If you aspire to serving affluent clients, providing financial plans that help them budget and prepare for quarterly estimated taxes is a must.

Unlike ordinary taxes, which are withdrawn automatically from wages and pensions, estimated taxes rely on the taxpayer's initiative. They usually apply to income derived from interest, dividends, capital gains, partnerships and trusts — precisely the type of income generated by wealthier clients.

It's important to pay attention to estimated taxes for one simple reason: penalties. If a client pays an insufficient amount of estimated taxes in a given year, the IRS levies a financial penalty based on amount due.

Getting Out the Calculator

The first step in determining if clients owe estimated taxes is to review their income from the previous year and estimate their tax liability in the current year. For tax year 2003, clients should have made quarterly estimated tax payments if both of the following occurred:

  • They expect to owe at least $1,000 in tax on April 15 after subtracting all withholdings and credits.

  • Their withholding and credits will be less than the smaller of: 90 percent of the tax shown on their 2003 tax return, or 100 percent of the tax shown on their 2002 tax return.

Please note, the 100 percent number listed above only applies if a client's adjusted gross income (AGI) for 2002 was less than $150,000. If a client's AGI was greater than $150,000, then it is 110 percent of the tax shown on their 2002 return.

For example, assume a client's total tax liability was $50,000 in 2002, and his AGI that year was $200,000. In 2003, he did some freelance consulting and also incurred a large capital gain. Consequently, he doubled his AGI in 2003 and now expects to owe more than $1,000 of additional taxes.

To avoid any underpayment penalties, and to be declared “safe harbored,” by January 15, the client must have paid the lesser of 90 percent of the tax he would incur or 110 percent of the tax shown on his 2002 return ($50,000 × 110 percent). It is not enough just to pay the 90 percent or 100 percent/110 percent.

A taxpayer also must have paid at least 25 percent of the amount under the safe harbor rule that is required on each of the four payment dates. If a client didn't earn income uniformly during the year, they may avoid the 25 percent rule by using the annualized exception method. (For additional information, refer to the IRS's Web site at www.irs.gov and review Form 1040-ES, Form 2210 and Publication 505.)

Planning for Quarterly Tax Bills

If a client has to pay estimated taxes, the next step is to be sure that he has adequate cash flow to meet the quarterly payments. Even affluent clients can have problems setting aside enough money to pay their regular estimated taxes, so it's imperative to work closely with them to budget for these expenses. By failing to proactively plan ahead, a client may be forced to liquidate assets at an inappropriate time — possibly triggering tax liabilities that could have been avoided.

When budgeting for a client's estimated tax payments you will want to position yourself as the primary advisor in order to have a complete picture of their financial portfolio. In doing so, you can see the synergies as well as conflicts between the client's investment plan and their goals and objectives. If you do not have the capabilities in-house, it is imperative to work closely with a client's CPA. In most cases, the CPA will do the estimated-tax calculations and the advisor creates the budget and payment strategy. Always be sure to keep the CPA in the loop during this stage.

Instinctively, when you heard the words “estimated taxes” you probably thought it was only an issue for your clients' tax advisor. But, as you have seen, there are numerous financial planning implications as well. Helping your clients to avoid IRS penalties and keep more of what they earn is an important way to show the value you add as their advisor.

Writer's BIO:
Susan L. Hirshman
is vice president at JPMorgan Fleming Asset Management.
jpmorganfleming.com

When are estimated taxes due?

Period Due Date
January 1-March 31 April 15
April 1-May 31 June 15
June 1-August 31 September 15
September 1-December 31 January 15 of the following year