Author Topic: Taxes and 401ks. I think I'm missing something...?  (Read 8055 times)

webguy

  • Bristles
  • ***
  • Posts: 268
  • Age: 33
  • Location: Minnesota
Taxes and 401ks. I think I'm missing something...?
« on: March 10, 2013, 11:39:27 AM »
I'm trying to figure something out...

Let's say I'm in the 25% tax bracket and I put 10k of my income into a traditional 401k or IRA, then that income isn't taxed so I save 2.5k in taxes now.  But let's say that income grows over 30 years to be 50k.  When I withdraw that 50k as income I have to pay tax on it.  Even if I'm in a lower tax bracket (let's say 15%) then I'm paying 15% tax on 50k, which is 7.5k.  So even though I save 2.5k now I still end up paying 7.5k right?

However, if I do a Roth 401k or IRA then I pay 2.5k tax on my 10k now, and then I pay zero tax on my 50k later.  So even if I'm in a lower tax bracket in retirement doesn't the Roth make more sense?

I have the option to utilize either a traditional or Roth 401k.  My plan was to put 17.5k a year into a traditional 401k.  If I do that over 10 years and if that 175k turns into a lot of money decades from now (let's say 1M), then even though I saved on taxes every year that I contributed and I'm now in retirement in a lower tax bracket, I'm now paying that lower amount of tax on ALL of my interest/dividends/capital gains.  25% tax on 175k is a lot less tax than 15% on 1M.

I feel like I'm missing something...?

dan

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #1 on: March 10, 2013, 11:52:45 AM »
This article might be a useful read--it talks about tax hedging.  Since you don't know what will happen to tax rates in the future, there is value in both a Roth and a tax deferred retirement plan.

Quote
When you do a Roth IRA, by contrast, you're investing after-tax dollars today and paying no tax on the withdrawals (assuming you meet the various requirements for tax-free withdrawals, which you can check out by clicking here). So with a Roth, you're paying taxes today and escaping them tomorrow.

This means that, generally, a 401(k) is a better deal than the Roth IRA if you think you'll face a lower tax rate in retirement than the rate you face during your career. The opposite is true for the Roth.

Note that I said "generally." For one thing, if you're willing to contribute the max, the Roth effectively allows you to shelter more money from taxes than the same sum invested in a tax-deferred account, which gives it a bit of an advantage all other things being equal.

http://money.cnn.com/2007/04/18/pf/expert/expert.moneymag/index.htm

Another thing to think about is--how much will that 2.5K in taxes hurt now, compared to the taxes in the future?

TheDude

  • Bristles
  • ***
  • Posts: 467
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #2 on: March 10, 2013, 11:54:02 AM »
No you have figure out the future value of that 2500 worth of taxes.

If you assume tax rates stay the same and you are going to need the same amount of income in retirement then there is no difference in the amount of tax you will pay. The biggest factor you need to consider is how much income you will need for retirement.

Kriegsspiel

  • Guest
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #3 on: March 10, 2013, 01:06:40 PM »
I believe you can take out less than the entire amount, so as to pay the lowest tax bracket.  IE, instead of taking out the entire amount, you can withdraw limited amounts to keep taxes low.

Nords

  • Magnum Stache
  • ******
  • Posts: 3181
  • Age: 58
  • Location: Oahu
    • Military Retirement & Financial Independence blog
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #4 on: March 10, 2013, 03:53:11 PM »
Let's say I'm in the 25% tax bracket and I put 10k of my income into a traditional 401k or IRA, then that income isn't taxed so I save 2.5k in taxes now.  But let's say that income grows over 30 years to be 50k.  When I withdraw that 50k as income I have to pay tax on it.  Even if I'm in a lower tax bracket (let's say 15%) then I'm paying 15% tax on 50k, which is 7.5k.  So even though I save 2.5k now I still end up paying 7.5k right?
However, if I do a Roth 401k or IRA then I pay 2.5k tax on my 10k now, and then I pay zero tax on my 50k later.  So even if I'm in a lower tax bracket in retirement doesn't the Roth make more sense?
The challenge lies in two predictions:
1.  The tax rates between now and the day you die (tax risk), and
2.  The taxation laws for the rest of your life (political risk).

