Wash sale rule applied to quarterly estimated taxes?

Question

I'm looking to pay estimated quarterly taxes. Do wash-sale rules apply to quarterly estimated tax payments (June 1st – August 31st with a due date of September 15th for this past period), or do they only apply when filing my completed year-end returns next year?

For example, I have multiple large realized short-term gains AND losses in options with the same underlying stock occurring around the end of August and early September. I'm interpreting this rule in one of two ways, but perhaps they're both wrong and I'm misinterpreting this greatly:

1. The wash sale rule is applied to quarterly payments. For this past period's estimated taxes, I need to make estimated tax payments on realized gains with a closing date on or before August 31st. For losses, I am unable to claim the realized losses from August because I bought options with the same underlying in early September. Even if I were to liquidate all my positions right now, I would not be able to claim these losses as they would be forwarded into the cost basis of these positions.
2. The wash sale rule is only applicable to the tax year as a whole. I only need to make estimated tax payments based on my net realized gain/loss related to this stock as of end-of-day August 31st. As long as I plan to fully liquidate all my positions related to this stock by end of year and refrain from buying back a related position for 30 days, I will be able to claim realized losses as expected when I file my 2020 returns next year.

Some people have advised on simply overpaying taxes just to cover myself, but this is something I'd like to avoid as my realized capital gains and losses are both large, making my net gain relatively small. My tax burden would be much higher than my net gain. I've sent my questions to two different CPAs but they have been terribly slow at responding, so I'm looking for other people's experience in the meantime.

Answer 1

You are correct in that The wash sale rule is only applicable to the tax year as a whole. All losses can be deducted if all involved positions are liquidated by the end of the year. Note that when you close a short sale at a loss, tax law treats the transaction as occurring on the settlement date so make sure that your transaction date leaves enough time for settlement within the same calendar year.

Disclaimer: The following explanation is what I have been doing and is not tax advice.

I filed my own taxes for many years. Beginning in 2007, I began trading a strategy that booked position gains while carrying paper losses, with lots of short sales involved. That meant that my realized gains were much larger than my unrealized losses. Given that that these losses would be realized by year end, I always knew what my cap gain number would be at year's end (lower than previously realized gains) and could judge my estimated payment accordingly.

In any year where I had large net gains (taking into account the unrealized losses to be closed by year end), I made quarterly payments. In any year where the gains were going to be less, maybe I sent in a 3rd quarter payment but most of the time I waited until late in the 4th quarter when the year's trading was close to done and the net gains were known.

Since I'm retired and I take distributions at year end, I don't have any year long income issue requiring the payment of estimated taxes. I think of it as 4th quarter income and I make a 4th quarter allocation payment for this as well.

I've used an accountant for the past 13 years. He knows very little about wash sales and applicable tax law. Don't get me wrong. He's a good accountant but in this regard, after I have verified that it's correct, he's just entering the summation details from my Form 8949 (Sales and Other Dispositions of Capital Assets) into his professional tax program and it does its magic.

I have done it this way for 20 years and not once has the IRS questioned this timing of estimated payments nor has it ever dunned me for a late payment of estimated taxes.

Disclaimer #2: Consult with a tax professional rather than taking the word of an anonymous stranger on the internet.

Answer 2

The question of whether income/loss applies to a certain quarter only matters when you are using the Annualized Income method to calculate your penalty on Form 2210. If you weren't using the Annualized Income method, then your estimated tax liability for each quarter would be assumed to be the same, i.e. you would be required to have paid 1/4 of the difference between your withholding from work and (90% of this year's tax liability or 100%/110% of last year's tax liability) each quarter to avoid a penalty. But if you paid less estimated taxes in early quarters and more in later quarters because you received more income in later quarters, you would have to use the Annualized Income method to avoid the penalty.

The Annualized Income method considers the actual income received in the year up to each quarter. So the estimated taxes expected 1st quarter would be based on income from Jan-Mar; the total estimated taxes expected 1st-2nd quarters would be based on income from Jan-May; the total estimated taxes expected 1st-3rd quarters would be based on income from Jan-Aug; and the total estimated taxes expected 1st-4th quarters would be based on income from Jan-Dec.

If you had a loss from a sale in August and bought the same stock within 30 days in September, the loss from that sale in August would be disallowed by the wash sale rule, for the purposes of calculating your income from Jan-Aug for the Annualized Income method. You can see this from that fact that for taxes for a whole tax year, if you had a loss from a sale in December that you bought back within 30 days in January, the loss would still be disallowed despite the fact that the repurchase was outside the tax year. That shows that the wash sale rule is not constrained to only looking at repurchases within the tax period you are considering. So logically, a sale loss from August that you repurchased within 30 days in September would work the same way when looking at income from Jan-Aug.