Time Is Near For Estimated Payments

Paying estimated taxes is one way for individuals to submit payments for their taxes to the federal government. Generally, people who run their own business, landlords, investors, and other people may need to pay in estimated taxes if their paycheck withholding won't cover all the taxes that are due. The other payment option is to pay in through withholding. Taxpayers might want to consider adjusting their withholding instead of paying estimated taxes.

You need to pay in at least enough tax through a combination of withholding and estimated payments to avoid the estimated tax penalty. To avoid the penalty, you will need to pay in "at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller," according to the IRS.

The penalty is basically the IRS's way of charging you interest for not paying your taxes throughout the year. The current interest rate for underpayments by individuals is 5%. (The IRS sets this rate each quarter.)

The easiest method for calculating your estimated payments is to divide last year's unfunded tax liability in four, and then make estimated payments using this figure. To do this, look on last year's tax return and find your total tax liability (found on line 63 of the 2007 Form 1040). Then subtract any withholding you expect to pay in for this year. If your withholding will be about the same as last year, you could subtract last year's withholding amount (found on line 64 of the 2007 Form 1040). The difference is the amount of tax that needs to be paid in through estimated taxes to avoid a penalty.

This method, while quick and easy to calculate, does not take into account changes in your income for this year. You might have more income, or more losses, or qualify for different tax deductions. The alternate method that I use personally and with my clients is to run a tax calculation based on this year's income.

Using these annualized income and deduction figures, you will calculate your projected tax liability. You will need to know the current year's tax rates. And you would subtract any withholding or tax credits you will be eligible for in order to find out exactly how much needs to be paid in through estimated tax payments.

To help keep track of these tax calculations, the IRS has a worksheet available with Form 1040-ES (pdf, 7 pages). This worksheet will help you calculate the minimum amount of estimated tax you should pay to avoid the penalty. The worksheet also includes all of the current year figures for standard deductions and tax rates, to help you obtain an accurate figure for this year's estimated payments.

Estimated tax payments are due quarterly.

Tax Debt Help - "Why We Do The Things We Do"

Doing taxes year round gives me the opportunity to see just what kind of situations most folks put themselves into by not filing timely.

One of the most common reasons most folks won't file a return are those dreaded 1099s. Whether it is a 1099-Misc or a 1099-R.

The 1099-Misc is pretty straight-forward and easy to understand, there's been no tax taken out and 90% of the recipients haven't saved or made estimated payments. The biggest thing to worry about in this case is the self-employment tax, which is actually paying into your Social Security account. So in reality, you are just paying yourself.

Last but not least are those 1099-R withdrawals. The IRS wants folks to save for their retirement and they give you tax credits for doing so. But with the economy being such as it is and folks loosing their jobs, it's understandable that sometimes the only place to go for help out of debt is to cash in on those 401K or IRAs. This is where you can really get into trouble and accumulate a large amount of tax debt.

Number one, if you don't have federal and state withheld at the time of withdrawal then you have to account for that at filing.

Number two, the IRS imposes a 10% penalty for early withdrawal and that too can be sizable if you have made a partial or total withdrawal.

Let's look at a worse case scenario.

Say you withdraw only a portion of the balance.....$20,000. No tax is deducted at the time of withdrawal.

Come time to file here's what you can expect:

• You are looking at 15-25% tax rate depending on your bracket. This could be anywhere from $3,000 to 5,000 in tax on Federal alone.




• Now you've got to calculate the State tax. If your State has a rate of 7.5%, then your having to pay an additional $1,500.




• And to top it all off, you have to calculate the IRS 10% penalty of $2,000.

Now let me show you just how much of that $20,000 you are actually getting to help pay off those debts you need to pay.

• $20,000 Withdrawal amount


• - 5,000 Federal tax due @ 25% tax rate


• - 1,500 State tax due @ 7.5% rate


• - 2,000 10% penalty to the IRS

Of the $20,000 that you withdrew, you have lost 57.5% or $11,500 of your withdrawal after tax and penalty.