You know the rules today, but you don't know how they'll change.  Your income may go up or down, and income tax brackets may also go up or down.  Roths aren't taxed by today's rules, but who knows what our children will start doing to us when they get elected to Congress.

From the tax-rate perspective, your $2.5K savings today could be invested to grow to far more than $7.5K later on, leaving you with money in your pocket even after you pay that $7.5K in taxes. 

But let's say that you save a huge pile of money (in taxable and tax-deferred accounts) as an employee and also have a huge 401(k) and a huge conventional IRA that will generate equally large RMDs someday.  You ER at 40 on your savings, hoping that they bridge the gap until age 59.5.  As an employee you'd be smart to put all your savings into a conventional 401(k) & IRA, avoiding taxes today.  When you ER'd then you could start converting them to Roth IRAs a little every year, paying taxes at a very low rate (because you have no W-2 income) and staying in the 10%-15% bracket.  If you'd still had that 401(k) and conventional IRA later in life, then your RMDs (and Social Security) would have beaten you up pretty badly on the tax front.  By investing your income in tax-deferred accounts and then converting at your life's lowest income and lowest tax rates (between ages 40-70) you avoided a huge steaming pile of taxes later in life.

Another perspective would be to invest in Roth 401(k)s and Roth IRAs now because you're in a lower income tax bracket and paying taxes won't punish you very badly.  That way when you ER in your 40s you've already paid your taxes and you're never subject to RMDs.  It might turn out to be a good idea because all income tax rates might go up over the next 40 years, so paying taxes now (to avoid higher taxes later) might be a very good idea.

A third perspective would be the political risk.  You could optimistically pay taxes now and invest in Roth 401(k)s and Roth IRAs under the assumption that Congress won't change the rules later, chase you down, and make you pay another round of taxes.  Or you could resign yourself to a gloomy future and decide to defer paying taxes now, expecting that paying a round of higher taxes later will be less punitive than paying a round now and a second round later. 

I can't predict political risk, so I'm just going to Pollyanna hope for the best.

I favor the idea of investing in Roth 401(k)s and Roth IRAs whenever you can.  (Assuming that a Roth 401(k) and a 401(k) have the same match.)  The small tax hit now (when your income is lower) is probably a better deal today because tax rates are also low.  In the future your income is likely to be at least as high, and future tax rates are likely to be higher.  ("Likely", not "certain".)  If your income is too high to invest in Roths then invest in conventional 401(k)s and IRAs, and convert when you ER to a lower tax bracket. 

A side advantage of investing in a Roth IRA now is that you can withdraw contributions whenever you want.  It's much harder (though not impossible) to get your hands on your 401(k) or your conventional IRA before you're age 59.5.

mm31

  • Stubble
  • **
  • Posts: 169
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #5 on: March 11, 2013, 12:55:51 AM »
Great explanation, Nords!

Roth IRAs/401ks are one of those things I'm never sure what the right choice is.

I'm young, so I should contribute exclusively to them, I'm told. Except that I'm in the middle of the of 25% bracket and may reach the 28% bracket in 10 years or more. I don't have the patience to enjoy the benefits of tax-free returns in 30 years, especially when I'm just starting out.

I don't expect to live in a higher tax bracket in retirement, and I'm pretty sure 90% of people don't.

The argument about uncertainty goes both ways: taxes may not go up at all. In fact, they've been going down for a long time. I can't expect the political class in the US to get their stuff together in 20-30 years.   

I still contribute to a Roth IRA every other year, because it's the best hedge we have. Doesn't stop me from complaining about it :)

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8519
  • Registered member
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #6 on: March 11, 2013, 01:36:58 AM »
The funny thing is you aren't missing anything.  You are on the right track, but most people just blindly follow typical financial advice.  Likely you come out ahead with these deferred growth vehicles.  Consider what would happen in a taxable account over 30 years.  You'll get dividends.  Likely, you will buy and sell, each time paying some taxes (short or long term capital gains).  Best case, you buy and hold something like BRKB with no dividends and end up paying a reduced capital gains rate after 30 years.  In this case, you might come out ahead of a 401k, particularly if they increase the spread between earned-income rates and capital gains rates.

