Big gains may require estimated tax payments

Published: Jan 19, 2000 5:12 p.m. ET



SAN FRANCISCO (CBS.MW) -- For all those tax-savvy people who locked in their big stock gains after the first of the year, there is one stumbling block that could eat up some of the profits: estimated tax payments.

If you don't pay enough tax either via withholding or estimated tax payments, you may be subject to a penalty.

The smart thing about waiting until January 2000 to cash in your stock profits is that you won't owe tax on the gains until April 2001. That is, unless your gains are big enough to require an estimated tax payment -- a quarterly payment to cover next year's tax obligation.

There are a couple outs that may allow you to avoid the quarterly payment requirement this year.

Why estimated payments?

Estimated tax payments were created after World War II to equalize the tax obligations between those who earn wages and have taxes withheld from each paycheck and those who have no withholding because their income derives from investments, self-employment or pensions.

Because the non-wage earners had no withholding, estimated tax payments required them to "pay as they earn" just like the wage earners. They were required to calculate the amount of tax they would owe and pay one quarter of that amount every three months, according to West Coast IRS spokesman Jesse Weller. And there are potential penalties for not making the payments.

Estimated tax payments are due on the 15th of April, June, September and January of the following year, unless the 15th falls on a weekend or holiday. Then give yourself until the next Monday to pay.

Even wage earners may owe estimated tax if their income suddenly jumps during the year, such as from a capital gain from the sale of stock.

When do you owe estimated tax

As a general rule, if you expect to owe at least $1,000 in additional tax in 2000, after subtracting withholding taxes taken from your paycheck and any tax credits you claim, then you should consider making estimated payments -- or at least doing the worksheet.

Part of the formula that also may obligate you to pay estimated tax is if your withholding and credits were less than 90 percent of the tax you'll show on your 2000 tax return, or 100 percent of the tax shown on your 1999 tax return. You take the smaller of the two choices to determine whether you may have to pay.

The good news for people with large capital gains or other unexpected increases in income during 2000 is the last of those three choices. The vast majority of people who avoid the obligation to pay estimated tax do it based on that provision.

For example, if you owed $5,000 in total federal tax in 1999 and you had $5,000 withholding in the current year, then you are not going to have to pay estimated taxes. Even if you owe $20,000 or $25,000 in extra tax at the end of the year because you cashed in all those Qualcomm QCOM, +1.64% gains in January.

So one way to avoid setting aside quarterly payments to cover an extra big tax bill in 2000 is to make sure the your total withholding for 2000 will equal at least 100 percent of the tax shown on your 1999 return.

Increase your withholding now

To increase your withholding, or adjust it at any time during the year, get a Form W-4, Employee's Withholding Allowance Certificate, either from your company's human resources department or from the Internet.

Form W-4 includes a worksheet to help you figure out how much to withhold. For additional information on specific requirements refer to IRS Publication 505, Tax Withholding and Estimated Tax.

Special exceptions to the general rules for estimated tax payments apply to certain higher income taxpayers (married couples whose adjusted gross income was more than $150,000 or individuals whose income was greater than $75,000 in 1999), farmers and fishermen. Higher income individuals must withhold more than 100 percent of last year's tax, for example, to avoid an estimated tax obligation.

If you absolutely must pay estimated taxes, it is possible to delay things a while longer. Starting March 1, 2000 it will be possible to pay all or part of your estimated tax by using a credit card, either American Express, MasterCard or Discover card. To do this call 1-888-2PAY-TAX, toll free. But you will have to pay a "convenience fee" based on the amount you charge. (The IRS does not receive the fee.)

Penalty for nonpayment

If you don't pay enough tax either via withholding or estimated tax payments, you may be subject to a penalty for Underpayment of Estimated Tax. But there are a number of exceptions to the penalty that may allow you to escape.

Figuring the estimated tax underpayment penalty is one of the more complicated jobs in the tax law, so we won't go into all of them here. If you want more details check Form 2210 or Publication 505.

The tax software programs all include the ability to calculate the penalty. But be sure you get all the breaks that you're allowed. The penalty is generally linked to the amount of tax you owed each quarter and it is based on the quarterly interest for back taxes. Those interest rates can fluctuate.

If the amount you owe is small or you were only a few days late with the payment, you may not get a penalty assessed at all from the IRS.

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