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Article Subtitle
Here's one more way to organize your records while making your life less taxing!

Article Article Intro
This issue will deal with a thorny problem that has constantly plagued taxpayers and has created numerous questions for us: the estimated income tax. Let's answer most of those questions here. Generally people worry about paying their taxes on April 15. However, what is not as well known or received by most small business people is that

you really should be paying your taxes four times a year in the form of estimated income taxes.

When do I have to worry about paying and filing estimated taxes? You need to file estimates when you will owe $1000 or more net of your withholding and any of the following apply:

Article Content
  • You have hired a nanny. You would pay her payroll taxes either quarterly or in one lump sum when you file your IRS Form 1040.
  • You or your spouse are self-employed and will owe taxes on income that had no withholding.
  • You made significant money in the stock market, playing poker, gambling, and commodities or from other investments.
When are they due? Estimated tax payments are due on Jan. 15, April 17, June 15, and Sept. 15. What happens if I don't pay estimated taxes? Will I go to jail and not pass go? You will not go to jail if you fail to pay estimated income taxes. However, if you are required to file and pay estimated income taxes and you fail to do so, you will pay a non-deductible penalty of 7%, which is the current rate as of the day of this article. All payments should be accompanied by form 1040 – ES. In addition, many states also require you to pay estimated state income taxes. You need to get the state forms and file these estimates at the same time that you file your federal estimates. Sandy's elaboration: Contrary to what many accountants note, there are circumstances that warrant not paying estimated taxes. For example, if you make more than 7% after-tax on your money, you might want to keep the money earning income and pay the penalty. Generally, if you can make 11% or more on your money (where the penalty rate is 7%), you should keep the money in your pocket for as long as possible. Paying the penalty is usually cheaper than giving the government the use of the money. How much should I pay? Good question. I am glad you asked this. There are several "safe harbor" methods, which you can use to avoid all penalties.
  1. 100% of last year's tax method: If your adjusted gross income is $150,000 or less, you can pay 100% of the tax shown on your 2005 return for 2006 taxes. (See line 63 of your IRS Form 1040, less any credits).
    Example: Gwen paid $10,000 in taxes in 2005. In 2006, she wins the Power Ball lottery for $60,000. She need only pay $10,000 in estimates, prorated at 25% for each quarter. She will, however, have to pay the full amount of the tax due on the $60,000 on April 15, 2007.
  2. 110% of last year's taxes: As I noted above, the previous safe harbor only applies if your adjusted gross income was under $150,000. If you made over $150,000 of adjusted gross income, you have a different safe harbor rule. (So much for tax simplification). You have to pay 110% of last year's taxes to be safe.
  3. 90% guesstimate approach: This approach works the way it sounds. You would guess how much you would owe for all federal taxes and pay 22.5% each quarter. If you come within 90% of your guess, you won't be hit with any estimated tax penalties when you file your IRS Form 1040. Although this is not my recommended approach, it is beneficial for those people who will make significantly less net income this year than last year. This way, you don't have to over pay your taxes using one of the above noted safe harbor approaches.
  4. Annualized approach: What happens if you earn a significant amount of income at year end such as with bonuses or large stock gains? Instead of using the safe harbor approaches, you can pay the estimates in accordance with your cash flow. Be advised, this is a complicated method, which usually requires an accountant's help.

The best way to avoid estimated taxes is a well-kept secret until now: withholding!

If you or your spouse has a job and has taxes withheld, you can use this instead of estimates. Any amount withheld is treated as paid equally throughout the year regardless of when the withholding occurs. Thus, if you forgot to make a quarterly payment, you can just increase your withholding to compensate for this problem. Even better is to have much of the withholding occur towards the end of the year. Thus, if you withhold extra money from September to December, you are treated as paying this money equally throughout the year even though the withholding occurred at year's end. Example: Under the safe harbor method, Karen was told by her accountant to pay $20,000 in estimated taxes. Instead of filing estimates each quarter, Karen instructs her employers to increase her withholding starting in September so that the extra withholding amounts to $20,000. Sandy's elaboration: This method works well if you will have enough salary to justify this extra withholding. You can actually instruct your employer to increase your withholding at ay time in the year. What if I didn't pay estimated taxes and don't meet the safe harbor rules? There are some exceptions that, if applicable, will get you out of paying any estimated tax penalties:
  • De Minimis exception: No penalty is imposed for the payment of estimated taxes if the taxes due, net of withholding, is less than $1,000.
  • No tax liability for preceding taxable year: You are not required to pay estimated taxes if you had no tax liability for the preceding taxable year, and you were a citizen or resident for the whole year. You are deemed to have had no tax liability for last year if your total tax was zero or if you weren't required to file an income tax return.
  • Waiver of estimated tax penalty: The IRS may waive the penalty for underpayment of estimated taxes in situations that involve hardship or unusual circumstances, or where the IRS determines that it would be inequitable to impose the penalty. For example, the waiver could be granted if your books and records were destroyed by fire, flood or other casualty, or if the payment was not made because of a "death or serious illness of the taxpayer". However, there must be reasonable cause for the non-payment of estimated taxes. Your willful negligence won't get you a waiver from the penalties. Thus, don't argue that you forgot, didn't know about paying these taxes (which you can't argue if you read this article), or were plain lazy.

The bottom line is that if you have $1000 or more of taxes owed above what was withheld, you will need to pay estimated taxes.

You should adhere to one of the safe-harbor rules if you want to avoid these penalties. It is that simple. Hopefully, by following our advice, you can make your life less taxing! One of the problems that I notice is that if taxpayers are audited, they have less money than the IRS to fight an audit. This results in a lot of settlements where taxes are paid unnecessarily. How would you like to be on the same level as the IRS? Well, now you can. There is a service entitled Tax Audit Defense whereby a national firm can handle all audit defense expenses, including necessary briefs to IRS Appeals, at no cost to you! This service covers both federal and state audits too. It also includes:
  • Unlimited consultation for your tax questions for as long as you have the service
  • Two years of prior tax returns reviewed for omitted deductions
  • Coverage for all prior tax years once you enroll
The catch is that it only can be obtained if you haven't received any notification of an audit. Obviously, you can't get the 'insurance' after the house burns down. I have this service in my corporation and can't imagine anyone not having it. The cost is only $395 and is fully tax deductible. You can order it by calling our office at 800 – TRI – 0 – TAX, which translates to 1.800.874.0829. You can also obtain this as part of our Comprehensive Business Survival Package by going to our website at www.taxreductioninstitute.com
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