RewardTraveler

  • 5 O'Clock Shadow
  • *
  • Posts: 27
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #7 on: March 11, 2013, 08:30:36 AM »
I think what you're missing is that you're comparing a $10k traditional 401k event to a $12.5k Roth event ($10k investment + $2.5k in taxes).  Look at it from a take-home pay perspective, contributing $10k to a traditional 401k will yield a different take-home amount than contributing $10k in a Roth 401k.

To keep the analysis even, you should be comparing a $10k pre-tax contribution to a $7.5k after-tax contribution (since it takes $10k of pre-tax dollars to get to $7.5k after-tax).

When you do this, you'll see that with a traditional 401k you come out with the $50k and you'll end up paying $12.5k in taxes (assuming unchanged tax rates) for a take-home of $37.5k.  On the Roth side, you pay $2.5k of taxes now and invest $7.5k for 30 years to get to a take-home of $37.5k.  Assuming your tax rate doesn't change, mathematically, the Roth and traditional will yield the same results.  Now, if you expect your tax rate to be lower in retirement a traditional 401k could be a better option, but there are some "soft" benefits of a Roth that may help as well (for example, Roth distributions don't count against the taxability of Social Security payments).

Another benefit of the Roth is that it essentially allows you to contribute more to the 401k ($17.5k investment + $5.8k in taxes)

sherr

  • Pencil Stache
  • ****
  • Posts: 657
  • Age: 34
  • Location: North Carolina
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #8 on: March 11, 2013, 10:10:32 AM »
I feel like I'm missing something...?

You are, and TheDude and RewardTraveler's posts above are the only messages thread to directly address what you are missing. I will say the same thing but in a different way.

You are missing the Opportunity Cost of the money that you are paying now in taxes.

Your comparison needs to have either the Roth and Traditional accounts both on an after-tax basis or both on a pre-tax basis for equal comparison. As an example, let's say you're contributing the max this year ($17,500) to your 401k, and that you will withdraw it later and that money will have doubled to $35000. I will assume the same tax rates as you did in your example, 25% now and 15% later.

Roth:
You contribute $17,500 now. You must come up with an additional $4,375 to pay your 25% taxes now. It doubles to $35000 later. You owe no additional taxes, so you have $35000.
Total spent: $21,875,   Total gained: $35,000,   Total returns: 1.6x

Alternate Roth:
You only have $17,500 to invest. You must pay 25% taxes on anything you put into the Roth account, so you can't contribute it all. You contribute $14,000 to your Roth account, pay $3,5000 in taxes. You $14,000 doubles to $28,000, you withdraw it tax-free.
Total spent: $17,500,  Total gained: $28,000,  Total returns: 1.6x

Traditional:
You contribute $17,500 now. You owe no extra taxes. It doubles to $35,000. You withdraw it and pay 15% taxes on it ($5,250). You have $29,750.
You also have $4,375 that you did not pay in taxes. You pay 25% taxes on it, leaving you with $3,281.25. You invest it in a non-tax-advantaged account. It doubles to $6,562.50. You withdraw it and pay 15% tax on the gains, leaving you with $6,070.31.
Total spent: $21,875,   Total gained: $35,820.31,  Total returns: 1.64x

Alternate Traditional:
You contribute $17,500 now. It doubles to $35000 later. You withdraw it and pay 15% tax later. You have $29,750.
Total spent: $17,500,  Total gained: $29,750,  Total returns: 1.7x

So no, it is not in any way better in choose Roth over Traditional just because the number you pay in taxes is lower. You also have to take into account the Opportunity Cost of giving the money to the government now instead of later. Nords is correct, the only two things that make a difference here are tax rate now and tax rate in the future (assuming they don't change the laws and suddenly make Roth accounts taxable on withdrawal or something (which I find unlikely)). If your marginal tax rate is higher now than it will be in retirement, then Traditional is better. If not then Roth is better. The trick is just in predicting the future.

webguy

  • Bristles
  • ***
  • Posts: 268
  • Age: 33
  • Location: Minnesota
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #9 on: March 27, 2013, 07:46:30 AM »
You guys are awesome.  Sorry it's taken me so long to get round to replying.  What you're all saying has cleared up a lot of my questions and really helped me to understand the best strategy for my situation, so I'm super appreciative to each one of you for taking the time to reply!

