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ESTIMATED TAXES: ANOTHER DEADLINE COMING UP

By: Julian Block

THE TAX ADVISER

Thursday, Jan. 15, 2009, is a key date for many taxpayers to remember. For individuals whose estimated income tax exceeds $1,000, that’s the due date for the final quarterly installment of estimated income tax for 2008 — including any self-employment tax and alternative minimum tax. But it’s okay to skip this final payment, provided they submit their 2008 returns and pay their tax in full by Monday, Feb. 2.

Who needs to make estimated payments? Individuals with income from sources not subject to withholding of taxes. This category mostly comprises self-employed individuals who operate businesses or professions as sole proprietorships, in partnerships with others, or as independent contractors, and investors who receive sizable amounts of interest, dividends and profits from sales of assets.

To avoid unnecessary payments, remember to take account of withholding during 2008 on what you or your spouse receive from salaries, wages and other types of compensation. Ditto for an overpayment of taxes in 2007 that you elect to apply to your 2008 bill.

The IRS can exact penalties for failing to pay sufficient tax during the year through withholding or quarterly payments, as well as for failure to pay required installments on time as they become due. It matters not that your final estimated payments are sufficient to erase any balance due when you submit your 2008 1040 form in 2009.

However, there are “safe harbors” or exceptions that excuse you from any penalties for underpayments of more than $1,000 for withheld or estimated taxes. For relief from these penalties, you must satisfy a two-step requirement:

First, make payments by the quarterly due dates — for 2008, by April 15, June 16, Sept. 15, and Jan. 15.

Second, those payments must at least equal any of the following three amounts:

(1) 90 percent of the total tax for 2008 (reduced to 66 2/3 percent for qualifying farmers and fishermen).

(2) 100 percent of the total tax for 2007. This is the amount on line 63 of the 2007 1040 form.

The exception based on the prior year’s tax is available even if the amount due was zero, provided the return covered 12 months, as it ordinarily would.

As the prior-year exception uses a fixed number, it’s the easiest way for most individuals to figure their payments and avoid penalties. To illustrate, your tax payments total $12,000 for 2007 and $15,000 through estimates or withholding in 2008. With those kinds of numbers, you’re home free, no matter how much extra you owe when you file for 2008.

There is a restriction on use of this exception when adjusted gross income for 2007 (the amount on the last line of page one of Form 1040) exceeds $150,000 — declining to $75,000 for married couples who file separate returns. To take advantage of the 100-percent escape hatch, payments must equal 90 percent of the total tax for 2008 or 110 percent of the total tax for 2007 — whichever is less.

(3) 90 percent of the total tax for 2008, figured by “annualizing” income actually received by the end of the quarter in question.

The annualizing exception helps those whose incomes unexpectedly increase or fluctuate throughout the year, such as Roth IRA converters who move money out of traditional IRAs and into Roth accounts at year’s end, or investors who receive higher than anticipated distributions of dividends and capital gains from their taxable accounts with mutual funds. But be warned: this calculation is complicated.
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