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ESTIMATED TAXES - TRIM THE PENALTIES

April 06, 2007

So you ended up owing the IRS this year. You had a big capital gain, maybe. Or you went out on your own, were self-employed, and you didn't count on not having taxes withheld. You're going to get a penalty, right?

Not necessarily. Just because you have a big balance due doesn't mean you have a penalty; even if you have one, a little calculation might help you trim it down.

The tax law has a default rule that requires you pay in 90% of your taxes each year through withholding or timely estimated tax payments. If you don't meet the requirement, you pay a non-deductible penalty computed using an interest rate set each quarter by the IRS. In effect, you pay the IRS interest for not giving them your money earlier.

There are important exceptions to the 90% rule that come in handy all of the time.

The biggest exception is the "protective" rule. If in 2006 you paid in at least as much tax through withholding and timely estimates as you had in 2005, you owe no penalty. If your 2005 adjusted gross income was $150,000 or more, you had to pay in 110% of your 2005 tax in 2006 to meet this exception. Most people who have a big one-time income boost can reduce or greatly eliminate their estimated taxes this way.

The other big exception is "annualizing" your 2006 income. If you had a big chunk of income late in the year, you can reduce or even eliminate your estimated tax penalties by filling out the "annualization worksheet" for Form 2210. This worksheet lets you compute the required tax payments quarter-by-quarter based on your income for each quarter.

When you do your estimated tax worksheet, you can spread your withholding evenly through the year. If you had a big year-end bonus, that withholding applies equally to each quarter.

And remember, the first estimated tax payment of 2007 is due April 17. Be sure to budget for it.

Look for a daily tax tip here through April 17; collect them all. Also, don't miss the Taxable Talk Bozo Tax Tips series, in case you need a smile.

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