From the December 2007 issue of Wealth Manager Web • Subscribe!

Timing is Everything

Make sure to stay on top of the deadlines for filing federal tax returns and the due dates for making estimated payments. Miss just one, and the law authorizes the IRS to exact a sizable penalty based on the agency's current interest rate for back taxes.

January 15, 2008, is a key date for many taxpayers to remember. For individuals whose estimated income tax exceeds $1,000, that is the due date for the final quarterly installment of estimated income tax for 2007--including any self-employment tax and alternative minimum tax. But it's permissible to skip this final payment, provided they submit their 2007 returns and pay their tax in full by January 31.

Who needs to make estimated payments? Individuals with income from sources not subject to withholding of taxes. This category tends to include self-employed individuals who operate businesses or professions as sole proprietorships, in partnerships with others, or as independent contractors. Also included are investors who receive sizable amounts of interest, dividends and profits from sales of assets.

Others who can run afoul of the estimated tax rules include divorced people who receive alimony payments, and retirees who choose not to have tax withheld from their pension payments, from traditional IRA withdrawals and other tax-deferred retirement plans or Social Security benefits.

To avoid unnecessary payments, taxpayers should make sure to take account of withholding during 2007 on what they or their spouses receive from salaries, wages and other kinds of compensation, pensions, Social Security benefits or retirement plans. Ditto for an overpayment of taxes in 2006 that you elect to apply to your 2007 bill.

The IRS can assess penalties for failing to pay enough tax during the year through withholding or quarterly payments, as well as for failure to pay required installments on time as they become due. The penalty period for each installment period runs from the due date for the underpaid installment to the date of payment or the April 15 due date for the tax return, whichever is earlier. It is immaterial that final estimated payments are enough to erase any balance due when a taxpayer submits his 2007 Form 1040 in 2008. And there will be no deductions for penalties, says the IRS--and the U.S. Tax Court agrees.

However, there are "safe harbors" or exceptions that excuse taxpayers from any penalties for underpayments of more than $1,000 for withheld or estimated taxes. (And don't worry about smaller amounts: There are no penalties for underpayments of less than $1,000--an amount that has remained unchanged since 1998). To help clients achieve relief from these penalties, advisors should tell them that they must comply with a two-step requirement:

First, make payments by the quarterly due dates--for 2007 by April 16, June 15, Sept. 17 and Jan. 15. And yes, the April-to-June "quarter" covers just two months, while the September-to-January "quarter" is four months.

Secondly, those payments must at least equal any of the following three amounts:

(1) 90 percent of the total tax for 2007 (reduced to 66 2/3 percent for qualifying farmers and fishermen)

(2) 100 percent of the total tax for 2006. This is the amount on line 63 of the 2006 1040 form.

The exception based on the prior year's tax is available even if the amount due was zero, provided the return covered 12 months, as it ordinarily would.

As the prior-year exception makes use of a fixed number, it's the easiest way for most individuals to calculate their payments and escape penalties. For example: Your tax payments total $12,000 for 2006 and $15,000 through estimates or withholding in 2007. With those kinds of numbers, you're home free, no matter how much you owe when you file for 2007.

The tax code restricts use of this exception when the adjusted gross income for 2006 (the amount on the last line of the first page of Form 1040) surpasses $150,000--decreasing to $75,000 for married couples who file separate returns. To take advantage of the 100-percent escape hatch, payments must equal 90 percent of the total tax for 2007 or 110 percent of the total tax for 2006--whichever is less.

(3) 90 percent of the total tax for 2007, figured by "annualizing" income received by the end of the quarter in question.

The annualizing exception helps those whose incomes unexpectedly increase or fluctuate throughout the year, such as freelance writers who receive book royalties in December. But be warned: this calculation is complicated.

Julian Block ( is an attorney and author based in Larchmont, N.Y.

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