Estimated Taxes Due Today

Third quarter estimated taxes, covering June 1 to August 31, are due today.  To learn more about estimated taxes, including due dates, penalties, and different methods for calculating it, see our post for the previous quarter.  But for today, here are the main things you need to know:

  • There is a penalty for underpaying estimated taxes. In 2008, the fine was a 5-6% annual interest rate compounded daily.
  • Generally, you must pay estimated taxes if (1) you expect to owe at least $1000 in taxes after withholdings and credits AND (2) you expect your withholding and credits to be less than (a) 90% of your 2009 taxes or (b) 100% of your 2008 taxes covering 12 months.
  • You still have time to file your estimated taxes today.  If you paid estimated taxes last quarter and did not use the annualized income method to calculate how much you owed, just pay the same as you did last quarter.  If you are not using the annualized income method, to avoid penalties, you only have to pay in estimated taxes the lowest of (1) 100% of your 2008 taxes and (2) 90% of the taxes you expect to owe in 2009.  Divide that amount by 4 and that is your quarterly estimated taxes payment.

If you paid last quarter’s estimated taxes using the annualized income method, however, you must do it the same way this quarter.  Use publication 505 to guide you and, if possible, find your calculations from the previous quarter to help you fill in the blanks.

  • Paying is easy. Estimated taxes have the same payment methods as regular taxes, but you do not even have to send in the forms you used to calculate them.  Rather, if you are paying by check or money order, you only need to enclose the Payment Voucher 3 from the form 1040-ES with it.

You may also want to check whether your state requires estimated tax payments as well.  As with the regular income tax, completing state estimated taxes may be easier once you have already calculated your federal one.  And penalties may actually be higher if you don’t file.

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Don’t Let Estimated Taxes Ruin Your Weekend Plans

As we mentioned last week, second quarter estimated taxes are due to the IRS on Monday, June 15.  You are likely required to pay these taxes if your employer does not withhold taxes for you (e.g., international organizations) or if you are part of the roughly 10 million self-employed work force in the US.

With only 3 days left, figuring out whether and how much you owe in estimated taxes is probably more than daunting.   Lucky for you, I completed my 1040-ES yesterday and read the IRS Publication 505, on withheld and estimated taxes, so that you don’t have to.  Here are the important points:

  • Deadlines. The due dates for the estimated tax payments (coverage period) are: April 15 (January 1-March 31), June 15 (April 1-May 31), September 15 (June 1-August 31), and January 15 of the following year (September 1-December 31).
  • Penalties. Pay your estimated taxes on time!  The penalty rates for underpayment 2008 were an annual rate of 5-6% for the number of days overdue.
  • Who has to pay estimated taxes. Generally, you must pay estimated taxes if (1) you expect to owe at least $1000 in taxes after withholdings and credits AND (2) you expect your withholding and credits to be less than (a) 90% of your 2009 taxes or (b) 100% of your 2008 taxes covering 12 months.
  • Who does NOT have to pay estimated taxes. If you were a US citizen or resident for all of 2008 and your tax year covered 12 months, but you did not have any tax liability for last year (i.e., your total tax came out to zero or you did not have to file a return), you do not have to file estimated taxes this year.
  • How much do you have to pay in estimated taxes? There are three ways to calculate your estimated taxes, listed from easiest to hardest:

1. Pay 100% of your 2008 taxes (or 25% each quarter).  Note: this year small business owners may be eligible to pay only 90%.

2. Pay 90% of the taxes you expect to owe in 2009 (or ¼ of that value each quarter).  Use the “2009 Estimated Tax Worksheet” that comes with form 1040-ES so that you can include deductions and credits in your calculations.

3. Use the Annualized Income Method to pay taxes on your earnings as you’ve earn them each quarter.  This method is most useful for people whose income is uneven throughout the year (i.e., you do not want to make an estimated tax payment if you have not earned any income over the respective quarter).

