Q. I retired April 1st of this year and think I might be in trouble with the IRS. Last week a retired golfing buddy of mine was grousing about estimated tax payment time coming up and said he was going to pay early to get it out of the way before he and his wife left to visit the grandkids. I didn’t know what he was talking about. He found it funny that I had no clue that I was suppose to pay taxes every quarter. I thought I could just pay anything owed when I filed my tax return next year. I have a pension and a distribution from my roll-over IRA, both on a monthly basis. I remember seeing a question in the pension paperwork asking about having taxes withheld from my pension and checking the “no” box. I don’t remember being asked about my IRA but my broker says I told him not to have any taxes withheld but he said a mandatory amount is being withheld for state taxes. Can you explain the process to me and other newly retired folks. Please include how on earth I’d figure out what I should pay and if there are penalties is there a way to get them waived?
A. The IRS likes to have its money in a timely fashion, even from retirees. You must make estimated quarterly tax payments if you have taxable income. If you don’t make your payments on time you will be subject to underpayment penalties. If you underpay an estimated tax installment you can’t avoid the underpayment penalty by overpaying in the next installment. You can avoid the underpayment penalty by following the safe harbor rules. The easiest way to determine the amount to pay is to use the prior year safe harbor rule. If you make estimated tax payments in 2015 equal to 100 percent of the tax owed for 2014 you will not be subject to an underpayment penalty. If your adjusted gross income (AGI) is over $150,000 this safe harbor amount is increased to 110 percent of your prior year tax liability. You can use this prior year safe harbor even if you know you are going to owe more tax this year than last. Since the required annual payment must be paid in four equal installments to avoid a penalty, determining the amount of estimated tax to pay is important.
Another method to avoid an underpayment penalty is to pay estimated tax equal to or above 90 percent of taxes you will owe this tax year. This requires some number crunching and guess work on your part. You may want to stick with the prior year safe harbor unless you have a very good idea as to what you will owe this year. The underpayment penalty doesn’t apply if tax due is less than $1,000 or you had no tax liability for the prior year.
For nearly all taxpayers, the due date for the first estimated tax payment of each year is the same day the return is due for the previous year, which for 2015 was April 15. The next payment, which is the one you missed, was due June 15, the next payments are due Sept. 15 and Jan. 15, 2016. Most states require estimated tax payments on the same schedule as the federal payments.
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Estimated federal payments are made on Form 1040-ES, Estimated Tax Voucher. This is a very simple form, asking for your name, address, social security number and the amount you are paying. Get the forms from your tax professional, tax software or directly from the IRS by calling 1-800-Tax-Forms or go the website www.usgov.org For NC state estimated payments you will need form NC-40, which can be found at the website www.ncdor.com.
You will probably owe an underpayment penalty since you did not make a payment for your 2nd quarter taxable income from your pension and IRA. You will need to complete Form 2210 if you want to request a waiver. A stated reason for a waiver is “retired after reaching age 62 and underpayment was for a reasonable cause.” Pleading ignorance may work; it’s worth a try!
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624