Estimated Tax to Pay or Not to Pay – That is the Question
Have you ever looked at your 1040 US Individual Income Tax Return and noticed near the space for signature there is a space (Line 79) “Estimated Tax Penalty.” You ask your accountant what that amount represents and he says you didn’t pay in enough taxes. Your immediate answer is “Yes I did!” In fact, you may have even received a refund.
However, per IRS rules it’s not just enough to pay your taxes for the year, they need to be paid at prescribed time intervals. Essentially the year is divided into four payment periods, or due dates, for estimated tax purposes. Those dates generally are April 15 , June 15, Sept. 15 and Jan. 15. In general, you must pay federal estimated taxes in 2018 if:
1) You expect to owe at least $1,000 in tax after subtracting your tax withholding (if you have any) and tax credits, and
2) You expect your withholding and credits to be less than the smaller of 90 percent of your 2018 taxes (the annualized method) or 100 percent of the tax on your 2017 return. If your 2017 Adjusted Gross Income was more than $150,000 ($75,000 if Married Filing Separately) substitute 110% for the 100% requirement (the general method).
If you have income from sources such as self-employment, interest, dividends, alimony, rent, gains from the sales of assets, prizes or awards, then you may have to pay estimated tax as these items generally are not subject to withholding but are subject to tax. If you also receive salaries and wages, you may be able to avoid having to make estimated tax payments on your other income by taking more tax out of your paycheck. To do this, file a new Form W-4, Employee’s Withholding Allowance Certificate with the folks who process your payroll. A very important point here is that the IRS considers withholding (from your paycheck or others such as on pensions, etc.) paid ratably throughout the year. Therefore, if you have the flexibility, you can have extra amounts withheld near the end of the year to “catch up” if you haven’t paid in enough by then.
Below are other important points you should consider regarding your estimated taxes, if you need to pay them and how to pay them.
* To figure your estimated tax, include your expected gross income, taxable income, taxes, deductions and credits for the year. You can use the worksheet in Form 1040-ES, Estimated Tax for Individuals, for this. You want to be as accurate as possible to avoid penalties. Also, consider changes in your situation such as increases or decreases in business income or investment income. If you are having problems calculating your estimated taxes using the annualized method, consider using the general method to be safe (however if you have made more significantly money in 2018 than 2017 you may owe significant taxes on April 15th 2019).
* Consider having your CPA prepare tax projections using several income scenarios and have them updated as the year progresses. This may be appropriate as income projections change and depending on the President and Congress, there may be tax changes ahead for this year.
* You can make more than four estimated tax payments. To do so, make a copy of one of your unused estimated tax payment vouchers, fill it in, and mail it with your payment. If you make more than four payments, to avoid a penalty, make sure the total of the amounts you pay during a payment period is at least as much as the amount required to be paid by the due date for that period.
* The disadvantage to utilizing the annualized method as opposed to the general method is that the calculation of your estimated tax payments may be more complex and time consuming. Additionally, your estimated tax payments must be recalculated at the end of every quarter. If you make an estimated tax payment using the annualized income method for a quarter, you may change to the regular method for a subsequent quarter but you must recapture the difference between the annualized income installments and the regular installments by adding the amount of the differential for all previous periods to the regular installment for the next payment period. For example, if you estimated a tax of $1,000 under the general method, $250 would be due each quarter. If you used the annualized method for the first quarter and paid $100, and then shifted to the general method for the second quarter, the second quarter installment due would be $400 ($250 for the second quarter plus $150 unpaid for the first quarter).
* An underpayment penalty is imposed on each underpayment for the number of days it remains unpaid. A penalty may be applied if you did not pay enough estimated tax for the year or you did not make the payments on time or in the required amount. A penalty may even apply if you have an over payment on your tax return. The penalty is essentially an interest calculation that is currently imposed at a rate of 4% per annum. Not necessarily the worst outcome.
When preparing, tax returns many CPAs include 2018 estimated tax vouchers with their client’s 2017 tax returns. When there is a material balance due on 2017 returns, vouchers are prepared using the safe-harbor estimate under the general method to avoid 2018 under payment penalties. Check with your CPA to ensure that he has considered the underpayment penalty when doing your tax planning