Understanding the Capital Gains Tax Bite So the IRS Doesn’t Zap You

Dear Liz: We have made significant capital gains this year and owe taxes plus a penalty for not paying estimated taxes. Is there a way to plan ahead for taxes since every year is different in terms of gain or loss? I know one option is to pay estimated taxes quarterly based on earnings from the previous year. Apparently, mutual fund companies don’t automatically withhold taxes.

To respond: Our tax system is “pay as you go,” which means the IRS expects you to pay taxes as you earn or receive income. If you fail to do so and your tax bill is over $1,000, you could face penalties.

As you rightly note, however, you won’t know what your total capital gains or losses will be until the end of the year. You wouldn’t want to pay taxes on a big win one quarter only to have a big loss the next quarter. You can avoid penalties by ensuring that your tax withholding and estimated tax remittances are at least 100% of the total tax you paid in the previous tax year if your income is $150,000 or less. If your income is more than $150,000, your payments and deductions must be at least 110% of last year’s taxes.

The alternative is to pay at least 90% of the tax you will owe on your estimated income for the current year. A tax professional can help you determine how much you need to pay and give you advice on how to reduce your tax bill.

When institutions won’t go paperless

Dear Liz: I’ve insisted for years on being paperless, not only for credit card statements and utility bills, but also for tax documents like the 1099-INT and 1099-DIV. My problem is that I receive income from two life annuities and these of course generate 1099-R forms every year, which are mailed to me. I asked to receive them as PDF files from the companies that run these annuities, and they say they can’t and don’t have to. Are they right, or is there a federal regulation I can cite to force the issue?

To respond: The idea that a company can’t generate an electronic form for a client is a little ridiculous, but there’s not much you can do to force these companies to keep up with the times.

The IRS requires any person or entity that files more than 250 information returns — 1099s, W-2s, and other forms that report potentially taxable income — to do so electronically. But that requirement only applies to forms sent to the IRS, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. There is no requirement that these forms be delivered electronically to individuals.

Which is unfortunate because, as you know, it’s much safer to get forms electronically than to get your private financial information in the mail. Since these companies are so insistent on hanging on to paper, consider sending a letter – registered mail, return receipt requested – to business leaders asking them to join the 21st century.

Sorting out the trust confusion

Dear Liz: In a recent column, you wrote about bypass trusts that “for many people, this estate planning tool has lost its usefulness.” In California, a trust avoids probate. Isn’t avoiding probate a reason to continue with a trust?

To respond: What you are referring to is a living trust – a revocable (meaning changeable) trust created during someone’s lifetime. A bypass trust is irrevocable (meaning it cannot be changed) and generally comes into effect upon the death of a person. To complicate matters further, an inter vivos trust or will may have provisions that create a bypass trust after a person dies.

Living trusts are indeed designed to avoid probate, the legal process that otherwise follows death to settle an estate. Living trusts remain useful for many people who live in states where probate can be expensive and lengthy, such as California and Florida. Living trusts are also private, unlike wills, which generally become public documents after death, and are therefore favored by people who want to avoid publicity.

Bypass trusts, on the other hand, were primarily designed to minimize or avoid estate taxes, which the vast majority of people are no longer concerned about. Bypass trusts have a number of disadvantages, so if you have one in your estate plan, you’ll want to consult with an experienced estate planning attorney to find out if you should keep it.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to him at 3940 Laurel Canyon, #238, Studio City, CA 91604, or by using the “Contact” form on asklizweston.com.

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