|
 he year-end tax planning process
begins with estimating your 1997 income, deductions, exemptions, and credits. Starting
early will give you extra time to
|
We've posted our updated tax planning guide. Click here for planning tips and strategies for 1999 and beyond.
|
obtain additional information on items that concern you or to investigate additional
ideas for tax savings or deferral. The tax rate tables and worksheet (1997 Individual Income Tax Rates and Tax Forecasting Worksheet) can help you compute your
expected taxable income and tax liability. The worksheet will help you view the current
year and next year together and will provide a starting point for evaluating the tax
effects of the various strategies set forth in this guide.
Six Steps for Determining Where You Are
- Estimate your income, deductions, credits, and exemptions for 1997 and
1998 using the Tax Forecasting Worksheet.
- Identify items that you can shift from 1997 to 1998 or vice versa by
reviewing Personal Tax Planning 1997.
- Determine your marginal tax rate -- the rate at which your next dollar
of income will be taxed -- for 1997 and 1998.
- Determine how much tax you owe and when you must pay it to avoid
underpayment penalties.
- Determine whether you are subject to the alternative minimum tax (AMT).
- Take the actions needed to make the best of your tax situation.
Minimizing Your 1997 Tax
Your goal in working through the year-end tax planning process is to reduce the amount
of tax-to-be as much as you can. There are two ways to do this: through permanent savings
of taxes or by deferring taxes to some future year. Examples of permanent savings are the
reduction or elimination of liability for the alternative minimum tax or the reduction of
your current tax liability by converting ordinary income into capital gain income that is
subject to a lower marginal tax rate. Table 2-1 below shows that
your marginal tax rate can actually be higher than the "advertised" tax rates of
31%, 36%, and 39.6%.
Table 2-1
1997 Effective Marginal Tax Rates on Income |
|
"Advertised"
Rate |
|
31% |
36% |
39.6% |
| Effect of 3-percent reduction in itemized
deductions |
0.9% |
1.1% |
1.2% |
| Phaseout of each exemption |
0.6% |
0.7% |
0% |
| Totals for: |
|
|
|
| Individual |
32.5% |
37.8% |
40.8% |
| Family with two
children |
34.3% |
39.8% |
40.8% |
| Family with four
children |
35.4% |
41.1% |
40.8% |
| Typically, married taxpayers with taxable
incomes of $271,050 or more, who are therefore in the 39.6% bracket, will have adjusted
gross income above the $304,300 level at which personal exemptions are fully phased out. |
It is extremely important that, after you determine your 1997 tax liability, you also
determine when those taxes must be paid to avoid underpayment penalties. The following
section discusses the rules that govern the requirements for the payment of taxes.
Avoiding Estimated Tax
Penalties
Federal tax law requires the payment of income taxes throughout the year as you earn
your income. This obligation may be met through withholding or quarterly estimated tax
payments or both. For 1997, if total tax minus withholding and payments is greater than
$500 ($1,000 in 1998), you will be assessed a penalty for underpayment of estimated tax.
However, if you overpay your estimated taxes, you are in effect making an interest free
loan to the government, which you would probably prefer to avoid. The penalty for
underpayment is calculated as interest on the underpaid balance until it is paid. The
interest rate on underpayments in 1997 is 9%, and the rates for 1998 will be announced
quarterly by the IRS. The rates are adjusted under a prescribed formula in response to
changes in federal short-term interest rates.
- Methods for Avoiding Estimated Tax Penalties for 1997 Taxes. There are several
ways to avoid estimated tax penalties. The basic rule is to pay the required amount by the
end of the year through withholding and quarterly estimated payments. The required amount
will be one of the following, depending on the individual taxpayer's situation:
- 90% of the current year's tax liability
- 100% of the prior year's tax liability if the prior year's adjusted gross income was not
more than $150,000 ($75,000 for married taxpayers filing sep-arately); otherwise, use 110%
of the prior year's tax liability. (The safe harbor for high income individuals is lowered
to 100% for 1998 taxes.)
- 90% of the tax liability based on a quarterly annualization of current year to date
income.
Penalties are based on the difference between the lowest amount required to be paid by
each quarterly payment date and the amount actually paid by that date. If payments are
based on one of the first two alternatives above, the annual required amount must be
divided equally among the four quarters to determine the cumulative amount due at each
quarterly payment date. In the case of annualized income, however, the amount due by each
payment date is determined based on income to date. Thus, the annualization method may be
the one for you to use if you accrue or receive much of your income during the latter part
of the year, because the annualization method allows for lower required payments in the
early quarters. Table 2-2 below illustrates the amount required to
be paid (cumulatively) for 1997 taxes under each method by each date.
Table
2-2
Cumulative Amount of Estimated Taxes to Be Paid |
|
Due Date |
| 1997 Tax Payment Methods |
15 April |
15 June |
15 Sept |
15 Jan |
| Current year's tax |
22.5% |
45% |
67.5% |
90% |
| Prior year's tax (safe harbor): |
|
|
|
|
| -- 100% |
25% |
50% |
75% |
100% |
| -- 110% |
27.5% |
55% |
82.5% |
110% |
Tax on annualized income
to date |
22.5% |
45% |
67.5% |
90% |
Payments made through withholding from your paycheck (or from your pension or other
payments) are given special treatment. The IRS treats income tax that is withheld as
having been paid equally throughout the year (unless you prefer to use actual payment
dates). This lets you make up for underpaid amounts retroactively, because amounts
withheld late in the year may be used to increase the amounts deemed paid in earlier
quarters.
Thus, you may reduce or avoid underpayment penalties by adjusting withhold-ing late in the
year, something you cannot do with quarterly estimated tax pay-ments. If you find that
your payments to date are inadequate, you should arrange with your employer or pension
provider to adjust your withholdings to the extent possible to cover any anticipated
shortfall. The additional amount must be withheld before December 31 to apply to the
current year's tax. If you cannot adjust withholding, you should at least make a prompt
quarterly payment, which will stop the growth of underpayment penalties.
- State and Local Rules. Most of the state and local taxing districts have similar
rules and penalties related to the prepayment of income taxes during the year. Since many
states have prepayment rules that vary from the federal requirements listed above, you
need to become familiar with the rules for the states and localities in which you file
returns and take the steps necessary to avoid underpayment interest and penalties. You
must therefore judge the adequacy of the tax payments to authorities at all levels.
- Other Taxes. When computing your required estimated tax payments, do not overlook
the increasing number of "other taxes" that apply in addition to the regular
income tax. Some, such as the self-employment tax and the alternative minimum tax, have
existed for many years. Others, such as the employment taxes for domestic employees, are
relatively new. For the latter, for the tax year 1997, employers are not required to
prepay FICA taxes on domestic employees. Beginning in 1998, employers will have to include
FICA taxes for employees in calculations of their own estimated tax liabilities.
|
Tax
Guide 
