By Sandy Botkin, Special for USDR
1. If you didn’t pay any taxes last year, you won’t be hit with a penalty for nonpayment of estimated taxes this year. Thus, if you paid no taxes last year but won the Power Ball Lottery this year, you will have no penalty. However, you will need to pay income tax on your winnings by April 15.
2. If your total taxes due are less than $1,000, there is no estimated tax penalty.
3. Safe Harbor Rule: If you pay in 90% of your taxes due in quarterly installments, there is no tax due unless you earn over $150,000 of adjusted gross income. At that point, you need to pay in 110% of last year’s taxes over four quarterly installments to avoid the penalty. Thus, if you make $200,000 this year of adjusted gross income and last year’s taxes were $80,000, you would need to pay in $88,000 under the safe harbor method. I often wonder who thinks of these things!
4. Withholding: Here is one of the biggest secrets to avoiding the tax; however, it is very underutilized. Imagine that you earned income throughout the year and didn’t pay any estimated taxes. Wouldn’t it be great if you can avoid the penalty anyway? Well, you can by taking advantage of the withholding rules. Withholding is treated as if it were made throughout the year regardless of when the withholding occurred. Thus, if you increase your or your spouse’s withholding towards the end of the year so that the total withholding will meet one of the exceptions noted above, there will be no penalty.
Example, John and Katie will owe $20,000 in taxes on commissions paid to John. Katie has a job that has withholding from her paycheck. If they paid in $15,000 last year in taxes, they only need to pay, through estimated taxes and withholding, $15,000 to avoid the penalty (assuming that their adjusted gross income was less than $150,000). If Katie’s withholding was $10,000, she can adjust her withholding for November and December and increase the amount withheld. If the total equals what they should have paid in estimates, there will be no penalty even though most of the withholding occurred in the latter part of the year. Pretty slick, huh?