Apr. 15, 2008 is the due date for affected calendar year taxpayers to make their first installment of 2008 estimated tax. There aren’t any drastic changes in the estimated tax rules themselves for 2008. However, there are a number of new, changed and expiring provisions that will affect some individuals’ estimated tax computations for 2008. This article provides a brief overview of the estimated tax rules for individuals and looks at the changes that may impact 2008 estimated taxes.
Who needs to pay estimated tax. Individuals who have income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony, etc.) must pay estimated tax or face a penalty. In addition, taxpayers who do not elect voluntary withholding on unemployment compensation and the taxable part of social security payments also may have to pay estimated tax on those items or face a penalty. (Code Sec. 6654)
When and how much to pay. For 2008 estimated tax, in general, a taxpayer must pay 25% of a “required annual payment” by Apr. 15, 2008, June 16, 2008, Sept. 15, 2008 and Jan. 15, 2009 to avoid an underpayment penalty. (Code Sec. 6654(c))
The required annual payment for most taxpayers is the lower of 90% of the tax shown on the 2008 return or 100% of the tax shown on the 2007 return even if filed late (“prior year exception”). However, a taxpayer (other than a farmer or fisherman) whose adjusted gross income on his 2007 return is over $150,000 (over $75,000 if married filing separately) must pay the lower of 90% of his 2008 tax or 110% of his 2007 tax. The prior year exception does not apply for a taxpayer who did not file a 2007 return or filed a 2007 return that did not cover 12 months. (Code Sec. 6654(d))
Other exceptions to penalty. There’s no underpayment penalty if the tax shown on the return (after withholding) is less than $1,000. Estimated tax does not have to be paid for 2008 if the taxpayer was a U.S. citizen or resident alien for all of 2007 and had no tax liability for the full 12-month 2007 tax year. (Code Sec. 6654(e))
Annualized method. A taxpayer who, after Mar. 31, 2008, has a large change in income, deductions, additional taxes, or credits that requires him to start making estimated tax payments should use the annualized income installment method. While the due dates will not change, the payment amounts will vary based on the taxpayer’s income, deductions, additional taxes, and credits for the months ending before each payment due date. As a result, this method may allow the taxpayer to skip or lower the amount due for one or more payments. A taxpayer who uses the annualized method should be sure to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with his 2008 tax return, to indicate to IRS how he has computed his payments, even if no penalty is owed. (Code Sec. 6654(d)(2))
Farmers and fishermen. Special estimated tax rules apply to farmers and fishermen.
New items for 2008. A taxpayer should use his 2007 return as a starting point for figuring his 2008 estimated tax. He should determine whether he will benefit by any of the following new provisions:
- Forgiveness of mortgage debt. For debt discharged on or after Jan. 1, 2007 and before Jan. 1, 2010, taxpayers generally may exclude up to $2 million of mortgage debt forgiveness on their principal residence.
- Tax relief for volunteer responders. An income tax exclusion applies for qualified state or local tax benefits (such as reduction or rebate of state or local income or property tax) and qualified reimbursement payments (up to $360 a year) granted to members of qualified volunteer emergency response organizations (e.g., state or local organizations whose members provide volunteer firefighting or emergency medical services). The exclusion applies for the 2008 through 2010 tax years.
- Homesale exclusion liberalized for surviving spouse. Before a late 2007 law change, the up-to-$500,000 exclusion was available only if a husband and wife filed a joint return for the year of sale. Thus, if the home was sold in a year after the year of a spouse’s deathit allows a surviving spouse to qualify for the up-to-$500,000 exclusion if the sale occurs not later than 2 years after the spouse’s death, provided the requirements for the $500,000 exclusion were met immediately before the spouse’s death and the survivor has not remarried as of the date of the sale.
- Capital gain tax rate reduced. As discussed in greater detail in Federal Taxes Weekly Alert 1/17/2008, beginning this year and continuing through at least 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate (last year, a 5% rate applied to such income).
- Kiddie tax broadened. For 2008 (technically for tax years beginning after May 17, 2007), a 2006 tax law expanded the kiddie tax to apply to children age 18, and children over age 18 but under age 24 who are full-time studentsif their earned income doesn’t exceed one-half of the amount of their support.
- Itemized deduction phaseout reduced. A higher-income taxpayer’s itemized deductions (other than those for medical expenses, investment interest, nonbusiness casualty and theft losses, and gambling losses) are reduced if his adjusted gross income (AGI) exceeds an inflation-adjusted amount. His itemized deductions generally are reduced by the lesser of (1) 3% of the excess of adjusted gross income over the applicable amount, or (2) 80% of the itemized deductions otherwise allowable for the tax year. For 2008, the phaseout begins at $159,950 of AGI ($79,975 for marrieds filing separately). However, under a 2001 tax law change that applies for the first time in 2008, a taxpayer will lose only 1/3 of the amount he would otherwise lose under the regular reduction computation. [See Federal Taxes Weekly Alert 1/14/2008 for details]
- Personal exemption phaseout reduced. The personal exemption amount of a taxpayer whose AGI exceeds an inflation-indexed threshold amount is reduced by an applicable percentage. This applicable percentage is 2% for each $2,500 (or fraction thereof) by which the AGI of a taxpayer (other than a married taxpayer filing separately) exceeds the appropriate threshold amount. For married persons filing separately, the applicable percentage is 2% for each $1,250 (or fraction of that amount) by which his AGI exceeds the threshold amount. The applicable percentage can’t exceed 100%. The inflation-adjusted threshold amounts for 2008 are $239,950 (joint returns and surviving spouses), $199,950 (head of household), $159,950 (unmarried individuals), and $119,975 (married persons filing separately). However, under a 2001 law change that applies for the first time in 2008, a taxpayer will lose only 1/3 of the amount he would otherwise lose under the regular phase-out computation.
