Minimizing your revenue tax invoice is a vital a part of your monetary plan.
Many physicians popping out of residency or transferring from an employed place to at least one as an impartial contractor or accomplice aren’t conscious of the necessity to pay quarterly estimated taxes.
Even worse, many docs do not understand the distinction between the quantity of taxes which are withheld and the quantity owed.
These numbers could be fairly totally different.
What You Have to Know About Estimated Taxes and the Secure Harbor Rule
Taxes Withheld Do Not Equal Taxes Owed
I all the time get a kick out of individuals excited to get a giant tax refund. “Tax refund gross sales” pander to the monetary ignorance of our nation. These fools rejoice in the truth that they obtained to mortgage their very own cash to the federal government interest-free for a interval of as much as 16 months!
As an alternative, your objective must be to pay as few of your taxes as potential till the final potential second with out owing any penalties or curiosity. An worker does this by deciding on an applicable variety of allowances on their Type W-4. An impartial contractor or a accomplice does this by paying an applicable quantity with their quarterly estimated tax funds. However both manner, the quantity withheld or despatched in with estimated tax funds could have little to do with the precise quantity of taxes owed on the finish of the yr.
Quarterly Estimated Funds
Since nobody is withholding your taxes anymore, you might be accountable for paying them your self. This consists of your federal revenue taxes; your payroll taxes (Social Safety and Medicare); your state revenue taxes; and, if integrated, your state and federal unemployment insurance coverage funds.
These quarterly funds should be postmarked by April 15 (of the present yr), June 15, September 15, and January 15. State deadlines usually differ barely, and the funds are despatched to the state tax fee as an alternative of the US Treasury/IRS. However the precept is identical. Directions for the way to do that could be discovered on IRS Type 1040-ES.
There are a couple of exceptions for the necessity to make funds, however most docs do not meet them—besides probably of their first yr as an impartial contractor/accomplice. To keep away from making quarterly estimated tax funds, it’s essential to both owe lower than $1,000 complete for the yr (fats likelihood of that), have 100%-110% (the requirement is larger when you have greater than $150,000 of revenue) of what you owed the earlier yr already withheld earlier than transitioning from worker to impartial contractor, or have already got 90% of what you owe for the present yr withheld.
I got here very near this case in 2012 (my first time making estimated tax funds), so I do know it’s fairly potential for a doc.
Extra data right here:
What Occurs If You Miss a Quarterly Estimated Tax Cost?
The three Massive Tax Errors
There are three large errors to keep away from when paying taxes.
#1 The primary, least severe mistake is to pay your taxes sooner than you need to (or pay greater than you owe within the first place).
#2 The second, extra severe mistake is to not pre-pay a excessive sufficient proportion of your taxes and, thus, owe penalties and curiosity (to not point out the taxes themselves).
#3 The third, and most severe mistake that generally will get folks into tax hassle with the IRS is to spend your tax cash on one thing apart from taxes, in order that when April 15 comes round, you do not even have the cash to pay the taxes.
Understanding the protected harbor guidelines will assist you keep away from the primary two issues. Understanding the tax code and being disciplined will assist with the final.
Secure Harbor Guidelines
The tax system is a pay-as-you-go system. You may’t simply wait till April 15 and pay your tax invoice. Should you do, you will owe penalties (0.25%-1% of the quantity owed for every month it’s owed) and curiosity (on the fee of the federal short-term fee—at the moment within the 4% neighborhood). However you may make a giant fee on April 15 with out paying penalties or curiosity IF you qualify beneath one of many following protected harbor guidelines.
- You did not owe any tax in any respect final yr. (Good luck with this one.)
- You underpaid by lower than $1,000. (Mainly, you by no means wish to pay that final $1,000 you owe early.)
- You underpaid by lower than 10% of what you owe this yr. (Once more, no level in ever paying greater than 90% of your tax invoice earlier than April 15.)
- You paid in, both by way of withholding or by way of estimated tax funds, at the very least 100% (110% if you happen to remodeled $150,000) of what you owed final yr. (Extra on this beneath.)
You can additionally keep away from the penalties (however not the curiosity) in case your underpayment was attributable to catastrophe, casualty, different unexpected circumstances, incapacity, and even retirement—if you happen to can present the underpayment was attributable to cheap trigger and never willful neglect.
Extra data right here:
The way to Pay Estimated Taxes on a Roth Conversion
The 110% Rule
Estimating your taxes is not essentially straightforward, particularly when you’ve got a variable revenue like most doctor impartial contractors or companions. Docs hardly ever qualify beneath Rule 1, and Guidelines 2 and three require you to considerably precisely estimate your present tax invoice. Rule 4 is absolutely the one protected harbor that almost all physicians can truly depend on. Take what you owed final yr, multiply it by 1.1, then divide it by 4, and ship in a examine for that quantity each quarter.
Should you transitioned from an worker place halfway by way of the yr (like most docs), it may be even trickier. You are taking what has been withheld to date for you, subtract that from the quantity owed final yr multiplied by 1.1, divide by two, and ship that quantity in on September 15 and January 15.
Unequal Funds
So, you are pondering to your self, why not simply ship in all the cash on January 15? Sadly, the IRS is one step forward of you. Your funds all year long should be associated to your revenue all year long, as you possibly can see on Type 2210. Apparently, when you have the cash withheld by an employer, it does not matter when it was withheld. You may declare 50 allowances all yr, then declare 0 in November and December, and if you happen to in any other case fall into the protected harbor guidelines, no penalties or curiosity are owed.
Keep in mind to Hold Your Tax Cash Secure
Should you pay lower than you owe, both intentionally or by chance, make sure to preserve sufficient money readily available to pay these taxes come April. Keep in mind that taxes withheld/pay as you go could have little to do with the taxes truly owed, and are available April 15, you have to sq. the accounts.
Should you need assistance with tax preparation otherwise you’re on the lookout for recommendations on the perfect tax methods, rent a WCI-vetted skilled that can assist you determine it out.
Do you pay estimated quarterly taxes? In that case, did you discover it painful to determine how a lot you owe? If not, how a lot have you ever paid in penalties and costs?
[This updated post was originally published in 2012.]
