A New Pitfall For Those Who Pay In AdvanceDick Janssen
Does 1992 look like it will be a better year for you than 1991? If so, and you pay estimated income taxes, Congress has come up with something that could turn your happiness into a headache. It's a new law that will require many unsuspecting Americans to fork over more taxes in advance.
The change affects a much-used "safe harbor" proviso: No matter how much tax you'll end up owing, you're safe from underpayment penalties if your quarterly estimated installments and withholding equal 100% of your previous year's tax.
But last November, in order to pull in additional revenue to pay long-term unemployment benefits, Congress closed that safe harbor to a new class of taxpayers. Instead, these people will have to make sure that their quarterlies cover 90% of their 1992 tax bill--or they'll face a penalty of roughly 10% on any shortfall come filing time in April, 1993.
When should you start worrying that you can't use the 100% safe harbor rule? If it looks as if your adjusted gross income in 1992 will top $75,000 and will also exceed last year's AGI by more than $40,000 (on joint and single returns alike).
Especially if the economy improves, "many people may be surprised to find themselves under this new restriction," says Bender's Federal Tax Week. All it might take is for one spouse to land a good job after having been out of work last year, while the other continues to have self-employment income that requires quarterly estimated payments. Selling some stocks at a big profit could spring the trap, too.
FEAST OR FAMINE. Generally, the rules "will catch people who aren't rich but whose income bounces around a lot," warns Wally Head, personal financial-planning chief at accounting firm Arthur Andersen in Chicago. Among them: real estate and insurance salespeople, attorneys working for contingency fees, investment bankers who get feast-or-famine bonuses, business owners, and employees who get a lump-sum settlement on leaving a job.
One exception is if the bulge in your AGI is the result of selling your home. Another is if you haven't paid estimated taxes in any of the past three years. But even the latter won't get you off the hook if you've been hit with any underpayment penalties in that period. And there are several other complex exceptions to check out with your tax adviser, especially if you're involved in limited partnerships.
If there's no way out, Head suggests "staying on the safe side" by keeping your payments above 90% of your estimated tax. You're still allowed to underpay your first-quarter installment on Apr. 15. But then, you'd face a catch-up payment with the second-quarter installment on June 15.