Trade Strategies for Retirement and Trader Taxation

Estimated Tax Payments, A Primer For Traders

For the majority of Americans, income taxes are collected on a pay-as-you go basis through the automatic withholding on their wages through their employers. However, if you receive substantial income from dividends, interest, business income, and/or capital gains, you should check your estimated tax liability to verify if you need to make estimated tax payments. Failure to pay a required estimated tax installment will subject you to a penalty based on the prevailing IRS interest rate applied to tax deficiencies.

Do You Need to Make Estimated Tax Payments?

If you expect your tax liability to be $1,000 or more after taking into account taxes and refundable credits, you are required to make quarterly estimated tax payments. You do not have to make estimated tax payments if you meet one of the following tests:

90% Current Year Test

If you expect your income, deductions and tax credits to be approximately the same in 2015 as it was in 2014, you can base your 2015 withholdings and quarterly estimated tax payments on 90% of your 2014 total tax. If you expect your 2015 total tax to be lower than in 2014 (your income dropped), you can base your 2015 withholdings and estimated tax payments on 90% of the estimated 2015 total tax.

For example, John files his taxes for 2014 and owes $30,000 in total tax. As long as John’s income is approximately the same in 2015, he owes an estimated tax liability of $27,000 ($30,000 X 90%).

Safe Harbor for 2015 Based on 2014 Tax

If you are unable to make a precise projection of your 2015 income (most traders fall into this category), you can play it safe and avoid penalties and interest from the IRS by having your withholdings and estimated tax payments equal to 100% of your 2014 total tax, as long as your adjusted gross income is $150,000 or less. If your adjusted gross income exceeds that amount, your payments for 2015 must be at least 110% of your 2014 total tax.

Using the example above, if John’s adjusted income was $160,000, his total estimated tax payments for 2015 will be $33,000 ($30,000 X 110%).

What To Do If Your Income Fluctuates

If your income fluctuates throughout the year (as is the case with most traders), the IRS allows you to use the annualized income method in order to figure your estimated tax payments. This method allows you to avoid a penalty for installment periods during which less income is earned by reducing the required estimated tax payments for such periods. Profitable traders should use the Annualized Estimated Tax Worksheet in IRS Publication 505 to figure their required estimated tax payments.

Adjusting Your Payments During the Year

Trading is a volatile business. If your income or expenses change during the year, you should refigure your estimated tax liability and adjust your payment schedule going forward.

For example: John finds out in July that his estimated tax liability for 2015 should be $30,000 rather than his original estimate of $25,000. He already paid $6,250 for the April and June installments ($12,500 total). Under the new schedule, he should have paid $7,500 per period ($30,000 / 4). John’s installment for September must be at least $9,000 ($7,500 + $2,500). The additional $2,500 is to make up for the $1,250 underpayment in the prior 2 periods.

Making Estimated Tax Payments

Estimated tax payments are made by filling out Form 1040-ES vouchers and mailing them in to the IRS with your tax payment. You can also make payments electronically through the Electronic Federal Tax Payment System (EFTPS). The due dates for 2015 are 1st Quarter: April 15th, 2nd Quarter: June 15th, 3rd Quarter: September 15th, and 4th Quarter: January 15th, 2016.

Traders need to be aware of estimated tax liability and whether they need to make quarterly estimated tax payments. With some proper planning, you can avoid the costly penalties and interest from the IRS and keep more of your hard earned profits.


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