There are two important tax deadlines for individuals on June 15: quarterly estimated income taxes for 2017, and the 2016 tax deadline for U.S. residents living outside the U.S.
“Individuals: If you are a U.S. citizen or resident alien living and working (or on military duty) outside the U.S. and Puerto Rico, file your 2016 income tax return (Form 1040) and pay any tax due. If you want a 4-month extension of time to file your return, use Form 4868 to extend your filing deadline to October 16. (The IRS grants the above individuals two additional months to file compared to U.S. residents living and working in the U.S. who had to file income tax returns or extensions by April 18, 2017.)”
“Individuals: If you are not paying your 2017 income tax through withholding (or you will not pay enough tax during the year that way), pay the second installment of your 2017 estimated tax. Use Form 1040-ES (Estimated Tax for Individuals). For more information, see IRS Publication 505 (Tax Withholding and Estimated Tax).” (Read a brief IRS explanation What Is Estimated Tax & Who Does It Apply To?.)
The four quarters for estimated taxes are:
• Q1: Jan. 1 — March 31, deadline is April 18, 2017
• Q2: April 1 — May 31, deadline is June 15, 2017
• Q3: June 1 — Aug. 31, deadline is Sept. 15, 2017
• Q4, Sept. 1 — Dec. 31, deadline is Jan. 15, 2018
Exceptions: Generally, you do not have to pay an underpayment penalty if either: Your total tax is less than $1,000, or you had no tax liability last year.
Estimated tax safe harbor rule. If your 2016 adjusted gross income (AGI) was more than $150,000 ($75,000 if you are married filing a separate return), you must pay the smaller of 90% of your expected tax for 2017 or 110%* of the tax shown on your 2016 return to avoid an estimated tax penalty. (*If your AGI is under these high-income thresholds, cover 100% of the prior year.)
Underpayment penalty: Traders with 2017 year-to-date trading gains should consider making quarterly estimated tax payments during the year to avoid an underpayment penalty. For 2016, the underpayment penalty rate was 4%. Some traders think this a reasonable price, sort of like another margin loan from a broker. But, the underpayment penalty is not tax deductible, whereas margin interest is.
Consider using the “Annualized Income Installment Method” if that generates a better result than the “Regular Method.” If you make the bulk of your trading income at the end of the year, the annualized method is better. (See the instructions for Form 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts.)
Three common scenarios for traders:
1. You left a high-paying job in late 2016, and your only activity for 2017 is trading, with significant profits year-to-date (YTD). It’s probably wise to make a Q2 estimated tax payment. If you did not pay a Q1 estimate and you don’t have an overpayment credit from 2016, then pay enough for Q2 to catch up for YTD. Under the safe harbor rule, covering your 2016 tax liability will be a substantial amount. Determine whether it’s preferable to pay 90% of 2017 taxes if that is a lower cost. The software used for preparing your 2016 tax return can generate the estimated tax payment vouchers based on the safe harbor exception or 90% of the current year. The state estimated tax rules vary, some require a different percentage for the current year vs. the federal 90%.
2. Your income tax liability for 2016 was small, and you have significant trading gains in 2017. Assume the safe harbor rule is best and cover the prior year tax liability.
3. You have trading losses in 2017. You may not owe estimated taxes for Q2 2017.
Traders face a quandary with estimated taxes:
If you pay what you owe for Q2, you may regret it with trading losses later in the year. You’ll be stuck waiting for a tax refund or applying an overpayment credit towards 2018 taxes. You won’t have that money available for trading capital for the remainder of 2017. Many traders don’t make estimated tax payments until Q3 and or Q4 when they have more visibility on trading results.
Loophole for S-Corp traders:
Traders eligible for trader tax status often use an S-Corp to deduct health insurance premiums and retirement plan contributions. They need to execute officer compensation through payroll in Dec. 2017 to unlock those employee benefits. Traders can withhold a significant portion of their salary as federal and state withholding tax. That alleviates estimated income taxes due. The loophole is that the IRS treats payroll tax withholding reported on a Form W-2 as made throughout the year, even though it’s all withheld in December.
Congress and President Trump are working on tax reform in 2017, and considering delays; I expect changes won’t be effective until 2018. There’s a small chance Congress could make tax reform retroactive to 2017, which would change 2017 estimated tax payment calculations. I think individuals should make 2017 Q2 estimated tax payments based on current tax law. Let’s see if there is any concrete news on tax reform before the Q3 deadline of Sept. 15, 2017.
Our clients should contact their assigned CPA if they need help with 2017 quarterly estimated tax vouchers.