Personal 401(k) and Estimated Quarterly Tax Payments


J

Jim Haselmaier

[I posted this in misc.taxes and the silence from the responses was
deafening. So I'll post it here, too.]

Background: I'm a sole proprietor with a personal 401(k). I'd appreciate
any help/comments about whether I'm understanding the following correctly.
I had a 401(k) with my former employer. So I'm trying to be sure I'm
getting some basic concepts right.

1) When I was with my former employer my 401(k) contribution was funded
with "pre-tax" money. But, even though I'm contributing to a personal
401(k) now, I must pay estimated quarterly tax payments on my net business
profits; calculated PRIOR to any 401(k) contributions I make. Or does the
govt not really care? (Yeah, right.....) They just want the estimated
payments be close to what my ultimate tax burden is? So, for simplicity
I'll
use round numbers: Lets say I've got Q3 net business profits of $30,000.
I'd normally send in 30% or so ($9,000) for federal estimated tax and 5%
or so ($1,500) for state estimated tax. Lets say I want to contribute
$8,000
to my personal 401(k). Can I pay 30% (federal) and 5% (state) on $22,000?
Or MUST I pay estimated on the full net profits, then "get it back" when I
file my return, per question 2) below?

2) When I file next year for 2003 I will get to deduct my 401(k)
contributions from my taxable income. This is where I'll "get it back".
So, if I make reasonably-sized 401(k) contributions then I should get a
reasonably-sized refund (approximately my 401(k) contributions minus my tax
rate).

Comments?

Thanks.
 
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J

John H. Fisher

"Jim Haselmaier" said:
2) When I file next year for 2003 I will get to deduct my 401(k)
contributions from my taxable income. This is where I'll "get it back".
So, if I make reasonably-sized 401(k) contributions then I should get a
reasonably-sized refund (approximately my 401(k) contributions minus my tax
rate).
Responding to your question, in my prior contribution, I pushed the
button too quickly and it was incomplete!!=:) There is a worksheet
used to calculate your allowable deductions for contributions to
retirement plans. On last year's return, the deduction was taken as
an adjustment to income on line 31 of your Form 1040.



"Jack" - John H. Fisher - (e-mail address removed)
Philadelphia, Pa - Atlantic City, NJ - West Wildwood, NJ
My Newsgroups & Boards at: http://members.aol.com/TaxService/index.html

Where Ignorance is bliss, 'tis folly to be wise!=:)
 
T

Tad Borek

Jim said:
1) When I was with my former employer my 401(k) contribution was funded
with "pre-tax" money. But, even though I'm contributing to a personal
401(k) now, I must pay estimated quarterly tax payments on my net business
profits; calculated PRIOR to any 401(k) contributions I make. Or does the
govt not really care? (Yeah, right.....) They just want the estimated
payments be close to what my ultimate tax burden is?
Actually, I'd say that this is a case where the govt doesn't really
care, they just look at your total tax liablity and the amount you paid.
The point of making estimated tax payments, rather than just writing a
big check in April, is to avoid penalties for underpayment of taxes
during the year. For most people withholding covers this, but when
you're self-employed (or have a lot of investment income) you need to
make payments. But the rules don't really look at the income source,
they're based on the bottom line of your 2003 personal tax return -
after all income, expenses, deductions, how much tax is owed, and what
did you pay? If it wasn't enough, and/or it wasn't early enough, you get
a penalty.

If your four quarterly estimated tax payments are equal, you avoid
penalties as long as you meet one of three "safe harbors":
1. in total, you paid at least a certain percentage of your net, 2002
tax liability OR
2. in total, you paid at least a certain percentage of your net, 2003
tax liability OR
3. you end up owing less than $1000
[many state estimated-tax schemes are similar]

I'm leaving out details to avoid a long/specific post - percentages vary
by income. The IRS publication on the topic covers it, or you could
google ESTIMATED TAX SAFE HARBOR.

If your payments aren't equal each quarter, then you need to essentially
pay enough as of the end of each quarter to meet your projected income
for the year. This is one of the more tedious tasks in all of tax, IMO,
essentially four mini-returns where you look at the timing of your
income and expenses (of all types) during the year. If time is no object
google "annualized income installment method."

#1 is the simplest safe harbor and so a lot of people simply use that
one. But in a year that your taxable income is lower than than prior
year, and tax rates haven't changed, you'll overpay taxes and get a
refund. If it's a big difference you might want to bother with that
quarterly assessment of your annual income, and use safe harbor #2 or
#3. My opinion is that this is better left to a tax expert (but the cost
of that assessment might leave you better off simply using #1).

But in any event it's all based on your bottom line taxable income for
the year.

Last point - self-employment tax...have you factored that into the mix?
This is just another item on form 1040 that increases your tax
liability, hence increases your required estimated tax payments.

-Tad
 
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G

Gene Utterback

Jim Haselmaier said:
[I posted this in misc.taxes and the silence from the responses was
deafening. So I'll post it here, too.]

Background: I'm a sole proprietor with a personal 401(k). I'd appreciate
any help/comments about whether I'm understanding the following correctly.
I had a 401(k) with my former employer. So I'm trying to be sure I'm
getting some basic concepts right.

1) When I was with my former employer my 401(k) contribution was funded
with "pre-tax" money. But, even though I'm contributing to a personal
401(k) now, I must pay estimated quarterly tax payments on my net business
profits; calculated PRIOR to any 401(k) contributions I make. Or does the
govt not really care? (Yeah, right.....) They just want the estimated
payments be close to what my ultimate tax burden is? So, for simplicity
I'll
use round numbers: Lets say I've got Q3 net business profits of $30,000.
I'd normally send in 30% or so ($9,000) for federal estimated tax and 5%
or so ($1,500) for state estimated tax. Lets say I want to contribute
$8,000
to my personal 401(k). Can I pay 30% (federal) and 5% (state) on $22,000?
Or MUST I pay estimated on the full net profits, then "get it back" when I
file my return, per question 2) below?

2) When I file next year for 2003 I will get to deduct my 401(k)
contributions from my taxable income. This is where I'll "get it back".
So, if I make reasonably-sized 401(k) contributions then I should get a
reasonably-sized refund (approximately my 401(k) contributions minus my tax
rate).

Comments?

Thanks.
The trick to your situation is that while your personal 401(k) contributions
reduce your income for income tax purposes it does NOT reduce your income
for self employment tax purposes. You have to calculate your S/E tax on the
$30K but can use the $22K to calculate your income tax. So your numbers
would result in the following:

Income for S/E tax = $30K - S/E Tax = $4,240

Income for Income tax = $30K MINUS 1/2 S/E Tax of $2120 MINUS 401(k)
contribution of $8K (ignoring itemized or standard deductions and personal
exemptions - because you did) LEAVES $19,880 subject to Federal income tax,
which equals Federal taxes at 15% of $2,982.

This makes your total Federal estimated payment $2,982 + $4,240 or $7,222.

I am ignoring your state calculation because I don' know what state you are
in and what adjustments to Federal income are necessary for your state.
However, if you can follow my example for Federal taxes you should be able
to handle the adjustments necessary to calculate your state taxes.

Good luck,
Gene E. Utterback, EA
 

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