Mid-Year Tax Planning for 2020

It’s not a major disaster if you owed some money when you filed your return-after all, you’d rather have the use of the funds for as long as possible. What you want to avoid is having to pay the IRS a penalty for underpaying your taxes during the year. If you owe the estimated tax underpayment penalty, which is nondeductible, you are paying the IRS interest for part of the money you should have prepaid during the year for taxes, but didn’t. On the other hand, if you got a big refund on last year’s return, you made an interest-free loan to the government. In that case, you should consider reducing the amount of withholding taken from your salary and/or the amount of estimated tax payments you make.

Here are some pointers to keep you on even keel when it comes to estimated taxes.

Basic rules

There is no estimated tax underpayment penalty for the 2020 tax year if the total tax on your return reduced by withholding (but not by estimated tax payments) is less than $1,000. If the amount owed on an individual income tax return comes to $1,000 or more after subtracting withheld tax, the estimated tax underpayment penalty generally won’t apply if your “required annual payment”-i.e., the amount that must be prepaid during the year in the form of withheld tax and estimated tax payments-equals at least the smaller of two amounts:

• 90% of your tax bill for 2020, or
• 100% of your tax bill for 2019.

For example, let’s suppose your tax bill for 2019 was $12,000, and your tax bill for 2020 will come to $15,000 (90% of which is $13,500). In this case, you must prepay at least $12,000 of your tax bill during 2020 to avoid the underpayment penalty. On the other hand, if the tax you will owe for 2020 will only be $10,000, you will have to make timely estimated tax payment of only $9,000 for 2020 to avoid the penalty.

A different rule applies if your adjusted gross income for 2019 exceeded $150,000 ($75,000 for married persons filing a separate return). During 2020, to avoid the underpayment penalty, you must prepay the smaller of (1) 90% of the tax for 2020, or (2) 110% of the tax for 2019.

Note that the IRS can waive an underpayment penalty if you didn’t make the payment because of a casualty, disaster, or other unusual circumstance (such as the ongoing pandemic), and it would be inequitable to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.

It’s a pay-as-you-go system

In general, one-quarter of your required annual payment must be paid by April 15, 2020, June 15, 2020, September 15, 2020, and January 15, 2021. For the 2020 tax year, the IRS allowed a deferment for the first two payments until July 15th due to the ongoing COVID-19 pandemic. Tax withheld from your salary is treated as an estimated tax payment, and an equal part of withheld tax generally is treated as paid on each installment date.

You may be able to make smaller payments under the annualized income method, which is useful to people whose income flow is not uniform over the year. You may also want to use the annualized income method if a significant portion of your income comes from capital gains on the sale of securities which you sell at various times during the year.

Time for a checkup

Although you now know what your 2019 tax bill came to, you probably don’t quite know what your 2020 tax will be. We can project what your 2020 tax will be based on your financial picture thus far, as well as on events you anticipate will occur and transactions you anticipate finalizing in the balance of this year. We should also review whether changes in your personal or financial situation require a change in estimated tax payments or withholding. For example:

• If you anticipate having substantial investment income in 2020, you may be subject to the net investment income tax (NIIT), a surtax equal to 3.8% of the lower of your net investment income or the excess of your modified adjusted gross income over a threshold amount (e.g., $250,000 for joint filers or surviving spouses).
• If you intend to retire sometime in 2020, you may wind up in a lower tax bracket for the year and may want to reduce your withholding.
• An IRA-to-Roth-IRA rollover (including a so-called “backdoor conversion”) results in taxable income. If you make such a rollover this year, the income from it must be included in estimated tax calculations.
• If you received one or more stimulus payments during 2020, you should be aware that such payments are structured as an advance tax credit and tied to income. If you earn more than the qualifying amounts in 2020, you may be required to return some or all of the money.

We are a resource for our clients year-round. Please contact us if you would like to discuss your estimated taxes or any other tax planning issue.