The Delights of Estimated Tax

As you know we moved to Oregon the middle of last year and had no W2 income in the state, our entire income was based on dividends and some capital gains from our portfolio, the majority of which was distributed at year end.

As dividends are taxed the same as ordinary income at the state level this meant we had a marginal state tax rate of about 10% to the State or Oregon. Of course no tax was withheld from our dividends so we paid 0% to Oregon in 2017.

The upshot of this is that yesterday we received a letter saying that as had underpaid tax during the year we were being assessed a penalty. It wasn’t a huge amount, just shy of $100 but it’s still annoying. This is where the concept of estimated tax comes in and it’s something as people with no W2 income coming in we should have paid more attention to.

Essentially at either the federal or state level if you owe more than $1000 then you are expected to pay estimated taxes the next year or have withholding increased at source. The second option is not viable for retirees or other people who live off investments. If your tax affairs are complex then being confident you will be somewhere within the $1000 band can be tricky.

We knew we would have a tax liability to Oregon, but with everything else going on it didn’t occur to us to prepay some of our taxes, it was a busy 6 months or so. The upshot is that as well as paying our 2017 liability by April 15th we also have to pay a quarter of the same amount each quarter through 2018. In theory if our income is similar in 2018 then we will have no liability this time next year.

At the federal level it’s a little more complex. A mixture of the new tax code, plus ACA tax credits and not having clear visibility on capital gains through the year makes it tough to have a clear picture on our 2018 federal liability. So I think we will not prepay any taxes at the federal level in 2018 and have a good review at tax time next year, with a view to prepaying if necessary in 2019.

Estimated taxes are an important change to the tax habits of retirees and people with a FIRE or entrepreneurial life style. It’s easy to forget but it’s a critical life change that accommodations need to be made for.

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