COMMENTS ON PAYING THE LOWEST AMOUNT OF QUARTERLY INSTALLMENTS AND STRATEGIES FOR USING THE ANNUALIZED INCOME METHOD AND OTHER METHODS TO LOWER OR ELIMINATE PAYING OF INSTALLMENTS.

OUR QITC CALCULATOR USES THE ACTUAL IRS FORM 2210 SCHEDULE AI TO REDUCE AND DEFER YOUR QUARTERLY TAX INSTALLMENTS--GET A FREE LOAN FROM UNCLE SAM, AND MAYBE EVEN AVOID PAYING ANY INSTALLMENTS.

Financially the WORST way to pay your quarterly tax installments is to blindly use one of the "safe harbors". If you paid 1/4 of last year's tax for each installment you wouldn't know the Annualized Method existed, nor how it could reduce or even eliminate your installments even though your income doesn't fluctuate and might be increasing over last year!

You are probably aware that if most of your income falls in the last quarters of the year, such as from Mutual Fund annual distributions bonuses or RMDs, the Annualized Method (AI) will compute a lower first installment than either safe harbor. So, if you owe a penalty with your return for underpaid installments you might avoid a penalty by completing the AI next April. The reason for this is that whether you use last year's tax, or 110% of last year's tax, or 90% of this year's tax as a safe harbor amount, 1/4 of any of these methods will usually be more than 1/4 of 90% of the tax on your annualized income that does NOT include the end of year distributions. So, if you knew how to compute the correct amount, you could pay lower early-year installments on purpose without incurring a penalty next April.

There is one MAJOR problem with utilizing the above knowledge: It is virtually impossible for a normal human being to correctly compute the annualizing of each quarter's income, particularly if it fluctuates. Also, if you are subject to, but don't really understand how to figure, the AMT, high income limitations, credits, capital gains and Qualified Dividends, business income, Self Employment taxes and the many deductions, credits now available and "other taxes" it isn't worth the effort. Trying to sort these out next April to feed your net income into your tax program on a quarterly basis is even close to impossible, but that's a bit too late anyway to really take advantage of the Annualized Method to purposely compute a lower installment to pay. If you read IRS Publication 505 you will quickly decide to forgo the calculations they propose. Also, the IRS doesn't tell you what to do about the AMT and a few other normal tax incidents in everyone's life. Much has been written about paying Installments and the "Save Harbors" but no real advice on how to use the AI Method to your advantage, let alone helping intrepret Publication 505 exists

We have developed a calculator that uses the actual IRS form 2210 and Schedule AI (instead of the IRS's mutiple worksheets) to compute the lowest installments for each quarter that will avoid a penalty next April. We use your ACTUAL income, expenses, and credits, etc. totaled to date for each quarter, NOT an estimate of future unknowns. The input form is quite simple--most of it looks just like a line numbered IRS form 1040 (plus a few lines of Schedule A and D). There's other forms displayed but we compute all the numbers for them for you. You add up your dividends, interest, capital gains, business income less expenses, Social Security, itemized deductions such as charity, medical, interest and property taxes and any other pertinent tax amounts, exactly the same information you need to complete your 1040 return, but just what has happened until March 31. We guide you in simplifying this process and you can refer to last year's 1040 if you are in doubt which items you need.
We compute without further input (in most cases) all applicable phase-outs, limitations, the Child Tax credit, form 6251 (AMT), the Schedule D Worksheets to compute your final tax, and supply precalculated forms for most Credits, Deductions and Other Taxes. If a particular item is difficult to figure, estimate it on the safe side. The net taxable income resulting from these are annualized, and then the tax computed and multiplied by the AI quarters' factors. Other taxes, such as the SE and AMT which we automatically compute also are added in, and any credits you earned and withholding amounts are deducted for your final installment amount. Incidentally, if either of the safe harbors develops a lower installment, the AI automatically uses that amount instead of the annualized amount.

The result is ABSOLUTELY the lowest installment amount to safely avoid a penalty because we do not *estimate* the current year's tax. The AI uses 4 times the first quarter's income instead, which under most circumstances will be lower than your final full year's income (or tax). In the rare instance where you can correctly estimate full year income as lower than the annualized amount, you can enter that figure in the calculator.

So, you say, your income is almost the same, or increasing, each year so why not pay 1/4 of last year's tax each quarter? Won't that be lower than even 90% of this year's tax? Well you may have to use 110% of last year's tax, which is 20% higher than the current year's 90% safe harbor amount. Even if you pay 1/4 of only 100% of last year's tax you are paying in 1/4 of your full year's tax liability without realizing that your first and second tax quarters' (only 5 months') income is probably considerably LESS THAN 1/4 or 1/2 of your full year's income. So why should you pay 1/4 and 1/2 your taxes in advance? Well, you shouldn't, and don't have to. The IRS gave you a legal way to avoid this, if you can figure it out. Our calculator makes all the Schedule AI calculations for you.