- Mortgage insurance deduction extended. Mortgage insurance premiums continue to be deductible after 2007. Originally, this deduction was available only for 2007. It now applies through 2010.
Observation: This technically is not new for 2008 as it also applied for 2007. Presumably, IRS included it as a new item on Form 1040ES for 2007.
Observation: The 2006 tax law did not change the kiddie tax rules for children who are under age 18. Rather, it expanded the kiddie tax to apply where:
… the child turns age 18, or turns age 19-23 if a full-time student, before the close of the tax year;
… the child’s earned income for the tax year doesn’t exceed one-half of his or her support;
… the child has more than the inflation-adjusted prescribed amount of unearned income (i.e., $1,800 for 2008);
… the child has at least one living parent at the close of the tax year; and
… the child doesn’t file a joint return for the tax year. [See Federal Taxes Weekly Alert 6/7/2007 for details]
Changed provisions. In calculating 2008 estimated tax, individuals also should consider the following changed provisions:
- Increased standard deductions. The basic and additional standard amounts have increased for most categories of taxpayers for 2008.
- IRA deduction. An taxpayer may be able to take an IRA deduction if covered by a retirement plan and the taxpayer’s 2007 modified AGI is less than $63,000 ($105,00 if married filing jointly or qualifying widow(er)).
- IRA contribution limit increased. In general, an individual who isn’t an active participant in certain employer-sponsored retirement plans, and whose spouse isn’t an active participant, may make an annual deductible cash contribution to an IRA up to the lesser of: (1) $5,000 (increased from $4,000 for 2007), plus an additional $1,000 for those age 50 or older, or (2) 100% of the compensation that’s includible in his gross income for that year. If the individual (or his spouse) is an active plan participant, the deduction phases out over a specified dollar range of MAGI.
- Standard mileage rates. The 2008 mileage rates for a taxpayer’s use of his vehicle are 50 1/2¢ per business mile, 19¢ per mile to get medical care or make a job related move, and 14¢ per mile for charitable use (the latter figure is unchanged).
- Tax breaks for adoption. The maximum adoption credit has increased to $11,650, as has the maximum adoption exclusion.
- Earned income credit. The maximum credit is higher, and the AGI-based phaseout figures are revised.
- Savers credit. The income limits have increased for the retirement savers credit.
Expired tax benefits. The following tax changes for 2008 involve tax provisions that expired at the end of 2007 but may be reinstated by Congress.
- Credits reduced by AMT calculation. Personal tax credits (other than the adoption credit, the child tax credit and the credit for elective deferrals and IRA contributions) can’t exceed the excess of regular tax liability over tentative minimum tax.
- Decreased AMT exemption amount. In 2008, the AMT exemption amount will decrease to $33,750 for unmarried individuals, $45,000 for marrieds filing jointly or qualifying surviving spouses, and $22,500 for marrieds filing separately. For 2007, the AMT exemption amounts were $44,350, $66,250, and $33,125, respectively.
- Educator expenses. The above-the-line deduction for educator expenses doesn’t apply for post-2007 tax years.
- Tuition and fees deduction. The above-the-line deduction for higher-education expenses isn’t available for tax years beginning after 2007.
- D.C. first-time homebuyer credit. This credit does not apply to homes purchased after 2007.
- Option to claim state & local sales tax as itemized deduction instead of deducting state & local income tax. This option is no longer available for tax years beginning after 2007.
- Tax-free distributions from IRAs for charitable purposes. The special rule for IRA distributions to charities has expired. Under this rule, which applied for distributions in tax years beginning in 2006 and 2007, an exclusion from gross income, not to exceed $100,000, is allowed for otherwise taxable IRA distributions by taxpayers age 70 1/2 and older from a traditional or Roth IRA that are qualified charitable distributions.
- Election to include nontaxable combat pay as earned income for purposes of the earned income tax credit. For tax years beginning after 2007, taxpayers no longer may elect to treat combat pay as earned income for purposes of the earned income credit.
- Penalty-free withdrawals for individuals called to active duty. A provision giving early withdrawal penalty relief for active duty reservists has expired. Under this rule, the Code Sec. 72(t) 10% early withdrawal penalty tax does not apply to a distribution from an IRA (or attributable to elective deferrals under a Code Sec. 401(k) plan, Code Sec. 403(b) annuity, or certain similar arrangements) that’s (1) made to reservists ordered or called to active duty after Sept. 11, 2001, and before Dec. 31, 2007, for a period of more than 179 days or for an indefinite period, and (2) made during the period beginning on the date of the order or call to duty and ending at the close of the active duty period.
- Credit for nonbusiness energy property. For property placed in service after 2007, a taxpayer can no longer claim a lifetime nonrefundable credit of up to $500 for making qualifying energy saving improvements to his home (only $200 for qualifying window expenditures).
- Research credit. The research credit does not apply for amounts paid or incurred after 2007.
- Indian employment credit. The Indian employment credit does not apply for tax years beginning after 2007.
Observation: This credit limit may reduce a taxpayer’s personal credits even if he has no AMT liability.
Observation: Although there’s a high probability that Congress will once again “patch” the AMT problem, taxpayers must nonetheless make their estimated tax payments as if this relief will not materialize.
Observation: The changed and expired items described above are those that IRS mentions in the instructions to Form 1040ES for 2008. There are many other items that have changed for 2008 as a result of inflation adjustments.
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