't mention it, but you probably had SE tax ini 2009 and 2010.

Download an IRS form 2210 and fill out the first page with your hypothetical values to see how this works, and even the Schedule AI . In either case it benefits you to average withholding over all 4 quarters.

You can download the IRS form 2210 from their web site

formatting link
, or there are spreadsheets available elsewhere on the web to download that will calculate the 2210 for you.

ed

Reply to
ed

Your dividends may be taxed at only 15%.

The withholding on your new job will probably cover your tax, since half the tax on $100K is much more than the tax on $50K. Also, as was pointed out, withholding is presumed to have been spread out evenly over the entire year, and not just the quarter in which it was withheld. (In fact, I once read a tax tip that those withdrawing money from a Regular IRA or 401K should have a substantial portion of a 4th quarter withdrawal withheld for taxes if they underpaid, or didn't pay, estimated tax during the year.)

I believe that you readjust your computation for the year and "catch up" with your estimated tax. For example, suppose you estimated your tax for the year to be $8K, and so you pay $2K the first quarter. Now, with this 500K of long-term (hopefully) cap gain, your tax is now $83K, so pay $40K the 2nd quarter in order to pay half the total. Then pay $21K each of the final 2 quarters.

Another option is to pay a lot less, because if your total payments are what your tax was last year (or 110%(?) of last years if income >

$150K), there's no penalty either, as long as they were paid each quarter.

I believe form 2210 calculates it for you at 1040 time.

Reply to
Stan K

You don't need to.

That $28K total income.

The withheld tax on the $100K earned in the second half will greatly exceed your 2009 taxes, which is a safe harbor for not suffering underpayment/underwithholding penalties or interest (provided you pay in full by April 15).

That's correct. (If your income is high enough, the safe harbor is

110% of 2009's taxes.)

No, you need to consider income for _this_ year. What if you sold the stock on Dec 31? What if the company paying big dividends went bankrupt?

The rules for estimated taxes are, basically, "Look at your income to date. Annualize it. Calculate taxes based on that. De-annualize to date; subtract withholding + estimated paid, if the result is positive, pay that much in estimated taxes."

You need to re-estimate.

Yes. (Actually, the rules would say based on roughly $1 million annual income if the $500K is in the second quarter.)

For the penalty, just wait. However, if you underpaid in Q1, you should make that up in Q2. (Better, tell your employer in the second half of the year to increase withholding to a high enough level to avoid penalties.)

Seth

Reply to
Seth

your prior year AGI. If your prior year AGI is under 75k, then safe harbor is 100% of last year's tax, even if this year you made over

75k.

BTW, they also have a 90% of last years' tax for qualified small businesses.

Reply to
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In addition to the other replies, I would go one step further. As you only have to pay 100% of last years taxes, do just that. On last year's income of 28k your tax was probably $3000 or something like that, including the SE tax on 1k. So just make sure that you pay $3000 through witholding (or equal estimated payments of 3000/4 each, but you missed the first 2 payments). Since your income in the last 6 months is go high, they will withold a lot of money. As soon as 3k is withheld for the whole year, which may be in the last paycheck of July, adjust your withholdings to like 1000 exemptions so that no federal tax is withheld. But don't spend the extra money. It will be due April/15 of next year. Put it into savings or US treasuries that mature on or before 4/15/2011. In other words, defer paying tax and earn interest on it.

You didn't mention what state you're in. Most states also have a safe harbor rule. Maybe all do, I don't know. For CA they follow the 110%/

100% rules of federal, but they don't have the 90% of last year's tax for qualified small businesses. For estimated payments, they have a strange ratio whereby you pay more tax in the first 2 quarters.
Reply to
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