And here's the real leveraging magic that makes the ability to compute the AI in advance a bonanza. You can reduce your first quarters' income artificially (and legally) by many methods and the installment tax deferral effect of that reduction will be 4 times the effect of the reduction on a safe harbor installment. This is because the full deduction is taken against only first quarter income before multiply by the annualization factor of 4, whereas for the safe harbors it is deducted from the full year's income to figure your actual tax last year and this year.

For example, if you normally contribute $2,000 to an IRA every year, and assuming for simplicity a 25% tax bracket, this reduces your annual tax by $500 (last year and this year and next year). 90% of 1/4 of that $500 is a $112.50 reduction in each quarter's installment if you use the 90% of current year's tax safe harbor. Even if you used 110% of last years tax as the safe harbor it reduced your tax last year by $500 for a reduction in each installment this year of only 1.10 X .25 = $140, but this is from at least a 20% higher payment than necessary. Using the AI, however, if you deduct the $2,000 in the first quarter, it reduces annualized taxable first quarter income by $8,000 for a $2,000 reduction in computed tax, divided by 4 and multiplied by .9 equals a first quarter installment reduction of $450. In the second quarter it's actually increased to $540 for an additional $90 deferral. $36 of that has to be paid back in the third quarter and finally you get to keep the full $450 in the last quarter versus accumulating the $450 over the 4 quarters.

Note that this AI Method does not actually reduce your tax below what it eventually would have been anyway, and by the 4th quarter you will have paid in the same total installments. It just reduces the first installment by the reduction that would have been spread over the 4 installments.

So it follows that any INCOME DEFERRAL (collect income later in the year on lines 7 through 22 of page 1 of the IRS 1040), or AGI REDUCTION (take a deduction in the first quarter instead of later on lines 23 through 33 of the first page of IRS 1040), or ITEMIZED DEDUCTIONS (in excess of 1/4 of your Standard Deduction whether you itemize on a full year basis or not) will have a fourfold effect on reducing your first installment versus either of the safe harbors.

Without your knowing you could use them to your advantage, some of these deferrals occurred anyway, such as your Capital Loss Carry forward (the $3,000 limit becomes $12,000 when annualized), year end bonuses and mutual fund distributions, property tax payments in January, unusual medical expense, and other Deductions from AGI that are fulfilled in the first quarter. Some are discretionary, such as paying Pension or IRA contributions in the first quarter, or deferring a mandatory IRA withdrawal until September. The new sales tax deduction for a new car which could be as much as $4,600, $1,000 property tax deduction, unlimited disaster loss deduction, the easing of other deductions all could reduce your first installment 4 fold.

The effect of these income reductions carry over into the second and third quarter, and it is not unusual for them to be sufficient to defer the entire first and second quarter installment (that would have been paid using a safe harbor) until the following January. It should be noted, however, that regardless of reducing an annualized income tax installment to zero, taxes such as Self Employment and Nanny Taxes, and Alternate Minimum Taxes (lines 53 through 58 of the 1040) are still payable in the percentage corresponding to the quarter's multiplier when they were incurred. However, 4972 tax is not included in the first installments if it was actually incurred later, which is less than if it is included in the 4 safe harbor equal installments.

If you anticipated a large form 4972 tax you should ideally wait till after September 1 for the Distribution so it is paid with the 4th quarter installment.

Credits affect your installments like other taxes (above). They have no special multiplying effect but the earlier they are incurred (or entered into the AI computations) the earlier they will reduce the current installments just as taxes will increase only the current installment (and later installments) when incurred. The new credits, or easing their limitations, could reduce your tax in 2009 considerably more than you anticipated, and the refund of all your ISO AMT tax could easily wipe out your entire tax liabiity. Use of this program will at least determine HOW LOW your 2009 taxes and installments could be.

There are a couple of other "adjustments" available when they can be used advantageously such as applying withholding in the quarter it is incurred instead of averaging it over the 4 quarters, and treating 1099 withholding separate from W-2 withholding in this regard. This is useful when more withholding occurred in early quarters, such as ceasing employment and starting a business. Also, over-withholding in December is useful to "retroactively" make up an early quarter installment deficiency.

Our calculator is NOT a tax program with questions. It is an Excel97 spreadsheet with 5 parallel 1040s for each quarter and the year final. It will compute your exposure to high income limitations, phase outs, the AMT, etc. independently for each quarter, and will accommodate unlimited businesses by both spouses who also may be employed, computing their SE tax, and SE Health and Tax deductions, as well as their withholding.

We provide a fully functional program as a FREE demonstrator that will compute the first quarter installment and the full year from actual data or estimates for year 2007 and several prior years. The entire program is an EXcel97 spreadsheet file small enough to put on a floppy disk.

Even better than computing annualized installments would be to eliminate them altogether! If you have a source of selective Withholding sufficient to equal your last year's tax (or 110% of it) or 90% of this year's actual tax, such as from RMDs, when you call your IRA or 401K trustee to advise them of the amount of your RMD you want distributed, have it distributed in late December, and have them withhold the amount of your last year's tax, or, since you can now calculate it more accurately, a bit over 90%, or within $1,000, of what you calculate you'll owe this year. This withholding automatically averages over all 4 quarters and makes filing form 2210, or payment of any underpayment penalties, unnecessary.
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