Build Wealth Wisely With 3 Steps to Estimating Taxes
Here’s an in-depth look at how to calculate estimated taxes.
February 1, 2001
Real estate professionals, along with most self-employed taxpayers, are generally required to make quarterly estimated tax payments. Carefully calculating your estimated tax payments can keep you from paying a 20 percent penalty on any underpaid tax.
Calculating estimated taxes is a three-step process. First, you must determine whether you’re required to make estimated tax payments. If so, the second step is calculating your estimated tax. Finally, the last step is determining how to make the payments.
1. Determine if you must make estimated tax payments.
You must make estimated tax payments unless one of several exceptions applies. First, if you had no tax liability for the previous full year or you won’t owe $1,000 or more in taxes for the current year, you don’t have to make estimated tax payments.
Second, if your income tax payments through withholding for the year are at least 90 percent of your tax liability, you won’t have to make estimated tax payments.
Finally, if your income tax payments are equal to or greater than your prior years’ income tax liability paid, you won’t have to make estimated tax payments.
However, if your adjusted gross income exceeds $150,000, for joint filers, or $75,000, for single or married-filing-separate filers, your prior payments must be 110 percent or more of your 2000 income tax liability paid.
If you’re required to make estimated tax payments, then you must make quarterly payments, by certain dates throughout the year. If you don’t pay enough tax in any one quarter, you may be assessed a penalty for that quarter, even if you’re entitled to a refund when you file your income tax return.
2. Estimate your tax.
Once you’ve determined that you must make estimated tax payments, calculate your estimated tax for the year. This involves projecting your 2001 income, deductions, and withholding payments to arrive at your projected 2001 income and self-employment tax liability.
For this reason it’s a good idea to do the calculation as soon as your 2000 return is prepared. Since the due date for the estimated tax payment for the first quarter coincides with the due date for calendar-year income tax returns, this should be easy to accomplish if your return will be filed without extension.
When calculating your projected income and deductions, be sure to consider whether you expect to have a better year and whether you’ll be purchasing any sizable items for your business that may be depreciated or expensed, lowering your tax liability. Also, it’s important to remember you can deduct one-half of the self-employment tax you pay for the year in calculating your adjusted gross income.
You should keep a written record of your estimated tax calculations in a safe place so you may refer back to them throughout the year. If circumstances change, you need to adjust your payments. IRS Publication 505 has several worksheets to help you make calculations. Most tax forms and instruction publications are available as PDF files at IRS.gov. Some forms, although not Form 505 are also available via fax on demand.
3. Calculate your payments.
The simplest method for calculating estimated tax payments is to divide your prior year’s tax liability by four and pay that amount in each quarter. By doing this, you will have paid 100 percent of your prior year’s tax liability and avoid a penalty.
As mentioned above, high-income individuals must add an additional 10 percent. This is known as the short method. You may not use this method if you’re late in making any estimated tax payments. If you or your spouse has withholding from wages, you should deduct such withholding credits before calculating the quarterly payments.
Although this method will avoid a penalty for underpayment of estimated tax, if you earn substantially more income in 2001, you may have a large tax bill when you file your return. Conversely, if you have substantially less income in 2001, you’ve overpaid your taxes.
Further, if you reduce your fourth-quarter payment to prevent overpaying, you may lose the penalty protection provided by using the short method technique and be subject to a penalty for one of the previous quarters where you earned income requiring a higher estimated tax payment than was made. For this reason, after determining your estimated tax in step two, if the number exceeds your 2000 liability, divide that number by four to determine your payments.
Since the real estate business can be seasonal and you may earn substantially more income during the second and third quarters, you may wish to calculate your estimated tax payments based on the annualized income method designed to lower each quarterly payment for individuals who don’t earn income evenly throughout the year.
The annualized method requires you to calculate each quarterly payment based on your cumulative income and deductions from the beginning of the year, but then “annualizes” the income and deductions by applying a weighted factor. This method is beneficial because it forces you to consider changes in circumstances throughout the year. If you use a tax preparer, the person should be able to help you use this method.
If you (or your spouse) earn wages subject to income tax withholding in addition to your real estate business, you may reduce or eliminate the need to make estimated tax payments by having your (or your spouse’s) employer withhold additional amounts from each paycheck or from your December paycheck by completing a new Form W-4.
For example, assume you had determined early in the year that you wouldn’t have to make estimated tax payments because your 2001 taxes owed after withholding wouldn’t exceed $1,000. However, upon reviewing your business records in the fourth quarter, you learn that due to your killer summer sales, you earned more income than expected and will owe $1,250 upon filing your return. You or your spouse can have an additional $250 withheld by an employer to avoid having to make estimated tax payments.
Nobody likes paying taxes, but with a little work and planning you can ensure that you only pay the amount you’re required to and lessen the pain.
Sites where you can find more information
If REALTOR Magazine’s February guide to financial planning got you thinking about insurance planning, the Web is a great place to educate yourself about insurance issues. Numerous Web sites provide insurance quotes, articles, and answers to frequently asked questions. Here are some to get you started:
- About.com—Search under insurance and self-employment for articles and a legion of practical links.
- Insurance.com--The site, an affiliate of Fidelity Investments, promises to walk you through the process of auto, term life, homeowners, and health insurance. It offers easy-to-read background, tips, and expert opinions on insurance products.
- InsWeb.com--The Insurance Web lets you plug in personal data and compare policy rates based on your profile. It also provides valuable quizzes, checklists, articles, and tools to measure your insurance needs.
- The Motley Fool--In its usual colorful way the site dishes the straight skinny on what insurance you need and how to get it.
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Updated: January 18, 2019