Are you underpaying your estimated taxes?


One common piece of year-end tax planning advice is to check your withholding to be sure you will have paid enough tax to avoid a penalty for underpayment of estimated taxes.

If it looks like you will be short, the solution is to increase the withholdings being taken out of your paycheck between now and the end of 2013.

Many higher-income people are aware that the new 3.8 percent net investment income tax may cause them to owe more taxes in 2013. Far less attention has been paid to the new 0.9 percent Medicare (hospital insurance) tax that applies to earned income above $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).

In theory, if you are subject to this tax, it is being withheld by your employer. However, if not enough is being withheld or you are self-employed, you must pay the difference with your income taxes. If you are not careful, an underpayment penalty could result.

For example, suppose your total earned income for 2013 will be enough to subject you to the 0.9 percent hospital insurance tax. However, if you worked for more than one employer during the year, perhaps no single employer paid you more than $200,000, the threshold for withholding.

In that case, you would be subject to the tax, but none would have been withheld. The same issue results if you have self-employment earnings in excess of the taxable threshold.

If you are trying to pay in more tax to avoid an underpayment penalty, the general recommendation is to ask your employer to increase your withholding.

A less conventional alternative is to take an eligible rollover distribution from a qualified retirement plan before the end of 2013. Income tax withheld from the distribution will be applied toward the taxes owed for 2013.

You then have 60 days to roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. If you complete the full rollover, no part of the distribution will be includible in your 2013 income, but the withheld tax will be applied pro rata over the full 2013 tax year to reduce previous underpayments of estimated tax.