I recently received a small Internal Revenue Service penalty for interest owed on taxes because I didn't make estimated tax payments for 1999. I wrote back explaining that I did not think it was necessary, since my only outside income is from investments and that I know of no way to estimate my investment income for the year. I have not received a reply and it has been nearly two months now. I have two questions:
1. Do I have to pay estimated taxes if my only nonwork-related income is from short-term investments? I am not a "trader," although I may make up to eight or 10 trades a month. 2. Do I have to submit to the IRS quarterly taxes on my short-term investment gains? -- Jerry Rusin
Yes and yes. And you owe the IRS that penalty for not making estimated payments in 1999.
Any income you receive -- from the sale of a stock or a lottery ticket -- is taxable. So you should have been making estimated tax payments in 1999.
Why? Because if, after withholding and credits, you would still owe at least $1,000 in taxes, then the rules say you must make estimated payments throughout the year. Since it seems that you had no withholding but had big investment gains, you would qualify.
Your estimated tax payments are supposed to be paid in equal amounts throughout the year. But what if your investment gains didn't come equally throughout the year? What if you made all your money in, say, the fourth quarter of 1999? If you pay all of your estimated taxes in that quarter, the IRS will assume you've underpaid the first three quarters and penalize you.
Instead, try "annualizing" your income to minimize those penalties. Annualizing your income means that you assume that your year-to-date income is the amount you will make for a full calendar year. So if you made only $10,000 total in the first two quarters but you grossed $40,000 in the third quarter, your annualized amount would be around $66,000 ($50,000 / 3 quarters x 4 quarters). So by the end of the third quarter, the IRS will expect you to have paid in enough tax to cover 75% of the tax due on $66,000.
If you do annualize your income, you must file
-- Underpayment of Estimated Tax by Individuals, Estates and Trusts
, which will walk you through the calculation. The form also will show the IRS that your income hasn't been a steady stream throughout the year because it will document the quarterly flow of your income.
In your case, if you believe that your income did not come in evenly throughout 1999, you might be able to go back and try to annualize it, suggests Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. If you could prove that most of your gains came in, say, the fourth quarter, then you may be able to reduce your penalty.
You don't need to amend your 1999 tax return. Just respond to the IRS' notice with Form 2210 showing the annualization, says Nissenbaum.
If you're still relying on investment income in 2000, start making estimated tax payments for this year. Get your brokerage statements and calculate the income earned at the end of each period, suggests Nissenbaum. Use Form 2210 to help you figure out how much you owe. Since I'm assuming you haven't made any payments this year but have made income, you may be hit with a small underpayment penalty for not paying first- and second-quarter estimated payments.
your third-quarter 2000 estimated tax payment is due by midnight, Friday Sept. 15
. And 75% of your tax balance must be paid in. The remainder is due on Jan. 15, 2001.
For those of you who don't annualize, here's a reminder on how to calculate your payment. For the year 2000, if your 1999 adjusted gross income was less than $150,000, your estimated tax payments must equal either 90% of your 2000 taxes or 100% of the tax you paid in 1999. If your 1999 income was more than $150,000, you must pay either 108.6% of your 1999 tax, or opt for 90% of the current year's tax. Generally, it's safer to use last year's tax bill as your litmus test, because if your estimation for 2000 is off, you'll owe underpayment penalties.
Trader Trying to Track His Trades
I am an active trader in a handful of specific stocks. Since I jump in and out of trades within each stock on a daily to weekly basis (including short-selling), I'm greatly affected by the wash-sale rule. I understand how this rule applies to me, but I'm looking for a software program that will simplify my accounting of these wash-sale "losses," including any cost basis adjustments that would apply. Are you aware of any such accounting programs? Are you aware of, or do you recommend any commercially available trader accounting software to simplify tax reporting (able to handle 1000+ trades on an annual basis)? For what it's worth, I am not a professional trader, just an individual who actively trades and is starting to get bogged down in the IRS-required accounting. -- David Garza
I am not allowed to trade stocks so I don't have firsthand experience with your dilemma. But based on readers' emails and my walk through the product,
GainsKeeper may be your answer. Not only can the program handle the wash sale, but the ability to track short sales was recently added, says Bill Beaulieu, GainsKeeper's manager of Web tax solutions. In addition, GainsKeeper allows you to specifically identify which lots you want to sell.
The downside: The program won't be able to track options trades until the end of the year and you can only import data from Excel spreadsheets. If you're currently keeping track of your trades using a different method, you would have to re-enter everything. (Check out
column for more on GainsKeeper.)
As advanced as the standbys, like
, have become, they still can't handle the wash sale.
But readers, please
chime in. If there's a great product out there that we should know about, please let me know. I'll pass the good news on to your fellow readers.
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TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.