Recent stories in the public media have indicated that many taxpayers may be surprised when they file their federal tax returns for 2018. These stories noted that taxpayers' refunds may be smaller than in previous years or, in some cases, that additional tax may be due. At least part of the reason for this problem may be due to inadequate amounts being remitted to the Government during the year. The purpose of this writing is to give the taxpayer guidance on how to plan for the payment of income taxes to the federal government. If the taxpayer does not make adequate payments during the tax year in question, the taxpayer may be subject to a penalty for the underpayment of estimated taxes.
The penalty is essentially an interest calculation that compares the amounts remitted by the taxpayer to the Government with the amount that should have been remitted. The amount that should have been remitted is determined by calculating three values, with the smallest of the three values being used to determine the minimum required remittance. The first of the three values is equal to 90 percent of the current year's tax liability. The second of the three values is equal to 100 percent of the prior year's tax liability, assuming that the prior year was a full tax year. However, for taxpayers whose adjusted gross incomes exceeded $150,000, the amount is increased to 110 percent of the prior year's tax liability. The third of the three values is calculated for taxpayers whose income varies significantly between quarters during the tax year. The third of the three values is equal to 90 percent of the tax that would be due on an annualized income calculation for the period running through the end of the quarter. Due to the problems noted at the beginning of this writing, the Internal Revenue Service has, for the tax year of 2018 only, modified the above-noted values. Where 90 percent was used for the first and third values, for the tax year of 2018 only, 85 percent will be used, instead. The result of this change will be to reduce the number of taxpayers subject to the underpayment of estimated tax penalty.
The amount of the taxpayer's refund or additional tax due when the return is filed is determined by the difference between all amounts remitted to the federal government for that tax year and the taxpayer's federal tax liability for that tax year. Good tax planning in the area, therefore, begins with the determination of an estimate of what the current year's federal tax liability might be. This estimate should be completed as early in the tax year in question as possible. In the simplest situations, that might be to ask whether there will be any significant changes in the taxpayer's amounts of income and deductions and life circumstances. If no major changes are anticipated, then the prior year's tax liability (or 110 percent of the prior year's tax liability for taxpayers with an AGI of more than $150,000) would be a reasonable estimate. In complex, situations, the taxpayer should seek competent tax assistance in preparing an estimate of the tax liability.
Once an estimate of the tax liability has been established, the taxpayer must decide on the amount to remit to the federal government for tax year in question. Some taxpayers might wish to remit the minimum amount required to escape the imposition of the above noted underpayment penalty. This approach allows the taxpayer to keep the maximum amount of assets for the longest period of time, but will potentially cause additional tax to be due upon filing the tax return. Other taxpayers might decide to have an amount remitted equal to the estimated tax liability. This approach will typically result in a small refund or additional amount due when filing the tax return. Yet other taxpayers may choose to remit an amount that is significantly greater than the estimated tax liability. This is a sort of enforced saving plan (albeit with a zero rate of return) that will yield a large refund when the tax return is filed.
Once the tax payer has determined the amount to be remitted it can be accomplished through withholding by the employer and/or estimated tax payments. If the taxpayer is an employee, the taxpayer can request the employer to adjust his/her withholdings appropriately. Alternatively, the employee-taxpayer could make estimated tax payments in addition to the amounts withheld by the employer. A self-employed taxpayer would accomplish the remittances by making estimated tax payments. The wise taxpayer will make choices early in the tax year so that there will be no surprises when the tax return is filed.