A Guessing Game on Taxes Owed

Paul Sullivan for the NY Times writes:  When it comes to income taxes, my wife and I try to pay exactly what we owe. And by this I mean we try to calculate what we need to pay during the year so we do not overpay. If given a choice, we would rather owe a bit more in April than find out we are getting a refund.

But for 2012, we overpaid our state and local taxes by a lot. Our accountant tried to comfort us: many of her clients did the same.

She said the negotiations at the federal level over the so-called fiscal cliff tax increases and budget cuts, which stretched into January, kept accountants from knowing who would be subject to the alternative minimum tax until just about the filing date for estimated taxes. The A.M.T., as it is known, ensures that people with a lot of deductions still pay federal tax. Those who fall into it lose various deductions, like state and local taxes and mortgage interest.

We made an estimated tax payment in January based on the worst-case situation, and when that didn’t happen, we discovered we had overpaid. But we also made the mistake of filing a paper return in New York, and the state has had huge delays in getting refunds to people who did not file electronically.

As we wait for that New York refund, I’ve thought about the increasingly confusing calculations that people who earn income from different sources — or have taxes withheld at different rates — have to make when it comes to paying estimated taxes.

“In years past, it was pretty easy to do a back-of-the-envelope calculation,” said Joshua Dubrow, a certified public accountant with Nussbaum, Yates, Berg, Klein & Wolpow. “Now with these new rules, with investment income taxes, Obamacare, the phase-out of deductions, not even the sharpest and most accurate practitioner can do a prediction. It’s more important to be on top of this and crunch the numbers.”

With the next estimated payment due on Sept. 15 — and the end-of-year reckoning not too far away — here are some things to consider and a few tips for the areas where you can have control over your tax payments.

Technology is no advantage Filing electronically usually gets you faster processing, but it is not always possible. Allison P. Shipley, principal in PricewaterhouseCooper’s Private Company Services practice, said people with complicated earnings and income had to file paper returns because their tax preparer’s e-filing software might not accept a certain form or there might be limits to the number of one form that can be submitted. She said that the Internal Revenue Service required that other forms be mailed in, like the one for noncash charitable contributions.

Those who file electronically are not guaranteed a quick refund. My accountant said a client filed his 2012 federal return electronically and included routing information to get his five-figure refund wired to his bank account. Instead he received a letter saying the return could not be processed electronically. The reason? The amount on the refund no longer matched the amount on the return. Eventually he received the refund by mail, less $7.49 for unpaid taxes from 2010.

Watch state penalties There are three ways to pay estimated taxes, and you can select a new method each quarter. You can pay in 100 or 110 percent of last year’s tax (depending on your income), pay 90 percent of this year’s tax or “annualize” your tax. With this last method, if you made $50,000 in the first quarter you would pay tax at a rate based on an annual income of $200,000. If in the second quarter you made $40,000, you would adjust your tax to an income of $180,000 and so on.

The goal is usually the same: to pay just enough to make sure you don’t get hit with a penalty. Yet some times, it makes sense to pay that penalty and hold on to the cash, said Elda Di Re, a partner in Ernst & Young’s personal financial services group. For example, when you don’t have the money to pay the tax on time or when you believe you can get a high return on the money. At 3 percent for federal taxes, she called the penalty “not a bad borrowing rate.”

But where it gets costly is with the states, who see the penalties as a revenue source. Connecticut charges 1 percent per month up to 12 percent a year. In Kansas, the penalty can go as high as 24 percent. “For that taxpayer who says ‘I don’t have the cash,’ I say, ‘How much do you have?' ” Ms. Di Re said. “Then I say, ‘Let’s get the states paid off.' ”

Mind the details If you have income coming from different states — say as a consultant, real estate investor or a person stringing together several jobs — the calculation of what to pay and when becomes trickier. You may end up owing different states because not enough or any tax was withheld, said Kim Rueben, senior fellow at the Tax Policy Center. And if you don’t keep up with those filings, you might have to make a large payment to one while awaiting a refund from another.

People who sell businesses or appreciated securities, or exercise stock options, have to be aware of timing, said Richard Coppa, managing director of Wealth Health, a financial advisory firm. If someone, for example, sold a business or thousands of shares of stock Aug. 30, he or she would owe taxes on Sept. 15. If, however, those sales went through on Sept. 3, he or she would have until Jan. 15 to make the payment.

Why this happens is a quirk in how the I.R.S. divides up the year. While it expects people to make quarterly payments, it does not divide the year into the same quarters as everyone else. Only its first quarter matches the calendar quarter. For tax purposes, the second quarter runs from April 1 to May 31, the third from June 1 to Aug. 31 and the fourth stretches four months, from Sept. 1 to Dec. 31.

A more confusing issue could be how the net investment income tax — an extra 3.8 percent tax on capital gains for higher earners — should be calculated throughout the year.

“The I.R.S. just put out the form, but there are no instructions yet,” Ms. Shipley said. “It’s calculated separately, but it’s clear the net investment income liability is subject to estimated taxes and penalties.”

One solution might be to pay 110 percent of last year’s taxes to avoid a penalty. But that could be onerous for someone who had a much higher income in 2012.

Calculating 90 percent of this year’s income could be challenging, too. Federal and state taxing authorities expect the taxpayer to be current in each quarter and assess penalties on a rolling basis. Ms. Shipley said this could make accounting for investment income difficult with the 90 percent rule — mostly stemming from the lack of filing instructions.

Overpaying consolation People who regularly pay estimated taxes can apply any overpayment to the next year and then not worry about a tax payment for a quarter or two.

With particularly late refund payments for returns filed on time, states are obligated to pay interest. But Ms. Di Re noted that the interest was always less than the penalty the state charges. In the case of New York, interest is 2 percent for late refunds, but for late payments the penalty is 7.5 percent.