Estimated Taxes: Pay as You Go or Pay the Price
The four estimated tax deadlines for 2013 fall on:
Monday, April 15 is the deadline for the first quarterly 2013 estimated tax payment for calendar year taxpayers. If you make estimated tax payments, be aware that there have been a number of changes made to the tax law this year that might change the amount of estimated tax you owe.
Who Must Make Payments?
The federal income tax is a pay-as-you-go system. You must generally pay tax as you earn or receive income during the year. If you don't have enough tax withheld and paid to the IRS and you owe at least $1,000 in tax for 2013 after withholding and credits, you must make estimated payments. In general, you're required to pay annually in four installments.
People who are in business for themselves usually pay their taxes this way. But you may also have to make estimated payments if you receive income such as dividends, interest, capital gains, alimony, rents, and royalties. Estimated tax is used to pay not only income tax, but self-employment tax and alternative minimum tax.
Fortunately, the tax law provides "safe harbors" for avoiding an estimated tax penalty. No penalty is imposed if your annual payments equal at least:
- 90 percent of the current year's tax liability, or
- 100 percent of the prior year's tax liability (110 percent if your previous year's AGI was over $150,000).
The penalty can also be avoided if you did not receive income evenly throughout the year and paid installments on an "annualized basis." Your tax adviser can provide more information on whether this option is available in your situation.
Remember: If you make federal estimated tax payments, you might also be required to make state estimated tax payments.
Tax Law Changes for 2013
There are a number of tax changes that became effective this year that you should take it into account when determining the amount of quarterly estimated tax payments to make. For example:
1. The Additional Medicare Tax. Beginning January 1, 2013, a 0.9 percent additional Medicare tax applies to wages, Railroad Retirement Tax Act compensation, and self-employment income. The extra 0.9 percent Medicare tax applies to:
- Salary and/or self-employment (SE) income above $200,000 for unmarried individuals.
- Combined salary and/or net SE income above $250,000 for married joint-filing couples.
- Salary and/or net SE income above $125,000 for married individuals who file separately.
2. The Tax on Net Investment Income. A new 3.8 percent "Net Investment Income Tax" (also called the Medicare surtax) kicked in on January 1, 2013. It is only imposed on certain high-income taxpayers.
Individuals will owe the tax if they have net investment income and also have modified adjusted gross income over the following thresholds:
- $200,000 for singles or heads of household.
- $250,000 for married couples filing jointly (or qualifying widow(er) with dependent child.
- $125,000 for married individuals filing separately.
In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer.
3. A Limit on Itemized Deductions. Beginning in 2013, itemized deductions may be reduced for single filers with an adjusted gross income of more than $250,000 ($300,000 for married taxpayers filing jointly and $150,000 for those married filing separately).
4. Payroll Tax Rate Increase. For 2011 and 2012, the Social Security tax withholding rate on an employee's salary was temporarily reduced from the normal 6.2 to 4.2 percent. If you are self-employed, the Social Security tax component of the self-employment tax was reduced from the normal 12.4 to 10.4 percent. Unfortunately for working folks, the payroll tax cut is over.
For 2013, the Social Security tax can hit up to $113,700 of salary at a 6.2 percent rate and up to $113,700 of self-employment income at a 12.4 percent rate.
5. Rates on Ordinary Income. For most individuals, the federal income tax rates for 2013 will be the same as they were for 2012: 10, 15, 25, 28, 33, and 35 percent. However, the maximum rate for higher-income folks increases to 39.6 percent (up from 35 percent). This change only affects single taxpayers with taxable income of $400,000 ($450,000 for married taxpayers filing jointly and $425,000 for heads of households).
6. Long-Term Capital Gains and Dividend Rates: The tax rates on long-term capital gains and dividends in 2013 will also remain the same as last year for most individuals. However, the maximum rate for higher-income folks increases to 20 percent (up from 15 percent). This change only affects singles with taxable income above $400,000, married joint-filing couples with income above $450,000, heads of households with income above $425,000, and married individuals who file separate returns with income above $225,000.
Other Tax Changes
In addition to the six changes listed above, there have been a number of other tax law changes implemented this year. For example, it is now more difficult to qualify to claim medical and dental expense deductions if you are under age 65. Certain tax breaks were increased slightly due to inflation, such as personal exemption amounts and standard mileage rates for business driving.
If you think that your estimated tax payments should be adjusted this year due to the tax law changes described above, consult with your tax adviser.