FAQ FRIDAY - July 11, 2008

Q. I owed a lot of money in taxes last year and my preparer said I have to pay estimated tax payments. Do I really?

A. Our federal income tax system is basically a ‘pay as you go’ system. If you don’t pay in the taxes you owe during the year, you may owe penalties and interest on the underpayment of taxes. There are exceptions to paying the penalties and interest and some of these exceptions are called the safe harbor rules. From the Internal Revenue Service website:
General RuleYou must pay estimated tax for 2008 if both of the following apply.

1. You expect to owe at least $1000 in tax for 2008 after subtracting your withholding and credits.
2. You expect your withholding and credits to be less than the smaller of;
-90% of the tax to be shown on your 2008 tax return, or
- 100% of the tax shown on your 2007 tax return. Your 2007 tax return must cover all 12 months.

For example, assume your 2007 total tax was $5,000 and you expect your 2008 tax to be $6,000. Your withholding for 2008 is expected to be $1,000 so you will have a balance due of $5,000. According to the above, you will have to have paid in taxes through withholding and/or estimated tax payments equal to 90% of the 2008 tax ($5,000) or 100% of the 2007 tax ($5,000). $5,000 required payment less $1,000 withholding leaves a balance due for estimated tax payments of $4,000 paid in quarterly payments. You can increase your withholdings or make the quarterlies to avoid penalties and interest on underpayment. In this example, you will still have a balance due when you file your tax return of $1,000.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of 1. avoiding penalties under the Internal Revenue Code or 2. promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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