To compound the situation, if you fail to file a return for 3 years, then you're looking at a failure to file penalty along with interest accruing for that three year period. We won't even do the math on that one.

So is it really worth making that withdrawal when you're going to loose over 50% of what you've worked so hard to save. There are two things that you can be sure of....."death and taxes" and they both can be devastating.

Like I always say, "it's better to be proactive than reactive"!

Tax Debt Help - Interest Rate Falls

Interest Rate for Tax Underpayments Drops to 6%

The Internal Revenue Service has lowered the interest rate charged on balances owed to the agency to 6%. IRS interest rates fluctuate quarterly, and the 6% rate applies beginning on April 1, 2008. Previously, the interest rate for the first quarter of 2008 was 7%, and prior to that the interest rate was 8%.

Individuals who have outstanding balances with the IRS pay penalties and interest on the balance due. Besides interest, the IRS charges a late payment penalty of half a percent per month (0.5%) on any outstanding balance. If tax returns have not been filed, a penalty of 5% per month up to a maximum of 25% is assessed on the tax owed. Thus, people who are filing a return and want to figure out a payment plan can use a standard loan calculator to calculate how much their monthly payments could be, but will need to use a annual rate of 12% to calculate their payments (6% for the interest and another 6% for the late payment penalty).

This drop in interest rates by the IRS might make it easier for individuals facing balances to set up a more affordable payment plan. However, it would be wise to compare the effective rate on a payment plan (12%) to other lending possibilities to make sure they are paying the least amount of finance charges.

More information: Interest Rates Drop for the Second Quarter of 2008

Retirement Fund Early Withdrawals and the Tax Penalty

As a veteran tax preparer, I have found that there are lots of reasons why folks don't file returns. But one of the biggest reasons is the early withdrawal of retirement funds. Most of the time they don't elect to have federal tax withheld. Then when it comes time to file and that 1099-R arrives in the mail, fear overwhelms them. Now they're facing not only the federal withholding, but also the 10% penalty for early withdrawal.

Below is some detailed information which I found at William Perez's website at About.com which gives the best overview of early withdrawals that I have found on the web. Take a few minutes to see just how overwhelming these withdrawals can be to your tax liability.

If you withdraw money from a traditional individual retirement account (IRA), 401(k), 403(b), or other qualified retirement plan before you turn age 59 1/2, you may be subject to an early distribution penalty of 10%. There are exceptions. This penalty does not apply to Roth IRAs as long as it has been at least five years since you first opened up your Roth account. Here's what you need to know about the early distribution tax.

The additional tax on an early distribution is 10% of the taxable amount. The taxable amount is also included in your taxable income. This 10% tax is in addition to regular income taxes. I call this the early withdrawal tax penalty, because it is similar to the penalty banks charge when you liquidate a savings account early. You can avoid this additional tax penalty if you meet certain criteria, but you cannot avoid including your retirement withdrawal from your taxable income.

So you will want to consider the tax impact before you tap your retirement accounts for short-term financial emergencies.

If you withdrew money from a SIMPLE IRA and you first began participating in a SIMPLE IRA plan within the past two years, then your early distribution penalty is 25% instead of 10%. You figure the additional tax either directly on Form 1040 line 59, or on Form 5329 (PDF) and Instructions for Form 5329 (PDF). You calculate the additional tax penalty directly on Form 5329 if you meet one of the exceptions and the retirement plan did not report the exception on Form 1099-R box 7.

To calculate the additional tax penalty directly on Form 1040 line 59, you:

1. Look on Form 1099-R from your retirement plan.
2. Find the figure in boxes 1 (Gross Distribution) and 2a (Taxable Amount), and the code in box 7 (Distribution Codes).
3. Multiply the amount in box 2a by 0.10.
4. Report this amount on Form 1040 Line 60.
5. Write "No" on the dotted lines next to line 59 to inform the IRS that you do not need to attach Form 5329.

