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Author: troyman Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Penalty for underpayment due to capital gains Date: 10/20/1999 2:34 PM
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I am concerned about the possibility of being required to pay penalties for underpayment of Federal Taxes for this year (1999) due to significant short term capital gains. Here's the situation:

Last year (1998)
Wages: $70k (fairly level throughout the year)
Capital Gains: $20k (mostly long term)
Taxes Owed: $606 (made some large end of year additional withholding payments)

This year (1999)
Estimated Wages: $85k (fairly level throughout the year)
Short Term Capital Gains: $88k (not a very Foolish investor, but lucky nevertheless with initial investment of $60,000)

Distribution of 1999 Short Term Gains
Apr: $10K (Long on I2 Technologies)
May: $4K
Jul: $60K (Long on Oracle $30K (bought in mid 20s) then Oracle Calls for another $30K)
Sep: $7K
Oct: $7K

Questions: 1) Was I suppose to pay taxes on the capital gains as they were realized. I had assumed that I could wait until the end of the year, since I could have losses that would offset the gains. 2) If I pay 105% of the taxes that I paid in 1998, then have I found a Safe Harbor?
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Author: BladeXrunners One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19888 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/20/1999 5:18 PM
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1) Was I suppose to pay taxes on the capital gains as they were realized.

Yup, you pay taxes as income are realized. U.S. tax system is a "pay-as-you-go".

I had assumed that I could wait until the end of the year, since I could have losses that would offset the gains.

Nope, tax are paid when realized. Tax are paid through employer withholding and "quarterly" estimated tax payment. See below for some details or see IRS Publication 505 Withholding and Estimated Tax for full detail.

If I pay 105% of the taxes that I paid in 1998, then have I found a Safe Harbor?

The 105% is the amount of withheld tax, not estimated tax payment, which are not included in this safe harbor calculation. If your company is willing, ask them to withhold additional amount to reach the safe harbor. If the withholding doesn't reach the safe harbor, then you're in trouble.

In the case that your withholding doesn't reach the safe harbor, you are required to make estimated tax payment for each periods (first period is from Jan 1 to Mar 31 w/ due date of Apr 15; 2nd period Apr 1 - May 31 : Jun 15; 3rd period Jun 1 - Aug 31 : Sep 15; 4th period Oct 1 - Dec 31 : Jan 15).

There are 4 ways to make estimated tax payment:
Option 1) make one lump-sum estimated tax payment on Apr 15 -- unless you're psychic and know exactly how much your capital gain for the whole year is, you won't be able to use this option.
Option 2) make equal installment payment -- again, unless you're psychic, you won't be able to use this option.
Option 3) make uneven estimated tax payment per period. To do this, you calculate all your income for the period only, minus capital loses, deduction, credit, etc, and pay tax based on that amount. Note that this is a per period--if you have capital loss later, it doesn't factor in.
Option 4) make uneven estimated tax payment through annualized income. To do this, your income is calculated from the beginning of the year to the current period. This method is used when most of the gain is made later in the year. Since most of your gains is in the 3rd period, you should use this method.

The safe harbor is per period, so by failing to make estimated tax payment in the first 3 periods, you will owe penalty unless . . .

You beg/plead/entice your employer to withhold more tax to reach the 105% of 1998 tax liability. You can do this by filing a new W4 with 0 allowance and by putting in an additional withholding amount. Some employer may withhold your whole check--most won't. So give payroll some early Christmas gifts. And if you don't have enough income to withhold the necessary amount, ask your employer to pre-pay you for the next year. Most won't, but you got nothing to lose.

If that doesn't happen, then make an estimated tax payment on Jan 18, 2000. You are still penalized for the first 3 periods, but at least you won't be penalized for the last period.



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Author: edcosoft Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19892 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/20/1999 6:49 PM
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Questions: 1) Was I suppose to pay taxes on the capital gains as they were realized. I had
assumed that I could wait until the end of the year, since I could have losses that would offset
the gains. 2) If I pay 105% of the taxes that I paid in 1998, then have I found a Safe Harbor?


With the increase in salary it looks like your withholding this year will just about equal 1998 taxes. Make sure it does with an extra withholding if necessary, then nothing more due until you file in April. Your safe harbor is 100% of 1998 taxes since your AGI waas under $150K.

Next year, this won't work because you'll expect lower taxes than 1999. Your withholding covers normal income but I suggest you calculate your tax due each quarter and pay an installment, or better yet, wait till November and pay enough in extra withholding so total withholding is at least 90% of what you estimate 2000 taxes will be. This can get dicey, but the worst that can happen is the withholding covers the first 3 quarters for a safe harbor and you pay an installment in January for any year end suprises, and file a 2210 and Schedule AI, which TurboTax will do for you if you have the right quarterly information. Or get a 2210 Calculator if you don't use TT.

You don't have to pay a preparer to do a 2210. You can tell him not to, and you do it and staple it to your return.. Ed

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Author: troyman Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19900 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/21/1999 12:13 AM
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[ With the increase in salary it looks like your withholding this year will just about equal 1998 taxes. Make sure it does with an extra withholding if necessary, then nothing more due until you file in April. Your safe harbor is 100% of 1998 taxes since your AGI waas under $150K.]