I've decided to go with the traditional for now.  I got hit hard with a lump sum of taxes this year from my freelance work and so had to take my first few months of savings which would have otherwise gone into investments to pay my taxes instead.  This year I plan to put most of my freelance income into a solo traditional 401k so that I can continue with my monthly investing without being interrupted by having to pay a crap load of taxes at the beginning of the year!  This ties in perfectly with what a few of you emphasized in 'opportunity cost', I get to put that money I save by not paying taxes to work to hopefully get me a good return over the coming decades.

Thanks again everyone for your explanations and advice! You all rock!

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #10 on: March 27, 2013, 08:34:56 AM »
If you're freelancing you should be paying estimates taxes, or increasing your withholding at your salaried job. You can end up owing a penalty for not paying enough estimated tax during the year.

webguy

  • Bristles
  • ***
  • Posts: 268
  • Age: 33
  • Location: Minnesota
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #11 on: March 27, 2013, 09:19:18 AM »
If you're freelancing you should be paying estimates taxes, or increasing your withholding at your salaried job. You can end up owing a penalty for not paying enough estimated tax during the year.

Hey fixer, thanks for the tip.  I'd always thought that as long as freelancing wasn't my main source of income then I wouldn't have to pay estimated taxes, but after some research I see that I still should.  I plan to put most of my freelance income into my 401k this year so won't end up owing much hopefully, but once I'm above my 401k contribution limit I'll be sure to start paying estimated taxes on the rest.

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #12 on: March 27, 2013, 10:03:47 AM »
The minimum amount of estimated tax required needs to be paid in equal installments through the year. For instance, suppose you're going to end up owing $2000 in extra income and SE tax for 2013. If you only pay $1000 in September and $1000 in January this is not equal and will get you in trouble. You would need to pay $500 at each of the four payment deadlines.

The safest and easiest way to deal with this is to look at your total tax from 2012. Subtract off this year's income tax withholdings on your paycheck. Now divide by 4. To guarantee avoiding a penalty for 2013, you'd need to pay at least this much in estimated taxes each quarter. You could also increase your withholdings at work to get that number down to 0.

Factors that play into whether or not you owe a penalty:
  • Owed more than $1000 when you file
  • Owed tax last year
  • Did not pay estimated taxes at a regular rate
  • Did not pre-pay the lesser of: 100% of last year's total tax, or 90% of this year's tax.
If you live in a state with income tax you also need to check your state's rules as they can differ from the federal ones. For instance, in MD I have to pre-pay 110% of last year's taxes instead of just 100%.

This is a complex subject and worthy of dedicating a good chunk of time to learning, and I'm by no means an expert. There may be books that discuss it in better detail, and you can always do a one-time consultation with an accountant to help you figure out what you need to do.

RewardTraveler

  • 5 O'Clock Shadow
  • *
  • Posts: 27
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #13 on: March 27, 2013, 10:09:00 AM »

Hey fixer, thanks for the tip.  I'd always thought that as long as freelancing wasn't my main source of income then I wouldn't have to pay estimated taxes, but after some research I see that I still should.  I plan to put most of my freelance income into my 401k this year so won't end up owing much hopefully, but once I'm above my 401k contribution limit I'll be sure to start paying estimated taxes on the rest.

I don't think it works like that.  If you are contributing a freelance-income equivalent amount of your salary to your 401k you will pay less in taxes at work, which means you should probably still pay estimated taxes.

webguy

  • Bristles
  • ***
  • Posts: 268
  • Age: 33
  • Location: Minnesota
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #14 on: March 27, 2013, 10:27:45 AM »

Hey fixer, thanks for the tip.  I'd always thought that as long as freelancing wasn't my main source of income then I wouldn't have to pay estimated taxes, but after some research I see that I still should.  I plan to put most of my freelance income into my 401k this year so won't end up owing much hopefully, but once I'm above my 401k contribution limit I'll be sure to start paying estimated taxes on the rest.

I don't think it works like that.  If you are contributing a freelance-income equivalent amount of your salary to your 401k you will pay less in taxes at work, which means you should probably still pay estimated taxes.

