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Help Clients Take a Fresh Look at Estimated Taxes and Withholding

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For many of your clients, the economic downturn may be putting their income outlook for 2009 into a tailspin. You can help your clients by pointing out that their changed income situation may require a fresh look at their tax situation.

Bottom Line: Your clients won't want to compound their troubles by overpaying their taxes when their incomes are falling.

Of course, we are not discussing clients whose only income is from salary and wages; their reduced income and tax liabilities will be automatically reflected through the withholding tables.

Other clients, however, will have income that is not subject to withholding—self-employment income, dividends and interest, capital gains and losses, rental income and the like. This latter group runs the risk of overpaying their 2009 tax liability unless they are careful.

Let's review current requirements on estimated tax payments.

Estimated Tax Payments

A client must pay 25% of a “required annual payment” on each quarterly due date to avoid an underpayment penalty. The required annual payment is generally the lesser of these two options:

• 90% of the tax shown on the current year's return.
• 100% of the tax shown on the prior year's return (110% for clients with more than $150,000 of adjusted gross income) [IRC Sec. 6654(d)(1)].

Clients may often choose the second option (at least those clients with AGI of less than $150,000) because it provides a simple fixed required payment with no need to estimate. And in periods of rising or stable income, the second option may produce the lower required payment. However, when income is dropping, last year's income may be a fond memory and last year's tax may be the wrong figure on which to base this year's estimated tax. In 2009, clients who used the second option in the past may want to actually estimate their income and tax.

Estimating 2009 Tax

Even if not using 2008's tax to figure 2009's estimated tax payments doesn't mean a client should not refer to the 2008 return when doing his or her calculation.

The 2008 income and deduction figures are good memory joggers and a starting point for estimating 2009 income. Form 1040-ES contains a worksheet clients can use to estimate their tax. Most tax software programs provide an estimated tax calculation, based on the last return created within it.

Factors to Consider

A reduction in income, of course, isn't the only factor that should be included in the estimate. As in other years, such things as a change in marital status, the birth of a child, the purchase or sale of a home can increase or reduce a client's income and should be taken into account. In addition, you must be sure your client is aware of tax law changes that may impact his or her tax liability.

For example, the per-casualty deduction threshold for personal casualties increases from $100 to $500 in 2009 [IRC Sec. 165(h1)(1)]. And changes have been made regarding the rules for a “qualifying child.” For example, starting in 2009, a qualifying child must be younger than the taxpayer and the taxpayer can claim a child tax credit for a qualifying child only if the taxpayer can and does claim a dependency exemption for the child [IRC Sec. 152(c)(3)(A); IRC Sec. 24(a)].

Wage Withholding

You probably have clients who skip the estimated tax process and use the wage withholding system for prepay their tax on income not otherwise subject to withholding.

For example, a wage earner may reduce withholding allowances or have additional amounts withheld to cover the tax on a spouse's self-employment income or on capital gain from stock investments or income from a rental property. These clients may also want to take a fresh look at their withholding for 2009 and file a revised W-4 with their employer. Form W-4 has worksheets that a client can use to get an accurate number of withholding allowances for 2009. For example, extra withholding allowances can be claimed for adjustments to income, such as a net capital loss or a net loss from self-employment.

Possible Client Letter

For any of your clients to whom you'd like to reach out on these issues, we've prepared a letter for clients who file Form W-4s that reminds them of the importance of keeping the form up-to-date, particularly in 2009, to avoid overwithholding.

The letter is in the form of Microsoft Word document, so you can download it to your computer to save and modify as appropriate.

• Dear Client on Withholding or Estimated Tax (Word doc. 29 KB)

Terence M. Myers, J.D. and Dorinda D. DeScherer, J.D. are nationally renowned writers on tax topics for such publications as Accountants Tax Weekly, Tax Return Preparer's Letter, Nonprofit Tax and Financial Strategies, and Executive's Tax and Management Report. For many years Myers was Managing Editor and DeScherer Assistant Managing Editor for many Prentice Hall tax newsletters. Myers and DeScherer have published books and other publications with Harcourt Professional Publishing, Aspen Publishers, Prentice Hall, and the AICPA.

Last Updated: 01/12/2009