One year ago, I published a blog titled, “The Benefits of Year-end Tax Planning” and that can be found on our website under blogs. I would echo the thoughts shared in that blog again this year and I also want to discuss the methods by which we, as taxpayers, can make payments toward the remaining income tax/self-employment tax we owe after doing all that is possible to reduce or mitigate our tax liability for a given tax year.
The majority of taxpayers are W-2 wage earners and we are all familiar with the fact that many deductions are taken out of our checks before we receive the remaining net pay in our personal bank account. These deductions always include social security and Medicare withholding and, in most cases, also include federal and state income tax withholding. The social security and Medicare withholding is mandated per the IRS and the employee portion of these taxes represent 7.65% (6.2% social security and 1.45% Medicare) of the gross wage amount in each case. In 2016, once the employee’s income from an employer for a given year exceeds $118,500, no more social security withholding will take place for the remainder of that tax year. In 2017, that threshold will increase to $127,200. Medicare withholding has no threshold and is withheld on gross wages no matter how high the gross pay is. Keep in mind that your employer is matching your social security and Medicare withholding dollar for dollar before remitting the funds to the IRS.
The other two items that can be withheld from your wages are federal and state income tax. The amount, if any, of these income taxes that are withheld will be determined by how the employee has completed the federal form W-4 and, in Arizona, the Arizona form A-4. These are the two income tax withholding forms that an employer is required to have an employee complete, along with the form I-9 proof of citizenship, before allowing the employee to work for the employer. For a taxpayer who only receives W-2 wages, the federal and state income tax withholding on those wages is usually the only avenue through which they pay their income tax liability into the system.
For those that are self-employed and receive forms 1099-MISC rather than a form W-2, there often are no wages and, therefore, there is no wage withholding avenue by which to make income tax payments to the government throughout the year. In these cases, the taxpayer is required to make quarterly estimated income tax payments to cover their income tax liability as well as any self-employment tax liability (social security and Medicare) they may have for the year. For a given tax year, these quarterly payment due dates are April 15th, June 15th, September 15th and January 15th of the following year. You will note that these due dates are not consistently three months apart. I have yet to see an explanation of why this is the case but how can we doubt the infinite wisdom of our government, correct? (sarcasm intended)
Whether a taxpayer pays into the system through wage withholding or quarterly estimated tax payments, there are estimated tax penalties that can be assessed if the taxpayer did not pay in nearly all of the tax due for a given tax year during the year (and not wait until the filing of the tax return early the next year). One thing I wanted to emphasize is that the IRS determines any estimated tax penalty for a tax year by the amount and timing of when quarterly estimated tax payments are made. However, for wages, the IRS is blind as to when during the year a taxpayer had withholding taken from their gross wages. Therefore, opportunities exist to make up lost ground and time by maximizing income tax withholding late in the year so that the taxpayer can avoid estimated tax penalties for that year. If quarterly estimated tax payments are the only avenue available, this strategy is not available.
Our goal with our clients is always to reduce the overall tax liability for a given tax year using strategies to reduce net taxable income. Then, once all that planning is complete, our next goal is to assist our clients to pay in the tax they owe in such a manner as to avoid tax penalties and interest and keep funds in their pockets as long as possible before remitting them to the government.
If you have questions related to year-end tax planning or methods available to pay in the tax you owe, please contact us.