Does the estimated tax rule apply to me?
According to the IRS estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment interest dividends alimony rent gains from the sale of assets prizes and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary pension or other income is not enough.
If you are filing as a self-employed individual (sole proprietor) partner and/or S corporation shareholder you generally have to make estimated tax payments if you expect to owe tax of $1000 or more when you file your return.
If you are filing as a corporation you generally have to make estimated tax payments for your corporation if you expect it to owe tax of $500 or more when you file its return.
How do I know how much to pay?
In order to avoid the underpayment penalty you must pay enough to satisfy one of the three safe harbor guidelines.
- If your adjusted gross income was $150000 or less in the previous year you must pay 100% of last year’s (2013) tax liability in withholding and quarterly estimates for the current year (2014) to not receive a penalty from the IRS. For example if your 2013 AGI was $90000 last year and your tax liability was $12000 You need to pay $12000 in withholding and estimated taxes to be free from penalty even if your income has increased. You will settle up any additional money owed in April 2015 but will remain penalty-free based on the safe harbor rule.
- If your income decreases from the prior year you must pay 90% of the current year tax liability to be free from penalty. For example if your 2013 tax liability was $12000 your income has dropped in the current year and the expected tax liability for 2014 is $9000 you need to pay $8100 ($9000 x 90%) in withholding and estimated taxes to be free from penalty. You will settle up any additional money owed in April 2015 but will remain penalty-free based on the safe harbor rule.
- If your AGI in 2013 was more than $150000 you will be covered under the safe harbor rule if you pay at least 110% of last year’s tax liability.
What if I miss a payment?
If you miss a quarterly tax payment there are a few different actions you can take. Here are two examples:
- You can reduce or eliminate the penalty you receive by increasing your salary withholding. Talk to your employer about your situation and ask to file a new W-4.
- Start overpaying your estimated payments to compensate for earlier underpayments. For example if you missed a $500 payment due on April 15 pay $1000 on June 15 to catch up.
Need more advice?
Don’t feel like you have to figure all of this out by yourself. Lindemeyer CPA is here to help walk you through these complicated tax issues. It’s what we do day in and day out. Contact us for help with estimated tax payments or any other tax-related needs.