A mid-year tax review

By midyear, there are actual results to compare with the assumptions used at the start of the year: a bonus, a business running ahead of plan, a sale, a move. A mid-year review compares those facts with the payments and plans set up in January, while two estimated payments remain and there are six months to act on the choices ahead.

Three kinds of answers

A review usually lands in one of three places. Sometimes the answer is to change the payments, because withholding and estimates are running behind a stronger year or ahead of a weaker one. Sometimes it is to look closely at one decision: an option exercise, a charitable gift, retirement contributions or the timing of a sale. Often the answer is that the current course fits, and that is worth knowing too.

Consider an owner whose company had an unusually strong first half. Last year’s estimates were set on last year’s income, and the business plans a large equipment purchase in the fall. A mid-year look can raise the remaining estimates to match the stronger year and model how the timing of the purchase affects the tax, while there is still time to plan both.

Where the payment rules matter

Federal rules generally avoid an underpayment penalty when timely withholding and installments cover last year’s tax, or 110 percent of it when last year’s adjusted gross income was more than $150,000 ($75,000 if married filing separately). A late estimated-tax payment generally does not erase an earlier underpayment. Withholding follows different timing rules, so a mid-year review should consider both withholding and estimates. California is less forgiving at the top: once California adjusted gross income reaches $1 million ($500,000 if married or RDP filing separately), the prior-year method is no longer available, and payments have to be based on the current year. For a household with a large sale or bonus, that difference alone can justify a mid-year look. California’s individual estimated payments usually follow a 30, 40, 0 and 30 percent schedule instead of equal installments, with exceptions such as the annualized income method.

When income arrives unevenly, as with a sale in the fall, the annualized installment method can match required payments to when the income was actually received.

What we look at

We start with what has already happened, including pay, withholding, estimates, business results and gains, and add what is expected for the rest of the year, marking what is still uncertain. Related entities belong in the review too. A K-1 reporting partnership income, a trust distribution or a change in an owner’s salary can move the household’s result as much as anything on the individual return.