Properly structuring tax payments requires careful planning, especially in light of tax reform

Withholding and Estimated Tax Payments

Individuals who are working are required to have income taxes withheld directly from their salary. Taxpayers who have little to no income other than their salary usually find their withholding is more than enough to cover their targeted tax payment, and they often end up with a refund when they complete their tax return. The exception to that might be those with larger bonuses, stock option income, etc., where a flat percentage is withheld that may be less than the actual tax rate applied to that income.

Those who have income that is not required to be withheld on – such as investment income, business income or retirement distributions – may find they need to make additional tax payments throughout the year. These payments are calculated by the taxpayer and delivered to the IRS along with a payment voucher, Form 1040-ES. These estimated payments are due on the quarterly deadlines, and late payments of those may result in a penalty being assessed until the payment is received by the IRS.

Taxpayers who find they missed a payment deadline should not wait until the next payment due date to catch up. The underpayment penalty is calculated on a daily basis, so the sooner the payment is made, the sooner the penalty stops.

For taxpayers whose only income is from a business or investments, where withholding is not typically available, estimated payments are likely the only option for paying their taxes. Taxpayers who have a combination of income that is withheld on and other income not subject to withholding, or retirees whose income consists of pension payments and IRA withdrawals, can typically choose how to cover the tax liability on that other income. As usual, there are pros and cons to each approach:

• By paying the tax on that additional income via estimated payments, the taxpayer can keep control of the income for a longer period of time. They might earn the income at the beginning of the year, but only make the estimated payments on each quarterly due date. However, this requires the taxpayer to be aware of the deadlines and be sure to send their payments on time. It also means they must be careful to set aside some of their income periodically to cover the tax cost, rather than spending or reinvesting it.

• Depending on the amount of non-salary income, a taxpayer could simply increase the withholding on their salary to cover the tax cost of this other income. Doing so relieves the fear of missing the payment deadline, but also means the taxes may be paid perhaps months before the estimated payment would be due.

Planning Around An Unexpected Increase In Income

For taxpayers whose income comes almost exclusively from wages that are subject to withholding, their withholding is usually more than enough to cover 90% of that year’s taxes. But what happens when that taxpayer experiences an unusual increase in their income, perhaps by realizing a large capital gain from an investment? In that case, the

taxpayer can often wait to pay the tax on that income until the April 15 due date for their tax return.

Special Consideration For 2018

The tax reform act passed in late 2017 (the Tax Cuts & Jobs Act) included many significant changes that take effect in 2018 and will impact all taxpayers. Taxpayers will want to take these changes into account when planning their 2018 tax payments. Some of the more impactful changes included in this tax reform are:

• New limitations on many of the deductions taxpayers have claimed in the past.

• A new exclusion for income received from a pass-through business.

• Significant changes that will limit the impact of the Alternative Minimum Tax.

• Lower tax rates applied to virtually all levels of income.

• Changes affecting families, including the repeal of the personal exemption along with the expansion of the existing child credits.

Article written by Tim Steffen, CPA, CFP®, CPWA® and provided by Rebecca Ross, Vice President and Financial Advisor at Robert W. Baird & Co. Incorporated, member SIPC. She has 34 years of financial services industry experience and can be reached at 239-541-9090 or rross@rwbaird.com. Baird does not offer tax or legal advice.