Clarification on a one-time large long-term capital gain and estimated payment

[samury]

I am very very fortunate and was able to realize a $300,000 long-term gain from a stock sale.  I am married and we had a taxable income of a little under $200,00 and paid about $24,000 in taxes for tax year 2023.  I estimate that I owe about $45,000 (15%) in taxes due to this long-term capital gain.  My wife and I will probably make the same amount from our salaried jobs this year, so taxable income should be very similar to 2023.  

I am a little confused about making an estimated payment to the IRS, even after reading through the forum and the IRS website.  

"Generally, you must make estimated tax payments for the current tax year if both of the following apply:

• You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits, and
• You expect your withholding and refundable credits to be less than the smaller of:
  • 90% of the tax to be shown on your current year's tax return, or
  • 100% of the tax shown on your prior year’s tax return. (Your prior year’s tax return must cover all 12 months.) "

For the first question, yes, I expect to owe at least $1,000.  

For the second question, I think that would be yes, as well.  However, if I make an estimated payment to the IRS this summer that would put me above 110% of 2023's tax return (e.g. roughly $24,000*10%=$2,400) by end of calendar year 2023, would that mean I can pay the remainder of the tax I owe for 2024 in April 2025 without an underpayment or late penalty (e.g. roughly $45,000-$2,400=$42,600)?  

As always, I appreciate all the work you all do to help the community here.

Thank you 

@dmertz 

[fanfare]

In your situation,
withholding + estimated tax must be 110% of your prior year tax 
IRS requires four Estimated Tax contributions, on the specified dates,
in addition to your withholding which by default is apportioned evenly to those dates.

To make this work you must start with the First Estimated Tax payment which is due April 15th 2024.

Since you missed the first two estimated tax payments, it may not work to eliminate all penalty.
If you meet the prior year tax test on withholding alone there is no penalty

See Form 2210 for options that may reduce or eliminate your penalty such as-

• Check Box D and file Form 2210.
• Use Schedule AI.
• increase withholding for the rest of the year

@samury 

[fanfare]

if your tax return ex the capital gain windfall is comparable to last year,  and got a refund for 2023.

you may already be meeting the test with withholding alone, or very close.

@samury 

[dmertz]

If additional tax withholding is needed to avoid needing to annualize income to avoid an underpayment penalty, you can increase tax withholding from sources of income that you will receive between now and the end of the year.  Unlike estimated tax payments which are credited when paid, tax withholding is treated by default as received evenly throughout the year.  This means that increased tax withholding later in the year can make up for what would be considered underpayment earlier in the year absent annualization of income.  You can even potentially manufacture tax withholding by doing an indirect rollover of a qualified retirement account.

[Mike9241]

"You can even potentially manufacture tax withholding by doing an indirect rollover of a qualified retirement account." Be wary of this option because you have to make up for the amount withheld otherwise it's treated as a distribution on which you will get taxed and may even owe a penalty if you are not at least 59 1/2 on the date of withdrawal.  

[samury]

Thank you all for the swift guidance!  So, if I'm understanding correctly, I can increase my withholding from my paychecks at work by a bit over $2,400 over the next ~6 months to hit the additional 10% tax payments and avoid penalties for late or underpayment?  

[dmertz · Accepted solution]

If your tax withholding with no change to your withholding rate would be $24,000, increasing your tax withholding by a total of $2,400 over the next 6 months would bring you to $26,400 of federal tax withholding which would satisfy the safe harbor of 110% of last year's tax withholding.

Don't forget to consider state taxes where you might have to do the same sort of thing.

[samury]

Thank you very much.  That's a great point.  I hadn't even considered the impact on state taxes.  I am a resident of Virginia, but I am having a hard time researching how a one-time large long-term capital gain would impact Virginia taxes.  Do you happen to know of a source I can read more about it?  Thank you 

[dmertz]

The gain is treated as ordinary income on your Virginia tax return.  I mentioned your state tax return simply to remind you that you might need to make Virginia estimated tax payments.

[fanfare]

satisfy the safe harbor of 110% of last year's tax withholding."

It is not 110%  of prior withholding.

It is 110%  (or 100%, given  low enough prior AGI ) of prior year's tax that must be withheld to use this strategy for a large windfall.

For a large windfall, tax will be due and even without penalty thanks to withholding, some Estimated Tax may be prudent.

@samury 

@dmertz 

[samury]

Thank you, all!  Luckily, I keep the withholding based on the tax amount due.  I will double-check to make sure it all matches with last year's tax bill.