Nobody likes to pay income taxes. The tax bite seems even more painful if you are writing the checks instead of having taxes withheld from each paycheck. However, retirees and the self-employed who ignore quarterly tax payments will wind up paying more in the end.
Just ask Fred, the retiree. Fred receives monthly payments from a taxable investment account. His account generates several types of income for him, each of which is taxed differently. Fred receives some interest from bonds, dividends from U.S. companies, and capital gain income from the sale of stocks. Dividends from the U.S. companies are “qualified” under our tax system and are taxed at a maximum federal rate of 15%. The same is true of his long term capital gains. However, short-term capital gains and bond interest are taxed at Fred’s ordinary tax rate, which could range from 25% to as much as 35%. Since the income his account will generate from year to year will vary considerably, so will his taxes.
Unlike the days when Fred’s employer withheld taxes each pay period, Fred is now responsible for paying taxes himself, and they must be paid during the year. In the first year of retirement, Fred was unaware of the requirement that his taxes be paid “as you go.” He waited to pay his taxes at the time he filed his tax returns. Because Fred had not paid on the “as you go” method, both the federal and state government charged him a penalty for underpayment, which is essentially interest on money that the government was expecting to receive during the year. Fred owed $10,000 in taxes and another $800 in underpayment penalties. The $800 penalty (interest) was wasted money.
Fred learned that it is better to estimate his yearly tax bill and make quarterly payments to the federal and state governments during the year. By paying quarterly, Fred could manage the payments more easily (smaller and more frequent payments = no surprises). Also, he avoided underpayment penalties.
BWFA has designed a Quarterly Estimated Tax Service to help people like Fred. Our service is designed for people who:
- Have larger amounts of interest, dividend, and capital gain income; our rule-of-thumb is income of $7,000/year or more.
- Receive distributions from Individual Retirement Accounts (IRAs);
- Sell high-value assets such as a home, rental property, or stock options that will generate a large tax liability; or
- Run their own businesses.
Our service begins with a projection of your current year’s tax return. Then we recommend the best way to pay your taxes on a timely basis. Finally, we prepare and deliver the estimated tax coupons to you so that you can pay the proper taxes before they are due.
If you would like assistance in estimating your quarterly taxes and advice about tax-savings strategies, give us a call.