My 401k isn't through my day job, it's a solo 401k opened through my freelance business. I'd be contributing all of my freelance income to it up to the contribution limit of 17.5k + 25% of my total freelance income, therefore reducing my taxable freelance income significantly.


The minimum amount of estimated tax required needs to be paid in equal installments through the year. For instance, suppose you're going to end up owing $2000 in extra income and SE tax for 2013. If you only pay $1000 in September and $1000 in January this is not equal and will get you in trouble. You would need to pay $500 at each of the four payment deadlines.

The safest and easiest way to deal with this is to look at your total tax from 2012. Subtract off this year's income tax withholdings on your paycheck. Now divide by 4. To guarantee avoiding a penalty for 2013, you'd need to pay at least this much in estimated taxes each quarter. You could also increase your withholdings at work to get that number down to 0.

Factors that play into whether or not you owe a penalty:
  • Owed more than $1000 when you file
  • Owed tax last year
  • Did not pay estimated taxes at a regular rate
  • Did not pre-pay the lesser of: 100% of last year's total tax, or 90% of this year's tax.
If you live in a state with income tax you also need to check your state's rules as they can differ from the federal ones. For instance, in MD I have to pre-pay 110% of last year's taxes instead of just 100%.

This is a complex subject and worthy of dedicating a good chunk of time to learning, and I'm by no means an expert. There may be books that discuss it in better detail, and you can always do a one-time consultation with an accountant to help you figure out what you need to do.

Last year I made about 10k from freelance, and the year before only 3k, so I didn't really think much about estimated taxes until I filed my taxes this year.  It's difficult to say how much I'll make this year as I work more in the winter and less in the summer and it just tends to depend on how many projects I land.  I have already earned about 18k and will probably hit 30-35k by years end.  If I net 30k then I can contribute 22.7k to my 401k and 5.5k to my SEP-IRa which only leaves about 2k left which is taxable.  That's the main reason why I haven't really considered estimated taxes yet, as that 2k is pretty much cancelled out by the small refund I get from my day job's W-2.

DK

  • Stubble
  • **
  • Posts: 196
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #15 on: March 27, 2013, 10:51:36 AM »
+1 to the posts describing a gross 5K into a 401k is not the same as a net 5K into a roth since you already paid taxes on the roth.

One thing to consider is you have about two weeks left to contribute to a traditional ira for this past year, if you haven't contributed to a roth yet for the past year. That would save you a bit in taxes if you said you got hit with them a bit hard. An extra 5K into the IRA deducted from the 25% bracket would save you $1250 in taxes this past year. Of course, if you already filed this might be more pain than it's worth.

Personally I play the numbers game between the roth/401k and contribute what I need to, to make sure nothing is over the 15% bracket. If you are in the 25 heading to the 28, you might too far along to make that work for you though.

RewardTraveler

  • 5 O'Clock Shadow
  • *
  • Posts: 27
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #16 on: March 27, 2013, 11:10:31 AM »

Last year I made about 10k from freelance, and the year before only 3k, so I didn't really think much about estimated taxes until I filed my taxes this year.  It's difficult to say how much I'll make this year as I work more in the winter and less in the summer and it just tends to depend on how many projects I land.  I have already earned about 18k and will probably hit 30-35k by years end.  If I net 30k then I can contribute 22.7k to my 401k and 5.5k to my SEP-IRa which only leaves about 2k left which is taxable.  That's the main reason why I haven't really considered estimated taxes yet, as that 2k is pretty much cancelled out by the small refund I get from my day job's W-2.

Don't forget about self-employment taxes, I don't think those can be offset by 401k contributions.  It actually looks like they reduce the amount you can contribute of your income.  Wikipedia (http://en.wikipedia.org/wiki/SEP-IRA#Self-employed) links to an IRS form that may help if you're inclined to calculate it.

You may also need to see if you're actually allowed to open both a 401k and a SEP-IRA.  From a quick search, it sounds like most discussions of either/or.

Jamesqf

  • Magnum Stache
  • ******
  • Posts: 4047
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #17 on: March 27, 2013, 11:23:02 AM »
The minimum amount of estimated tax required needs to be paid in equal installments through the year.