Edcosoft and BladeXrunners,

Much thanks for your assessments of my situation!

If I understand them correctly, and given that:
1) my 1998 withholdings through my employer amounted to $18,277
2) my 1999 employer withholdings to date are $16,498 through 19 paychecks (semi-monthy 7th and 22nd of each month) with 5 paychecks to go
3) my current Federal withholding amounts to $800 per paycheck (since I have maxed out on 401K contributions at $10,000)

Then:
1) at the current clip, my 1999 withholdings will amount to $20,498
2) $20,498 is 112% of $18,277
3) AND I WILL BE IN THE SAFE HARBOR WITH NO ESTIMATED TAX PENALTIES FOR 1999!!!

Ecosoft,

As a side…since I am not married and earned more than $75k, isn't my safe harbor amount actually 105%?

troyman


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Author: edcosoft Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19909 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/21/1999 5:01 PM
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troyman wrote: Ecosoft,

As a side…since I am not married and earned more than $75k,
isn't my safe harbor amount actually 105%?


No, 105% is only if AGI for anyone was over $150K last year and $75K if Married Filing Single this year (not Single). You got the rest of it correct. Congrats. Ed

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Author: RheS Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19911 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/21/1999 5:43 PM
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troyman is trying to withhold enough to reach the "safe harbor":

If I understand them correctly, and given that:
1) my 1998 withholdings through my employer amounted to $18,277
2) my 1999 employer withholdings to date are $16,498 through 19 paychecks (semi-monthy 7th and 22nd of each month) with 5 paychecks to go
3) my current Federal withholding amounts to $800 per paycheck (since I have maxed out on 401K contributions at $10,000)

Then:
1) at the current clip, my 1999 withholdings will amount to $20,498
2) $20,498 is 112% of $18,277
3) AND I WILL BE IN THE SAFE HARBOR WITH NO ESTIMATED TAX PENALTIES FOR 1999!!!


You've got it right, except for one nit (plus, Ecosoft's comment about the fact that you haven't reached the 105% zone yet).

That nit is that you're comparing with withholding last year, when you should be comparing last years' total tax. Since you said in the original message that you owed about $606 when you filed last year, then the amount to compare with is $18,277 + $606 = $18,883. Of which $20,498 is 108%, so you're still fine; you will have withheld enough.

But if you'd owed a big bunch when filing last year, then your safe harbor is higher... and you might have been in trouble.


Hope this helps. Fool On!

Dick Smith

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Author: troyman Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19923 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/22/1999 2:56 PM
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------------------------------------------------
You've got it right, except for one nit (plus, Ecosoft's comment about the fact that you haven't reached the 105% zone yet).

That nit is that you're comparing with withholding last year, when you should be comparing last years' total tax. Since you said in the original message that you owed about $606 when you filed last year, then the amount to compare with is $18,277 + $606 = $18,883. Of which $20,498 is 108%, so you're still fine; you will have withheld enough.

But if you'd owed a big bunch when filing last year, then your safe harbor is higher... and you might have been in trouble.
------------------------------------------------------

RheS,

Good catch! I actually realized that I had made this error after I had posted the message and my head was hitting the pillow (see time of post). But it's reassuring to know that you recognized it as well. It gives me all the more confidence that I now know where I stand.

And as Ecosoft and yourself have pointed out, this loophole will not be of much use to me next year when my withholdings will come nowhere close to equaling my 1999 total tax liability.

A final comment....

Even with the phenomenal success (up 148% this year) that I've with short term (less than a year to me) trading, I am considering reverting back to a buy and hold approach to investing. Fact is, if I had held on to my stakes in Oracle, Sun Microsystems, Microsoft, and Cisco, (all sold last November with long term capital gains, but bought Oracle back in early June ), I would have done even better and with less overall risk. And I wouldn't have this short term capital gains tax payment to make next April. I'm not complaining, just not so arrogant as to not recognize that I have been more lucky than good.

Thanks for your reply post...now help me find some innovative way to get this tax bill pushed out a year. :-)

troyman

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Author: edcosoft Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19927 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/22/1999 4:12 PM
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Thanks for your reply post...now help me find some innovative way to get this tax bill pushed
out a year. :-)

troyman


Can't do that, but next year set your withholding to normal amount for you salary. If you make stock trades that are profitable, DON'T pay an installment to cover them. Instead wait until December and take an overwithholding to cover 90% of year 2000 estimated taxes when added to your regular withholding. Watch out that you don't exceed withholding capabilities if you make interim trade profits, and you may have to withhold in November and December. If you get an after end of year suprise (pay bonus -actually you can withhold from this-, mutual fund distribution, etc, you can make a 1/15/00 installment and file the AI of 2210 to eliminate any penalty.

This will delay paying any taxes on trading till Dec. Sorry, best I could do. Ed

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Author: mphipps Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 19977 of 121061
Subject: Re: Penalty for underpayment due to capital gain Date: 10/23/1999 11:56 PM
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The answer is 2.is a Safe Harbor.

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