HOW ARE ESTIMATED TAX PAYMENTS CALCULATED?

The amount of any required ‘quarterly’ estimated tax installment is the lowest of the amounts computed using three alternatives. Different alternatives can be used for different installment payments.

Alternative 1: Tax Shown on Current Year's Return

Under Alternative 1, the amount of each installment required to be paid is 22.5% (25% X 90%) of the tax shown on the income tax return for the taxable year, or if no return is filed, 22.5% of the actual tax due for such year. However, nonresident alien individuals allowed to pay their estimated tax in three installments would have to pay 45% (50% X 90%) as their first installment.

The tax shown on the return means just that. Unusual items of income (e.g. a capital gain) cannot be ignored. It is the tax shown on a timely filed, original return for the year which controls, and not the tax ultimately shown on a subsequent, amended return. The original return is the last return filed on or before the due date (including extensions) of the return for the taxable year. However, a joint return filed within three years of the due date of the return to replace separately filed returns is the return on which Alternatives 1 and 2 are based.

TIP: Anyone who is contemplating filing a revised return on or before the due date of the original return should consider the effects of the amendment on his estimated tax for the current taxable year and for the next taxable year.

TIP: Alternative 1 requires the individual to estimate his tax liability for the year. Although it allows a 10% margin for error, unexpected events which increase income, reduce deductions or require prior tax credits to be recaptured can cause an underpayment of estimated tax.

Alternative 2: Tax Shown on Prior Year's Return

Alternative 2 requires quarterly payments equal to:

1. if adjusted gross income is $150,000 or less, 25% (25% X 100%) of the tax shown on the return for the preceding taxable year,

OR

2. if the adjusted gross income is more than $150,000, for installment payments due in taxable years beginning after 1997, 25% x “the applicable percentage” of the tax shown on the return for the preceding taxable year

   For married individuals who file separate returns, the adjusted gross income threshold is reduced to $75,000.

For the nonresident alien allowed to pay his estimated tax liability in three installments, the amount of the first installment is increased to 50%.

Alternative 2 cannot be used if the preceding taxable year was not a 12 month period or the individual did not file a return for the preceding taxable year.

As in the case of Alternative 1, the Alternative 2 amount must be increased to recapture any saving achieved by using Alternative 3 (rather than Alternative 2) to determine the amount of a previous installment payment during the taxable year. In such case, each subsequent installment under Alternative 2 must be increased by the entire amount of the savings, to the extent it was not previously recaptured.

TIP: This is the simplest alternative and is generally used where the tax for the current year is expected to equal or exceed the tax for the prior year. Since it provides a simple and safe method of avoiding the penalty, it is the most widely used alternative.

Alternative 3: Tax on Annualized Income

Taxpayers who receive their income unevenly throughout the taxable year may be able to reduce their estimated tax installment payments for one or more payment periods under Alternative 3, the annualized income installment method. Under Alternative 3, the amount of the required installment is the “annualized income installment,” that is, the excess, if any, of (1) the "applicable percentage" of the tax for the taxable year computed by placing on an annualized basis the individual's taxable income, alternative minimum taxable income and "adjusted self-employment income" for the months in the taxable year ending before the due date of the installment, over (2) the aggregate amount of any prior required installments for the taxable year.

In determining the amount of the required installment under Alternative 3, an individual must accurately compute the amount of his income, deductions, tax preference items and credits for the calendar months in the taxable year preceding the installment date in question.

A husband and wife may compute their estimated tax requirements individually or jointly (even if they are not living together). It does not matter that one spouse has no income or deductions.  Joint payments, however, cannot be made if neither the husband or wife is a nonresident alien, or they are separated under a decree of divorce or separate maintenance, or they have different tax years.