Planning around the new estimated tax rules.

• Author: Morrow, Gregory E.

Beginning in 1992, certain high income individuals are no longer allowed to use the 100% of prior year tax safe harbor for making estimated tax payments. (For a detailed discussion of the new rules, see Luchs, "New Rules for Estimated Tax Payments" (TTA, Apr. 1999., at 203).) However, other opportunities still exist for individuals to defer payments of estimated tax during the year.

The new rules apply if (l)the taxpayer's "modified" adjusted gross income (AGI) for the current year exceeds the prior year's AGI by more than $40,000 ($20,000 for married individuals filing separately), (2) the taxpayer has AGI in the current year exceeding $75,000 ($37,500 for married individuals filing separately)and (3) the taxpayer has made a payment of estimated tax (or has been assessed an underpayment penalty) with respect to any of the three preceding tax years (Sec. 6654(d)(1)(C)(ii)).

An individual who meets all of these requirements is generally required to make estimated tax payments equal to 90% of his "modified" current year tax liability (and cannot use the 100% of prior year safe harbor), beginning with the second quarter of 1992. (Note: Sec. 6654(d)(1)(C)(iii)allows taxpayers subject to the new rules to use the 100% safe harbor for the first quarter with a "catchup" in the second quarter if necessary). Thus, certain individuals with significant increases in taxable income in the current year will no longer be able to defer the tax on such income until the following April 15. However, these individuals can defer estimated tax payments until year-end on such income by adjusting tax withholding on their wages.

Sec. 6654(g)(1) deems wage withholdings as being paid equally on each installment due date (unless the taxpayer establishes the actual withholding date). Thus, any underpayments of estimated tax in the first, second or third quarters could be covered retroactively through increases in wage withholdings at year-end. (This assumes, of course, that the individual is approximately equally underpaid in each of these quarters.)Although this technique is not as effective a deferral as the 100% safe harbor, an individual subject to the new rules can defer payment of estimated tax on income not subject to withholding (e.g., capital gains, income from passthrough entities, etc. ) by increasing wage withholdings at year-end.

Another benefit of using wage withholdings rather than estimated tax payments is that it may enable an individual presently...