Not true, except in the case where you have equal income throughout the year.  If you have an unpredictable income stream, as I do, you can't possibly do this.  As for instance, last year I had basically zero income July to November, then a really big chunk in December, so the June & September payments were small, the April & January ones large.  I tend to go with a percentage of income for each reporting period, making sure the total is as much as needed to avoid the chance of a penalty.

In the case where you're freelancing on the side, though, it's probably easier just to increase your withholding on your W2 job.  As long as they're getting either (IIRC) 100% of last year's tax, or 90% of what would be do this year, you should be ok.
« Last Edit: March 27, 2013, 11:26:40 AM by Jamesqf »

webguy

  • Bristles
  • ***
  • Posts: 268
  • Age: 33
  • Location: Minnesota
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #18 on: March 27, 2013, 11:50:19 AM »

Last year I made about 10k from freelance, and the year before only 3k, so I didn't really think much about estimated taxes until I filed my taxes this year.  It's difficult to say how much I'll make this year as I work more in the winter and less in the summer and it just tends to depend on how many projects I land.  I have already earned about 18k and will probably hit 30-35k by years end.  If I net 30k then I can contribute 22.7k to my 401k and 5.5k to my SEP-IRa which only leaves about 2k left which is taxable.  That's the main reason why I haven't really considered estimated taxes yet, as that 2k is pretty much cancelled out by the small refund I get from my day job's W-2.

Don't forget about self-employment taxes, I don't think those can be offset by 401k contributions.  It actually looks like they reduce the amount you can contribute of your income.  Wikipedia (http://en.wikipedia.org/wiki/SEP-IRA#Self-employed) links to an IRS form that may help if you're inclined to calculate it.

You may also need to see if you're actually allowed to open both a 401k and a SEP-IRA.  From a quick search, it sounds like most discussions of either/or.

Haha believe me I don't forget about self-employment tax. That was a nice little surprise to me this past year!  The 30k in my example would be after SET.

I can have both a SEP-IRA but after a little more research I don't think I can contribute as an employer to both in the same plan year, and as a SEP is all employer contribution then I would only be able to contribute 22.7k to both (combined). 17.5k as an employee to my solo 401k and 5.5k as an employer to either my solo 401k or my SEP.  In my example above I was counting the employer contribution twice (once from the SEP and once from the solo 401k).  This tax stuff is confusing and it's difficult to find concrete, reliable sources online so I'll probably just make an appt. with a small-business tax professional so I don't get myself in trouble!

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #19 on: March 27, 2013, 11:58:33 AM »
The minimum amount of estimated tax required needs to be paid in equal installments through the year.

Not true, except in the case where you have equal income throughout the year.  If you have an unpredictable income stream, as I do, you can't possibly do this.  As for instance, last year I had basically zero income July to November, then a really big chunk in December, so the June & September payments were small, the April & January ones large.  I tend to go with a percentage of income for each reporting period, making sure the total is as much as needed to avoid the chance of a penalty.

I have to admit I haven't tried this, but I couldn't find anything when I was researching this last year on how to do unequal payments. For instance, the IRS would need to know that your income was uneven through the year; how would this get reported to them? Are they just trusting you unless they decide to audit you?

By the way, my best source for explaining estimated tax stuff has been http://www.businessownersideacafe.com/tax_center/irs_you/estimated_tax.php

the fixer

  • Handlebar Stache
  • *****
  • Posts: 1037
  • Location: Seattle, WA
Re: Taxes and 401ks. I think I'm missing something...?
« Reply #20 on: March 27, 2013, 12:12:05 PM »
Okay I just found this from http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes
Quote
However, if your income is received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income and making unequal payments. Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to see if you owe a penalty for underpaying your estimated tax.
So yes there is a way to do it, but it will take more reporting to do so. I guess I shouldn't be so rigid with saying that you must make your payments equal, just that you will have fewer tax headaches that way. And as you're discovering this stuff gets VERY complicated.

The easiest way to meet your estimated tax requirement without worrying about a penalty is to make four equal payments, or increase your paycheck withholdings, so that your total payments during the year add up to at least 100% (or 110% if your income is high enough) of last year's income. There are several other ways, but they will not be as simple and may require an accountant to help you out.