If you’re like me, you can hardly believe that the Fourth of July has come and gone for another year. Not only is the summer halfway over, but so is the calendar year. For most people, Independence Day is an excuse to escape from their normal grind and relax for a few days. While I did enjoy my fair share of relaxation over the long weekend, I also used this holiday as a reminder to revisit tax planning with my clients.
I know what you’re thinking, and yes, it’s still nine months until your 2016 tax return will be due. But that’s only the due date for the return itself. The majority of taxing authorities mandate payment of taxes throughout the year as income is earned. Failure to make periodic payments may result in underpayment penalties and interest. One way to ensure timely payments is withholding federal and state income taxes from your paychecks and retirement account distributions. But those withholdings often only cover the taxes associated with that income. If you have an investment portfolio that is generating material amounts of interest, dividends and capital gains, you may need to make quarterly tax payments as well.
Now the question is, how do you calculate what to pay each quarter? The IRS gives you two options to determine the amount that needs to be paid in by January 15 of the following year to avoid underpayment penalties and interest. Option one is to pay in 110% of your prior year total tax (100% if your adjusted gross income is below $150,000). Option two is to pay in 90% of your current year total tax. If you find your income and deductions to be consistent from year to year, the first option is likely the easiest. It is clear-cut and doesn’t require much effort on the part of you or your CPA as it’s based solely on known information. Most CPAs will often include quarterly vouchers based on option one when they deliver your tax returns each April if you had a large balance due or paid estimates in the past.
The second option usually involves preparing a tax projection. You might choose this option if you had a large one-time income or deduction item in the past or if you’re newly retired and trying to figure out appropriate withholding rates. A projection involves collecting actual year-to-date information (pay stubs, quarterly investment statements, estimated K-1s, etc.) and then making assumptions for how much income will be generated for the remainder of the year. This may require more legwork for both you and your CPA, but the end result can be very helpful in anticipating cash flow needs and minimizing penalties and interest. You may be pleasantly surprised to find that your CPA offers projection services and welcomes the opportunity to connect with you more than just once every spring. This is also a great way to introduce your CPA and financial advisor to get everyone on the same page and working for you.
You may cringe at the thought of discussing taxes outside of April, but being proactive now can help prevent a surprise and potentially save you money in the spring.
If you have further questions, please reach out out to us at White Oaks Wealth Advisors.
Laura Bereiter, CPA, PFS™, CFP® joined White Oaks Wealth Advisors in October 2015. She offers comprehensive wealth, tax, and estate planning to the firm’s clients.