Dear Liz: I live totally on my investment income. I receive the majority of my income at the end of the year, mostly dividends from my brokerage account.
A couple of years ago, when talking to an IRS agent about another matter, I asked when I should make my estimated tax payment. I was told that I had to make the payments quarterly. This year, when I was talking to my accountant, she told me that I could make a lump-sum payment at the end of the year without incurring a penalty. Who is correct, the IRS agent or my accountant?
Answer: Ours is a pay-as-you-go system, and the IRS assumes that your income is received evenly throughout the year, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Therefore, the agency typically expects four estimated tax payments of roughly equal size, with the payments due April 15, June 15, Sept. 15 and Jan. 15. If the payments aren’t made as expected, you can get hit with an underpayment penalty.
However, the IRS allows a taxpayer to show that their income is not earned equally throughout the year by filing a Form 2210 with a related Schedule AI (Annualized Income Installment Method), Luscombe says. Schedule AI allows you to show when income was earned during the year so you can match your estimated payment dates to when you actually received the money.
Schedule AI is more work, since it requires you to report adjusted gross income for each of the four quarters, as well as your itemized deductions and other tax details items, Luscombe notes. But if your income comes at the end of the year and the corresponding estimated tax payment was made on Jan. 15 of the following year, filing this paperwork may be sufficient to avoid a penalty for underpaying estimated taxes, he says.
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