New rules for estimated tax payments.

• Author: Luchs, Lorin D.

On Nov. 15, 1991, President Bush signed legislation to extend unemployment benefits.(1) To raise revenue to help pay for these benefits, Congress accelerated estimated tax payments for certain individuals, effective for tax years beginning after 1991.

Generally, all individuals must make estimated tax payments if they have income that is not subject to withholding. This article will discuss the change to the estimated tax requirements for such individuals--those who are self-employed; retired; have investment income, such as interest, dividends and capital gains; and are partners or S corporation shareholders.

Old Law

Individuals may compute their current year's estimates based on their prior year's tax even though they expect their current income to be higher.(2) This method ("Exception 1") is a safe harbor that eliminates IRS underpayment penalties.

Exception 1 provided individuals with a practical and uncomplicated method for determining their current year's estimated tax. However, it also allowed individuals to defer tax payments for the year in which their income increased over the prior year. This was identified as a "loophole" by a desperate Congress seeking revenue to pay for the extension of unemployment benefits.

Example 1: Husband H and wife W file joint returns for 1991 and 1992. H is a general partner of a partnership, with his share of the earnings approximating $90,000 a year. W is an employee earning approximately $50,000 a year. H and W have made quarterly estimated tax payments for years because of his partnership earnings. Taking advantage of the old law, H and W postponed the sale of unimproved real estate from December 1991 to January 1992. The gain on the sale was $100,000.

Under the old law, H and W would have been able to base their 1992 quarterly estimated tax payments on their 1991 tax, without the $100,000 gain, because the sale did not occur until 1992. Payment of the $28,000 capital gains tax would not be due until Apr. 15, 1993. Simply by postponing the sale until 1992, H and W would have use of the money without interest for 15 1/2 months.

New Law

Individuals may continue to use Exception 1 for their first estimated tax installment payment.(3) However, individuals can no longer use this method for their remaining three installment payments if their current year's adjusted gross income (AGI) --exceeds $75,000 ($37,500 for a married individual filing a separate return); and --increases by more than $40,000 over...