Quote from jeb9999:
I have been making quarterly estimated tax payments for over 30 years. The IRS rules specified on Form 1040ES say I have to make them and my brother the CPA says I have to make them. I don't want to pay the IRS any extra, so I do what is required.
I have known a number of people over the years that should have made estimated tax payments due to capital gains or extra dividends/interest and they all got hit with penalties and interest for underpaying their taxes during the tax year after they filed their tax returns. And the states involved (NY, NJ and PA) also hit them with penalties and interest for underpaying their taxes during the tax year.
A few things:
1. It's not penalties and interest for underpayment/non-payment of estimated tax. It's just interest as the penalty on the amount of tax underpaid or not paid.
2. The penalty interest, if assessed, will add to your total combined state and federal tax liability to the tune of about .25% to 2% depending on your tax bracket, the state you live in and the penalty amount per quarter which ranges from 4% to 8% in recent years. For 1256 contract traders, since you don't file a schedule D (though required to keep personal record of transactions for 7 yrs), the IRS doesn't know precisely when you made your capital gains. So they will simply divide the cap gains tax liability (as computed from your 1099B) by 4 and apply the penalty interest per quarter on a annualized basis. Meaning, 1st quarter interest will be higher than the subsequent quarters with last quarter's interest being roughly 75% less than Q1's..
For some 1256 contract traders, risking not filing the 1040ES and paying the penalty interest might be a better way to go. If your P/L at the end of the year is negative because you suffered a draw down, and is reported as such on your 1099B, you would have done a lot worse if during that year you were paying estimated tax. Sure, you'd get a refund if you paid estimated taxes in the year that you ended up with a negative or lower than anticipated P/L. But that's money you could have used to trade with.
3. It comes down to an opportunity cost. Remember, the IRS only knows how well/bad you did with a 1099B. You enjoy 60/40 tax treatment as well if you're a 1256 contract trader. No matter what, you will pay less tax than a stock trader or wage earner at the same income level.
So, do you pay the penalty if assessed (which by the way they will calculate for you if you don't want to bother doing it yourself with a form 2210) and lose trading capital to the tune of ~ 20% to 30% each quarter? Or do you wait for year end 1099B and lose .25 to 2% additional in extra tax penalty interest?
Something to think about if you're not consistently profitable month to month or year to year.
Paying a penalty isn't the end of the world and doesn't make you a "bad person." It's a business decision. Pay-as-you-go tax system works best for those who are paid by an employer or have fairly steady income. What's more, if the IRS detects/determines that you should have paid the estimated tax, they are forthright about billing you. They don't sit on their hands about it. Bill would come at most a few weeks to two months after you file and pay what you thought or calculated you owed without respect to any penalty interest. So it's best to file as soon after one gets a 1099B.
4. If a trader had negative p/l for the year or didn't make enough to owe taxes after deductions, then they generally don't have to worry about estimated taxes or being assessed a penalty due to "safe harbor" rule for the following year.
