Pay Estimated Taxes on Big Gains

A few years ago, I talked to someone who made a big profit on land that he owned and sold.  His complaint was that the IRS charged him a penalty on taxes owed.  That's because the IRS expect taxes to be paid contemporaneously with income received.   For most people, this the federal tax withheld from one's paycheck.  Typically, no withholding is done for asset or stock market sales.

 I knew he used a tax accountant and said, "Your tax advisor should have should have told you to pay estimated taxes."  His response was, "He claims he did."   I don't know who made the error in this situation, the accountant or the taxpayer.  However, I do know the IRS doesn't care.

Bottom line, if one has taxable income where no taxes are withheld, one has to pay quarterly timely estimated taxes to cover the deficit.  Otherwise, one will likely pay a penalty for not paying them on time.

There is some ways to avoid the penalty, if one forgets to pay the estimated tax on time.    One is adjusting the withholding on wages or retirement account withdrawals.  Withholding  is considered to be paid on time, even if it is paid later in the year.   Thus, one can increase withholding, even up to 100% at the end of the year, and not be penalized for make a late estimated payment of taxes.  If one withhold at least 110% (or 90% below 150K AGI) of the tax liability or the previous year, then there is no penalty for underpayment of taxes in the current year.

If you work with a tax professional, they can do the calculation with you.  Otherwise, one should do the calculation on their own.

For more on Reaping the Rewards, check back every Friday for a new segment.

This is not financial nor tax advice. Please consult a professional advisor.

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