As the last two quarterly estimated tax payments for 2022 loom, what adjustments should wealthy taxpayers think about?
“When someone realizes their income, capital gains and/or dividends or interest will be significantly lower in one year over the previous year, it likely is a time to re-evaluate whether estimated tax payments need to be adjusted,” said James Chalmers, senior advisor at Moneta in St. Louis.
“Generally, for federal purposes, 90% of the current year’s tax liability must be covered by estimated tax payments to avoid an estimated tax underpayment penalty,” said Tom Kelley, director of income tax at Wilmington Trust in Baltimore.
Safe harbor provisions permit avoiding a late penalty by paying 100% of the prior year’s tax liability, he added. For higher income individuals, this safe harbor percentage is 110%.
The IRS has been rapidly increasing the penalty rate (interest charge) on underpayments of income tax liabilities: The rate rose to 6% per year for the quarter beginning Oct. 1, up from 5% per year for the quarter beginning July 1. “The highest rate during 2021 was 3% per year,” said James G. McGrory, a partner at Armanino LLP in Philadelphia.
“The second half of the year is critical for those who work in industries with variable compensation or have bonuses paid in December” regarding estimated tax liability, added Michael Lane, head of iShares U.S. Wealth Advisory at BlackRock in Austin, Texas. “Typically, equal payments are based on years past, but this year, with the slowdown and a potential recession, there is a chance this strategy could result in paying higher estimated taxes than needed."
“If a high-net-worth client had a significant income event in 2021 that they don’t expect to repeat in 2022, we generally recommend they use the current-year safe harbor,” McGrory said. “Depending on how much, as well as the timing of when a wealthy taxpayer earns income in 2022, this may make it necessary to adjust the third quarter and fourth quarter 2022 estimated payments.”
What’s the typical lead time for the calculations? “For the fourth quarter, due Jan. 15, we typically review everything in late November, early December,” said Rachel Efthemes, partner at Mazars in Edison, N.J.
Tax rates were expected to rise this year; they didn’t. And after another volatile year on Wall Street, clients “should be reviewing their portfolios with their investment advisors, including where they stand with year-to-date realized gains and losses, as well as identifying any investments with unrealized losses that they may want to recognize before year-end to offset any gains,” Efthemes said. “Additional losses recognized in the last two quarters may allow some taxpayers to reduce or even avoid third- and fourth-quarter estimated payments.”
A potentially light-income tax year could be an occasion to accelerate income, Chalmers said. “We’re gathering updated pay stubs and completing tax projections to see if clients need to make third or fourth quarter tax payments or if they should hold off,” he said.