Per IRS guidelines, estimated tax payments are required when you receive income that isn’t subject to withholding. Examples are independent contractor income, investment income and prizes won or certain gambling winnings. Since income tax withholding doesn’t take place when these types of income are earned, taxpayers must make estimated payments during the year to cover the tax liability this income creates.
The IRS expects taxpayers who have this type of income to make estimated income tax payments on a quarterly basis. Logic would dictate that “quarterly” payments would be made every three months. However, the IRS (and government in general) doesn’t often operate by logic. As such, the due dates for estimated tax payments for a given tax year are due on April 15th, June 15th, September 15th and January 15th (of the following year). These deadlines are treated similarly to income tax return filing deadlines – in other words, as long as the payment is electronically sent or mailed by the due date, it is considered to be submitted timely. Also, if one of these dates falls on a weekend or legal holiday, you have until the following business day to make the payment.
It is important to accurately estimate the amount to remit for each of these payment due dates because if, when preparing the income tax return for the year in question, you have not paid in sufficiently, estimated tax payment penalties and interest may be assessed. There are safe harbors offered by the IRS when taxpayers determine how much to pay in for estimated taxes. The general safe harbor is that if your total payments to the IRS, including withholding, are at least 90 percent of your current year overall tax liability or 100 percent of your prior year overall tax liability, you won’t be subject to an underpayment estimated tax penalty. One caveat to this rule is that the required estimated payment amount rises to 110 percent if your adjusted gross income for the year is over $150,000 for most taxpayers.
Another safe harbor option is to make payments based upon the annualized income payment method. In this case, you are allowed to pay estimated tax for each period based on an estimate of income and deductions for that time frame rather than paying your full estimated tax amount in equal installments throughout the year. You are still required to pay tax on at least 90 percent of your current year annualized income but you may be allowed to skip one or more of the four estimated tax payment deadlines if no income was generated in those periods. In order to use the annualized income payment method, you must submit form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with your federal income tax return.
Lastly, if you live in a state that has an individual income tax like Arizona, don’t forget to analyze your state estimated income tax requirements as well as there is likely a state payment due each time a federal payment is due.
At Weech Financial, PLLC, we assist our clients with making their needed quarterly estimated income tax payments each year based on either their current year projected income tax liability or their prior year income tax liability. In a situation where income is rising from year to year, the safe harbor rules allow the taxpayer to only pay in 100 percent of the prior year overall tax liability and retain the remaining tax projected to be due for the current year until the tax return is filed by the April 15th deadline the following year. In a situation where income is declining from year to year, we can ensure that our clients pay in sufficient to cover the 90 percent of current year projected tax liability instead.
If you have questions regarding estimated income tax payment requirements, please contact us.