Under federal law, taxpayers must pay taxes during the year as they earn or receive income, or they can find themselves falling victim to substantial underpayment penalties. Even worse, they may have spent the money, and when tax time comes are unable to pay their past taxes and spiral into financial distress.
To facilitate the pay-as-you-earn concept, the government has provided several means of assisting taxpayers in meeting that requirement. These include:
Payroll withholding for employees – W-4;
Pension withholding for retirees – W-4P;
Voluntary withholding for Unemployment and Social Security benefits – W-4V; and
Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding – Form 1040-ES.
Employees with primarily wage income can use the IRS online tool, the Tax Withholding Estimator, to determine if their withholding closely matches their projected tax liability or if they need to adjust their tax withholding by providing a revised Form W-4 to their employer.
Employees and those with significant income from other sources, multiple jobs, rentals, side gigs, children subject to the kiddie tax, capital gains, etc., may find it appropriate to consult with this office for a more sophisticated tax projection and estimate of needed withholding and/or estimated tax payments.
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what might be earned from a bank. The penalty is applied quarterly, so for example, making a fourth quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters.
This can be accomplished with cooperative employers or by taking an unqualified distribution from a pension plan, which will be subject to 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory rollover limit.
Genesis Business and Tax Services
9330 LBJ Freeway, Suite 900
Dallas, TX 75243
469.436.3747
www.genesisbts.com
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