LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

Overview of Estimated Tax Rules for 2001

It’s not a major disaster if you owed Uncle Sam some money when you filed your return – after all, you’d rather have the use of the funds for as long as possible. But what you want to avoid is having to pay the IRS a penalty for underpaying your taxes during the year. If you owe the estimated tax underpayment penalty, which is nondeductible, you’re in effect paying the IRS interest for part of the money you should have prepaid during the year for taxes, but didn’t. On the other hand, if you got a big refund on last year’s return, you made an interest-free loan to the government, something you may want to avoid this year. If that happened, you should consider reducing the amount of withholding taken from your salary and/or the amount of estimated tax payments you make.

Here are some pointers to keep you on an even keel when it comes to estimated taxes.

Basic rules. There is no estimated tax underpayment penalty if the total tax on your return reduced by withholding (but not by estimated tax payments) is less than $1,000. If the amount owed on an individual income tax return comes to $1,000 or more after subtracting withheld tax, the estimated tax underpayment penalty won’t apply if your "required annual payment" – the amount that must be prepaid during the year in the form of withheld tax and estimated tax payments – equals at least the smaller of two amounts:

1. 90% of your tax bill for 2001, or
2. 100% of your tax bill for 2000.

For example, let’s suppose your tax for 2000 was $12,000, and your tax bill for 2001 will come to $15,000 (90% of that is $13,500). In this case, you must prepay at least $12,000 of your tax bill during 2001 to avoid the underpayment penalty. On the other hand, if the tax you will owe for 2001 will only be $10,000, you will have to make timely estimated tax payment of only $9,000 for 2001 to avoid the penalty.

A tougher rule applies if your adjusted gross income for 2000 exceeded $150,000 ($75,000 for married persons filing a separate return). During 2001, you must prepay the smaller of (1) 90% of the tax for 2001, or (2) 110% of the tax for 2000. Last year, the required annual payment for higher-income earners was the smaller of: (1) 90% of the tax bill for 2000, or (2) 108.6% of the tax for 1999. Thus, if you are in the higher-income category and "prepay" the same minimum amount as you did last year, you could wind up owing a penalty.

It’s a pay-as-you-go system. In general, one-quarter of your required annual payment must be paid by April 16, 2001, June 15, 2001, September 15, 2001, and January 15, 2002. Keep in mind that tax withheld from your salary is treated as an estimated tax payment, and that an equal part of withheld tax generally is treated as paid on each installment date.

Time for a checkup. You know what your 2000 tax bill came to, but unless you have a reliable crystal ball, you don’t know what your 2001 tax will be. We don’t have a crystal ball, either, but we can project what your 2001 tax will be based on your financial picture thus far. It may be a good idea to contact us in advance of the second estimated tax installment, due June 15, to see how your payments are tracking and make any necessary adjustments to your wage withholding and/or estimated tax payments. Keep in mind that our review of your situation may discover that you’re withholding too much rather than too little.

We should also review whether changes in your personal or financial situation require a change in estimated tax payments or withholding. For example:

• If one of your children graduated college in January and is working and supporting himself, you will have one less dependency exemption deduction for the year and may need to file a new W-4 to increase withholding.
• If you anticipate having large capital losses due to the recent stock market decline, you should keep in mind that those losses can offset capital gains plus up to $3,000 of ordinary income. That could mean smaller estimated tax payments than you made in the past.
• If you’ve shifted significant portions of your non-IRA stock market portfolio into money-market accounts, you may have significantly higher amounts of interest income than last year, possibly requiring higher estimated tax installments to be made.

(04/19/01)

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Last modified: July 05, 2001