Exceptions to the Early Distribution Tax Penalties

You do not have to pay the additional 10% tax penalty on your early retirement distribution if you certain exceptions. Exceptions for Early Distributions from an IRA:

1. You had a "direct rollover" to your new retirement account,
2. You received a lump-sum payment but rolled over the money to a qualified
   retirement account within 60 days,
3. You were permanently or totally disabled,
4. You were unemployed and paid for health insurance premiums,
5. You paid for college expenses for yourself or a dependent,
6. You bought a house*,
7. You paid for medical expenses exceeding 7.5% of your adjusted gross income**, or
8. The IRS levied your retirement account to pay off tax debts.

Exceptions for Early Distributions from a Qualified Retirement Plan such as a 401(k) or 403(b) plan:

1. Distributions upon the death or disability of the plan participant.
2. You were age 55 or over and you retired or left your job.
3. You received the distribution as part of "substantially equal payments" over your
   lifetime.
4. You paid for medical expenses exceeding 7.5% of your adjusted gross income.**
5. The distributions were required by a divorce decree or separation agreement
   ("qualified domestic relations court order"),

* The home-buying exception has the following additional criteria: you did not own a home in the previous two-years, and only $10,0000 of the retirement distribution qualifies to avoid the tax penalty. ** You do not need to itemize in order to claim the medical expense exception. If the exception is properly coded in box 7 of your 1099-R form, you do not need to fill out Form 5329. If an exception applies and is not recorded in box 7, then you need to fill out Form 5329.

1099-R Box 7 Distribution Codes

The following is a list of distribution codes that may appear in box 7 for Form 1099-R to report distributions from a retirement account. This list is taken from (PDF), pages 9 and 10. Distribution Codes for 1099-R Box 7

Distribution Code	Description
1	Early distribution, no known exception
2	Early distribution, exception applies
3	Disability
4	Death
5	Prohibited transaction
6	Section 1035 exchange
7	Normal distribution
8	Excess contribution
9	Cost of life insurance protection
A	May be eligible for 10-year tax option
D	Excess contribution
E	Excess annual additions
F	Charitable gift annuity
G	Direct rollover
J	Early distribution from Roth IRA
L	Loans treated as deemed distributions
N	Recharacterized IRA contribution
P	Excess contribution
Q	Qualified distribution from a Roth IRA
R	Recharacterized IRA contribution
S	Early distribution from a SIMPLE IRA in the first two years, no known exception
T	Roth IRA distribution, exception applies

Figuring the Additional Tax Penalty on Form 5329

You calculate the additional tax on early withdrawals from a retirement account using Form 5329 (PDF) lines 1 through 4.

Line 1: Report the taxable distribution from box 2a of Form 1099-R.

Line 2: Enter the amount not subject to the additional tax because an exception applies. Enter the appropriate exception code.

Line 3: Subtract line 2 from line 1. This is the amount of retirement distributions that are subject to the additional tax.

Line 4: Multiply the figure on line 3 by 0.10. Also enter this amount on Form 1040 line 60. If the distribution was from a SIMPLE IRA, the penalty may be 25% instead of 10%. The 25% penalty applies if you began participating in a SIMPLE IRA account within the past two years. Multiply the amount on Line 3 by 0.25 instead.

Exception Codes for Form 5329 Line 2

The following exception codes are to be used for Form 5329 Line 2 to inform the IRS that part or all of your retirement withdrawal is not subject to the early withdrawal tax penalty. The following exception codes are found in Instructions for Form 5329 (PDF), pages 2 and 3.

01: Separation from service after reaching age 55.

02: Distributions are paid as part of a series of substantially equal periodic payments.

03: Distributions due to permanent and total disability.

04: Distributions due to death.

05: Distributions to pay for medical expenses exceeding 7.5% of adjusted gross income.

06: Distributions to another person under a qualified domestic relations court order.

07: Distributions to pay for health insurance premiums and you were unemployed.

08: Distributions to pay for college expenses.

09: Distributions to pay for a first-time home purchase, up to $10,000.

10: Distributions due to an IRS levy.

11: Other. Use this code if more than one exception applies and see IRS Instructions page 3.

S. Raines, Sr. Financial Advisor/Tax Preparer