The tax system is “pay as you go” by law. If you have income on which no taxes are withheld, it is up to you to prepay the proper amount of taxes. Generally, if you expect to owe at least $1,000 in federal taxes and your withholding and tax credits are less than 90% of your 2014 tax liability (or less than 100% of your 2013 tax liability), estimated tax payments are required. You are essentially required to “estimate” your income and taxes, and make the appropriate payments. Additionally, your estimated tax payments must be computed to also pay for any self-employment (i.e. FICA) taxes on your net business and/or partnership income that you might also owe.
Recent tax changes affect withholding requirements
New rules, including higher tax rates, limits on itemized deductions, and two Medicare surtaxes, may also affect estimated tax calculations.
For example, say you and your spouse will be subject to the additional 0.9% Medicare surtax because your combined wages exceed the $250,000 threshold. The two of you might be expecting your employers to withhold the additional amount.
However, employers are only required to withhold when your compensation exceeds $200,000 – without taking into consideration how much your spouse makes or any income you may earn from another job.
That could mean you’ll owe tax – and perhaps a penalty for underpaying the tax – on your 2014 return. Estimated payments can help cover the shortfall.
The 3.8% surtax on net investment income affects estimated payments too. Are you receiving income from capital gains, interest, or dividends? It’s a good idea to estimate your income to determine if you’re over the $250,000 income threshold ($200,000 when you’re single).
Basic rules have not changed
The basic estimated tax rules have not changed. Generally, you can avoid penalties by paying in the same amount of tax for 2014 that you owed on your 2013 return, or 90% of this year’s tax, whichever is less. If your 2013 income is over $150,000, you’ll have to pay 110% of last year’s tax or 90% of this year’s.
Once you compute your estimated income and taxes, you pay them in four installments with due dates of April 15, June 15, September 15, and January 15 of the following year.
Think you may need to make or adjust your 2014 estimates? Give us a call. We’re here to help.