Although you’d probably prefer to forget about taxes at this time of year, you certainly don’t want to pay underpayment penalties next April. But that’s what could happen if you don’t set aside some time to check your tax withholding and/or estimated tax payments.
A mid-year review of your 2000 tax situation will show you whether your current tax withholding or payments are sufficient to avoid penalties.
Estimating Your Income. Federal income taxes are generally withheld from wages by employers, who transmit the withheld taxes to the IRS throughout the year. But if you have nonwage income , such as interest, dividends, capital gains, alimony, rental, or self-employment income , from which taxes are not withheld, you may owe estimated taxes on those earnings. In addition, certain strategies such as converting a traditional IRA to a Roth IRA may result in substantial taxes on previously tax-deferred amounts. If you convert your IRA in 2000, make sure you adjust your tax payments accordingly.
Conditions For Taxing Benefits,
The recent repeal of the Social Security earnings test brought unexpected income to many working seniors, ages 65 to 69. If you are one of the 900,000 Americans who was affected by this change, your Social Security benefits can be taxed if either of the following situations applies to you:
1. The total of one half of your benefits and all your other income is more than $34,000 , or $44,000 if you are married filing jointly.
2. You are married filing separately and lived with your spouse at any time during 2000.
If your Social Security benefits are taxable, you may need to increase your tax withholding or estimated taxes. You may ask the government to withhold federal income taxes from your Social Security benefits at the rate of 7 percent, 15 percent, 28 percent, or 31 percent by completing Form W-4V, Voluntary Withholding Request.
Alternatively, you may request additional withholding from other income or increase your last two estimated tax payments.
o When and How Much. To avoid penalties, you must pay your taxes as regular withholdings from your income or according to the government’s quarterly schedule for estimated payments. If you are making quarterly payments, you must generally pay 25 percent of the required annual payment on or before April 17, June 15, Sept. 15, and Jan. 15, 2001.
Penalties May Be Avoided
If your income is seasonal , or you receive a large sum of taxable income all at once , you may be able to avoid the penalty even though you vary your quarterly payments according to your quarterly income. This means that you can make smaller tax payments in the quarters in which you received the lowest income and larger tax payments in the quarters in which you received the highest income. However, this method requires regular monitoring of your quarterly taxable income. Avoiding underpayment penalties is practically foolproof if you base your withholdings and/or estimates on the total tax you paid in 1999.
If your 1999 adjusted gross income was $150,000 or under ,$75,000 or under for married filing separately , paying 100 percent of the tax shown on your 1999 return through regular withholding and/or timely quarterly estimated payments will eliminate underpayment penalties for 2000. If your adjusted gross income is more than $150,000/$75,000, paying 108.6 percent of your 1999 tax obligation according to the quarterly schedule will avoid the penalty. For 2001, this figure will rise to 110 percent of your 2000 tax obligation.
Ways To Avoid Paying Penalties
Another way to avoid underpayment penalties is to estimate your 2000 taxes and pay 90 percent of that estimate. You also won’t have to pay an underpayment penalty if the tax shown on your return after withholdings is less than $1,000. If you expect your 2000 taxes to be substantially less than your 1999 taxes, you may want to consider either of these two options. Example: Tony’s federal income tax for 2000 is $10,000. During 2000, his employer withheld $9,001 from his pay. Therefore, Tony owes $999 when he files his return. Since that’s less than $1,000, Tony won’t have to pay an underpayment penalty.
Critchlow, CPA, is a partner in the firm Grice, Lund & Tarkington, LLP, CPAs.