September, 2022
Estimated tax payment requirements exist to ensure that the U.S. government has a steady cash flow throughout the year. An individual taxpayer is required to pay a certain amount of tax throughout the year, either through withholdings or through estimated taxes. Estimated taxes are due on 04/15/X0, 06/15/X0, 09/15/X0, and 01/15/X1.[1]
Estimated Tax Penalties
Penalties apply when you don’t pay enough tax throughout the year.[2]
How much is enough? No penalties will apply if you pay throughout the current year at least:[3]
– 90% of the current year tax liability.
– 100% of the tax shown on the prior year return.
– 110% of the tax shown on the prior year return IF your adjusted gross income (AGI) was over $150,000.
Example
John filed an income tax return, showing a tax of $10,000 on adjusted gross income exceeding $150,000. John figures that next year his adjusted gross income will still exceed $150,000 and his tax will increase to $16,000. He also estimates that the total amount of income tax that will be withheld from his income next year will be $12,000.
John should compare the amount of tax to be withheld next year, $12,000, with the lesser of (1) 90 percent of the tax to be shown on next year’s return or (2) 110 percent of the tax shown on his current return. John will not meet the 90 percent test because $14,400 (90 percent of $16,000) is more than the $12,000 expected to be withheld during the next year. However, he will meet the 110-percent test because the $12,000 tax expected to be withheld next year is more than 110 percent of his $10,000 current year’s tax. As a result, John need not make estimated tax payments for next year.[4]
Protective Estimates
We prepare protective estimates for our clients. The known variable is the return that we just prepared. Therefore, depending on your AGI, we will give you estimates that equal either 100% or 110% of the tax liability shown on that return. This ensures that if the estimates are paid as advised on the due dates mentioned above, no penalties will apply for underpayment of estimated tax.
Planning
If a significant change in income is expected and you want to pay an amount that will closely approximate the expected current year income tax liability throughout the year, we can calculate estimates based on your estimated current year tax liability in a separate tax planning engagement.
[1] IRC § 6654(c)
[2] IRC § 6654
[3] IRC § 6654(d)
[4] IRC § 6654(d) Example (1)