Get More Accuracy in Your Tax Forecasts

With ever-changing tax laws, forecasting your tax obligation is now extremely difficult to do. To make matters worse, this uncertainty can create the need to write a large payment to the IRS and pay penalties to boot! Here are some suggestions to help you manage this for you and your family.

The basics of forecasting

The objectives of an accurate tax forecast are to avoid IRS penalties and eliminate surprises.

No penalties, please! To avoid IRS underpayment penalties, your estimated tax payments must be large enough to satisfy these thresholds:

1.) 90% of your current year tax liability, or

2.) 100% of your prior year tax liability (110% if your adjusted gross income is more than $150,000).

So if you want to avoid any penalties you must calculate and pay estimated taxes throughout the year to satisfy the IRS.

Avoiding a tax surprise. Most taxpayers want as much clarity as possible about next year’s potential tax bill way before April 15th arrives. Very few of us have a pile of cash sitting around to pay to Uncle Sam on tax day. So a tax surprise can quickly turn into a nightmare if you do not have the funds available to pay the tax. The only way to avoid the surprise is to know about it as early in the year as possible.

Better tax forecasting

Here are some suggestions for making your tax forecasts as accurate as possible.

  • Make tax planning a year-round endeavor. Your initial tax forecast will naturally flow from your recently-filed tax return. But the best forecasting method reviews your situation at least once per quarter, about two weeks before quarterly estimated tax payments are due. So mark your calendar for April, June, September and January following the end of the year. If you make tax planning a year-round endeavor, you can continuously recalculate your tax liability to account for the increases and decreases in estimated income and expenses.
  • Use a rolling average for passthrough entities. If you’re a limited partner in a partnership or a shareholder of an S corporation, consider using a 3- or 5-year rolling average of previous dollar amounts reported on past Form K-1 tax forms. This approach won’t always yield an accurate number, but using a rolling average can help eliminate some of the year-to-year volatility.
  • Keep great books. Don’t wait until December to balance your books. This holds true for both individuals and small businesses. Create periodic income statements and project what the full year will look like. Then look at your projected cash balance. Remember, you will need to accumulate enough cash to make required estimated tax payments or face the consequences of late payment penalties.
  • Get help! Preparing an accurate tax forecast can sometimes be very time consuming and complex. Please call if you have questions about preparing your own accurate tax forecast.

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