  • Consider your options. To avoid a penalty, you only have to pay the lowest value from methods 1 or 2, or the calculated value from method 3.  If you did not have an income from January to March (net of credits and deductions) or you missed the first quarter estimated taxes deadline, using the annualized income method may ensure that you don’t get penalized.
  • Check your 2008 tax return. If you overpaid taxes, did you ask to have some of it applied to your 2009 estimated tax (1040 line 74 or 1040A line 46)?  If so, you can count that against your minimum required estimated tax payments.
  • Payment. As with annual taxes, there are several different payment methods for estimated taxes.  If you, like most people, are paying by check or money order, make sure to send that with Form 1040-ES for Quarter 2 along with a slip that can be found on the IRS website, by Monday, June 15th.

And don’t forget to do the same for your state taxes!  The determinants for who has/does not have to pay as well as for the minimum payment are usually the same as for the federal taxes, though the penalty for underpayment might be even higher.  In DC, for example, the penalty is a 10% annual interest, compounded daily!

Overpay vs. Underpay

Today’s Wall Street Journal has an article on how the economy might make the cash-strapped underpay and the affluent overpay their estimated taxes (deadline for 2Q is June 15th).  The goal, as mentioned in yesterday’s post is to do neither, but to pay just enough so that you aren’t giving Uncle Sam an interest-free loan or incurring an interest penalty for next April.  If you are knowingly underpaying this quarter, note the difference and make sure to catch up by the end of the year.  Despite the emphasis on math, paying just enough is an art, not a science.

Two Things Are Certain in Life: Death and Taxes

The deadline for filing your income tax return might have passed two months ago, but the deadline to send in your estimated taxes for the period of April 1st to May 31st is a week from yesterday.  Anyone is required to pay estimated taxes if your employer does not withhold taxes for you (i.e. you work as a short-term consultant/contractor or you are considered self-employed) or if your employer does not withhold enough taxes (i.e. you still owe Uncle Sam more than $1,000 in taxes even after withholdings and credits).  And I hope you take this seriously, because if you underpay the IRS, the IRS has the right to penalize you, even if you are entitled to a tax refund when you file your income tax return.

Read Publication 505 to figure out whether you are withholding enough taxes and to calculate the estimated taxes you owe the IRS.  If you do need to increase your withholdings, you can contact your HR department to make the changes.  Of course, the optimal plan is to pay just enough.  But I think it is usually better to withhold more and overpay, because this increases the chance that you will be entitled to a tax refund next April.  Even though all or a portion of your refund might have been your own money all along, it still feels like a windfall.  And it’s much better to receive a “windfall” than to come up with money to send the IRS should you fall short. 

Obviously, taxes are a huge topic and we will cover more about it in later posts.  Here are a few tips to get you started:

  1. Start keeping a record of the expenses you have incurred during the year that might translate into tax deductions or credits, such as student loan payments, out-of-pocket medical or prescription costs, contributions to your retirement account, charitable donations, etc.
  2. Try to read through the instructions to the Form 1040 Individual Income Tax Return.  We don’t recommend relying solely on tax software the first time you file your taxes, and we have several reasons for doing this. 
  • The Internal Revenue Code is a deeply complex organism.  It is much too complicated than it needs to be, and most first-time taxpayers are not familiar with the Form 1040/1040A/1040EZ.  Reading through the instructions gives you a chance to see the format of the form and the kind of information it asks for.  You’ll also be able to learn about the deductions and credits you can take and can plan to take advantage of them in the next calendar year.  Once you have read through it, all you have to do to stay updated is read the “What’s New” section at the beginning of the instructions each year. 
  • The tax softwares available are not always 100% accurate and vary in their calculations.  If you don’t believe me, just read Washington Post’s technology columnist Rob Pegoraro’s troubles this past March.  He rants about the same thing year after year.  For simple returns such as ours where we have single-income, little assets, and no children, the tax softwares work without a glitch.  But should you continue to rely on them as you get older, when we have several incomes, mortagage, investments, and dependents, the algorithms become more complex and the various softwares might give you different results as to how much you owe/are owed taxes.  As a result, you should become comfortable with figuring out your taxes on your own, without the aid of a software.

If taxes are the only thing that is certain in life besides death, don’t you think it deserves more than just an afterthought?