Q. We have medical insurance, but in spite of that the costs of my wife's cancer treatments and real estate depreciation deductions resulted in a net loss on our 2006 1040 form. So we ended up not owing any taxes for 2006. We had paid $5000.00 in estimated amounts for 2006, so we applied these 2006 estimated payments to our taxes due in 2007.
We have submitted an automatic extension for our 2007 taxes.
During 2007, we received a payment from previously sold property, so we will probably owe something over $10,000. Our 2006 tax liability was under $150,000.00 and we have already paid in over 100% of our 2006 tax liability.
We conclude that we will not be liable for a penalty for underpayment of estimated tax.
A. Your conclusion is correct.
Because your 2006 federal income tax liability was “0” and you had $5,000 from 2006 applied to 2007 you will not be penalized for “underpayment of estimated tax” for 2007 if you waited until October 15, 2008 to file your 1040 and pay the $5,000 anticipated balance due.
You are covered under what we call the “safe harbor” rule. As long as you had 100% of your prior year tax liability paid in either via withholding or estimated tax you will not be penalized. The alternative is to have 90% of the current year liability paid in.
If your 2007 tax liability was $5,000 and your 2008 tax liability will turn out to be $100,000, as long as you have at least $5,000 withheld during 2008 you can put aside the remaining $95,000 in an interest-bearing account and wait until you file your 2008 return in April of 2009 to send it to “Sam”.
In the case of estimated tax payments the penalty is determined on a quarterly basis. With the above example you would have to pay $1,250 per quarter in estimated tax, for a total of $5,000, to satisfy the safe harbor rule. If you paid the entire $5,000 as your 3rd quarter payment you would be penalized for the first two quarters.
Withholding is automatically treated as being paid evenly throughout the calendar year, regardless of when the money is actually withheld and remitted to “Sam”. You could have no federal tax withheld for the first 11 months of the year and have the entire $5,000 withheld in December and you would avoid the penalty under safe harbor.
Here is a good tip for this time of the year. First pull out your 2007 tax returns. Now get your most recent pay-stub(s) for all your employers and determine the total amount of income tax that has been withheld for the year. Add in any withholding from other sources – pensions, etc. Now compare the total amount withheld-to-date for 2008 to the total tax liability on Line 63 of your 2007 Form 1040 (or Line 37 of a 2007 Form 1040A).
If the 2008 number is already at least as much as the total tax liability for 2007 you are ok. If the 2007 liability is greater, based on your current year pay-stubs estimate the amount of income tax that will be withheld during the rest of 2008. Now see how it compares to the 2007 liability. If you come up short you can have your employer withhold an additional amount from the rest of your 2008 pay checks to cover the shortage. Be aware that it will probably take a week or two for your employer to properly process the additional withholding request – so calculate accordingly.
Make the withholding comparisons for state as well as federal income tax. Most states have a similar “safe harbor” rule.
Of course if you expect your taxable income to be substantially lower for 2008 than it was in 2007 there is no need to meet the “safe harbor” requirement.
If your 2007 Adjusted Gross Income (AGI) is more than $150,000 you must have 110% of the total 2007 tax liability paid in during 2008 to be covered by the safe harbor rule.