Who is at risk? Taxpayers who have income outside of wages and salary—Schedule C self-employment income, capital gains, interest and dividends—all need to pay estimated taxes in quarterly installments and monitor the fourth quarter payment carefully this tax season.
That includes even beginning investors: A lot of mutual funds paid out significant distributions at year-end 2013, and those dividends and gains alone could put taxpayers in higher estimate territory. (You don’t have to make estimated payments if your tax due—after subtracting withholding and credits—is less than $1,000.)
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Of course it’s good news if your income is up. But it’s bad news if your tax bite is up too, whether you choose to delay the pain and pay up in April or pay in now.
“Bad news is bad news,” says Saul Brenner, a tax partner at Berdon LLP in New York who has been busy calculating fourth quarter estimates for his clients and fielding calls from potential new clients asking what they can do to lessen the new higher tax bills. “Our clients appreciate getting it early rather than late. You can at least prepare for it,” he adds.
A business owner client in his 70s, for example, got in a huff in late December when Brenner explained that he and his two adult children owed $50,000 more in taxes for 2013 than 2012 on similar income. “Sticker shock is starting to sink in. They start seeing the numbers and say, ‘What’s happened here?’” says Brenner.
Why the big hit? There’s the new top income tax rate of 39.6%, up from 35%; there’s the new top capital gains and dividends tax rate of 20%, up from 15%; there’s an additional 3.8% Obamacare tax on net investment income; there’s a 0.9% additional Medicare tax on wages; and there’s the return of phase-outs of itemized deductions and personal exemptions.
In that family’s case, Brenner had them on a protect basis (also known as the “prior year safe harbor”), so they’ll settle up with Uncle Sam come April 15. With the safe harbor, you pay in 100% of the prior year’s tax as estimates –or 110% if your adjusted gross income was above $150,000—to avoid underpayment penalties.
But some taxpayers – those who opted to pay in 90% of their projected tax liability instead of using the safe harbor-- may need to pay in more than planned on January 15, when fourth quarter estimated payments are due to the Internal Revenue Service for 2013 taxes. You might have gone the 90% route if your accelerated income and sold stock realizing capital gains to lock in lower tax rates in 2012 in anticipation of the 2013 tax hikes.
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The problem for taxpayers who are paying in at 90% of projected 2013 liability is that 2013 is still a moving target, especially for those in hedge funds or partnerships where income comes in on K-1 forms in late spring or even summer. They have to pay April 15 even if they get an extension until October 15.
Does Brenner have a remedy for the higher tax bills? Clients are looking at changing their investment mix to include more municipal bonds, tax-efficient mutual funds and ETFs for starters. His parting advice: “We say, ‘Write your Congressmen and Senators because some don’t think you’re paying enough.’”
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