Publication 505: Tax Withholding and Estimated Tax; Introductory Material

This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Table of Contents

Introduction

The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. There are two ways to pay as you go.

Withholding. If you are an employee, your employer probably withholds income tax from your pay. Tax may also be withheld from certain other income, including pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld is paid to the Internal Revenue Service (IRS) in your name.
Estimated tax. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated tax. People who are in business for themselves generally will have to pay their tax this way. You may have to pay estimated tax if you receive income such as dividends, interest, capital gains, rents, and royalties. Estimated tax is used to pay not only income tax, but self-employment tax and alternative minimum tax as well.

This publication explains both of these methods. It also explains how to take credit on your return for the tax that was withheld and for your estimated tax payments.

If you did not pay enough tax during the year either through withholding or by making estimated tax payments, you may have to pay a penalty. The IRS usually can figure this penalty for you. This underpayment penalty, and the exceptions to it, are discussed in chapter 4.

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What's New for 2004

You should consider the items in this section when figuring any underpayment penalty for 2004. Figuring the penalty is discussed in chapter 4.

Penalty rate. The penalty for underpayment of 2004 estimated tax is figured at an annual rate of 5% for the number of days the underpayment remained unpaid from April 15, 2004, through June 30, 2004; 4% from July 1, 2004, through September 30, 2004; and 5% from October 1, 2004, through April 15, 2005.

What's New for 2005

This section summarizes important changes that take effect in 2005 and that could effect your estimated tax payments for 2005. More information on these and other changes can be found in Publication 553.

Definition of dependent. A dependent is either a qualifying child or a qualifying relative. Qualifying child. In general, a qualifying child must meet all of the following conditions.

The child must be your child (including an adopted child, stepchild, or eligible foster child), brother, sister, stepbrother, stepsister, or a descendant of any of them.
The child must have lived with you for more than half of 2005. But an exception applies, in certain cases, for children of divorced or separated parents.
At the end of 2005, the child must be under age 19, or under age 24 and a full-time student, or any age and permanently and totally disabled.
The child must not have provided over half of his or her own support in 2005.

Qualifying relative. In general, a qualifying relative must meet all of the following conditions.

The person must be either your relative or any other person (other than your spouse) who lived in your home all year as a member of your household. If the person is not your relative, your relationship must not violate local law.
The person cannot be the qualifying child of another person in 2005 (see above).
The person must have gross income of less than $3,200. If the person is permanently and totally disabled, certain income from a sheltered workshop may be excluded for this purpose.
You must have provided over half of the person's support in 2005. But exceptions apply, in certain cases, for children of divorced or separated parents and for a person supported by two or more taxpayers.

The following rules also apply in determining if a person is your dependent.

If you are a dependent of another person in 2005, you cannot claim any dependents on your return.
If the dependent is married, he or she cannot file a joint return unless the return is filed only as a claim for refund and no tax liability would exist for either spouse if they had filed separate returns.
A dependent generally must be a U.S. citizen, U.S. national, or a resident of the United States, Canada, or Mexico.
New tie-breaker rules apply if a child meets the conditions to be a qualifying child of two or more people and more than one person claims the child as a qualifying child.

Certain tax benefits, such as qualifying widow(er) filing status and medical and dental expenses, can still be claimed based on a person who is not your dependent if the only reason that person is not your dependent is because he or she is a qualifying relative who has gross income of $3,200 or more or because of items (1) or (2) above.

Head of household. In general, you can use head of household filing status only if, as of December 31, 2005, you were unmarried or legally separated (according to your state law) under a decree of divorce or separate maintenance and you paid over half the cost of keeping up a home:

That was the main home for all of 2005 of your parent whom you can claim as a dependent. Your parent did not have to live with you.
In which you lived for more than half of the year with either of the following:
1. Your qualifying child (defined above, but without regard to the exception for children of divorced or separated parents). This does not include a qualifying child who is married at the end of 2005 and is not your dependent because he or she either (i) filed a joint return, or (ii) is not a U.S. citizen, U.S. national, or a resident of the United States, Canada, or Mexico.
2. Any other person whom you can claim as a dependent.

You cannot use head of household filing status for a person who is your dependent only because:

He or she lived with you for all of 2005, or
You are entitled to claim him or her as a dependent under a multiple support agreement.

The rules under prior law allowing certain married persons living apart from their spouses for the last 6 months of the year to use head of household filing status also apply for 2005.

Earned income credit (EIC). You may be able to take the EIC if:

A child lived with you and you earned less than $35,263 ($37,263 if married filing jointly), or
A child did not live with you and you earned less than $11,750 ($13,750 if married filing jointly).

Donations of motor vehicles, boats, and airplanes. In general, if you donate a motor vehicle, boat, or airplane that is valued at more than $500 and the charitable organization sells the item donated, your deduction on Schedule A will be limited to the gross proceeds from the sale.

Retirement savings plans. The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans. For more information, see Publication 590, Individual Retirement Arrangements (IRAs). Traditional or Roth IRA contribution limits. The contribution limit to a traditional or Roth IRA for 2005 is increased to $4,000 ($4,500 if you are 50 or older). Traditional IRA income limits. If you have a traditional IRA and are covered by a retirement plan at work, the amount of income you can have and not be affected by the deduction phaseout increases. The amounts vary depending on filing status. Salary reduction contributions under a SIMPLE. For 2005, salary reduction contributions that your employer can make on your behalf under a SIMPLE plan are increased to $10,000 (up from $9,000 in 2004). For more information about salary reduction contributions, see How Much Can Be Contributed on Your Behalf? in Publication 590, chapter 3. Additional salary reduction contributions to SIMPLE IRAs. For 2005, additional salary reduction contributions can be made to your SIMPLE IRA if you meet certain requirements. For more information, see How Much Can Be Contributed on Your Behalf? in Publication 590, chapter 3.

Standard mileage rates. For tax years beginning in 2005, the standard mileage rate for the cost of operating your car increases to:

40.5 cents a mile for all business miles driven,
15 cents a mile for the use of your car for medical reasons, and
15 cents a mile for the use of your car for determining moving expenses.

Credit for child and dependent care expenses. Generally, a qualifying person for purposes of the credit for child and dependent care expenses is your qualifying child (defined above) who is under age 13, or your dependent or spouse who is physically or mentally incapable of caring for himself or herself and who lived with you for more than half of 2005. However, for a qualifying child or dependent, the special rule for children of divorced or separated parents does not apply, and the child is treated as a qualifying person only for the custodial parent. You no longer need to pay over half the cost of keeping up a home for the qualifying person.

Deduction for domestic production activities. You may be able to deduct up to 3% of your qualified production activities income from the following activities.

Construction performed in the United States;
Engineering or architectural services performed in the United States for construction projects in the United States; or
Any lease, rental, license, sale, exchange, or other disposition of:
1. Tangible personal property, computer software, and sound recordings that you manufactured, produced, grew, or extracted in whole or in significant part within the United States,
2. Any qualified film you produced, or
3. Electricity, natural gas, or potable water you produced in the United States.

The deduction does not apply to income derived from: the sale of food and beverages you prepare at a retail establishment; property you leased, licensed, or rented for use by any related person; or the transmission or distribution of electricity, natural gas, or potable water. This deduction is allowed for alternative minimum tax purposes, but is not allowed in determining net earnings from self-employment.

Sales tax deduction. You can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Form 1040, Schedule A. See the instructions for Schedule A (Form 1040) for more information.

Reminders

Social security (FICA) tax. Generally, each employer for whom you work during the tax year must withhold social security tax up to the annual limit.

Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.