Estimated Tax FAQs       

Whenever one of our clients makes the big leap from "contented employee" to "stress-filled business owner," one of the first tax-related discussions we typically have with them concerns the rules for paying estimated taxes.  This article should help to clear up some common misconceptions many people may have.

If you have significant amounts of investment income (or other types of income that aren't subject to withholding) you may incur a penalty if you don't make quarterly payments of estimated tax.  The following FAQs can help you to better understand the requirements of estimated tax payments.

If you have significant amounts of investment income you may incur a penalty if you don't make quarterly payments of estimated tax. 

Am I required to pay estimated taxes?

The general rule is you have to pay estimated tax if your withholding doesn't cover 90% of your tax liability. But there are exceptions:

  • No estimates are required if the amount due after subtracting withholding and credits will be less than $1,000.
  • In general, no estimates are required if your withholding and credits add up to at least as much as your prior year's tax.  For 2017, the amount is 110% of the 2016 tax for people whose 2016 AGI exceeds $150,000. This rule doesn't apply to farmers and fishermen.

The second exception is particularly important. If you receive a large amount of investment income in one year — for example, you sell stock at a large gain or make a rollover to a Roth IRA — you may not be required to pay estimated tax even though you owe a great deal of tax that year. You may be able to delay your tax payment until April 15 because of the exception for the prior year's income.

You won't get this free ride the following year, though. Now you'll be looking back at a year in which your income was higher. 

How do I calculate the estimated payments required?

You figure the amount you need to pay the same way you determine whether you need to pay. It's the difference between the amount of withholding and credits you would need to have to avoid making payments, as described above, and the amount of withholding and credits you actually have, with one exception: you don't get the benefit of the $1,000 rule mentioned above once it's determined that a payment is required.

The amount you have to pay is usually pretty easy to determine if you're basing your payments on the prior year's tax liability. Figuring the payment based on 90% of the current year's tax liability is more difficult — which is why most people try to avoid that approach.

Am I allowed to make voluntary payments even if I'm "safe?"

Some people may choose to make estimated tax payments even when the payments aren't required. We don't recommend this approach since it deprives you of the opportunity to earn interest on the amount you prepay, but it does assure that you won't have a crushing tax bill on April 15.

If I don't want the hassle of estimated payments, can I simply increase my wage withholdings?

In many cases where you would otherwise be required to make estimated tax payments, you can avoid that process by increasing your withholding. Request the appropriate form from your employer and fill it out in a way that will cause an additional amount to be withheld from your paycheck.  Give us a call and we can assist you with that process.

How do I make estimated payments to the IRS?

If you're unfamiliar with this process, you'll be pleased to learn how easy it is. You don't have to explain to the IRS how you arrived at the amount you're paying. The form you fill out is minimal, basically telling the IRS who you are and what you're paying. The only parts that are sometimes hard:

  • Figuring out how much to pay.
  • Coming up with the cash.
  • Remembering to send it in on time.

Your payments for 2017 are (were) due April 18, 2017, June 15, 2017, September 15, 2017 and January 15, 2018. Notice that although they're considered quarterly payments, they're not all three months apart.

What happens if I underpay the final tax amount that I actually end up owing?

Don't panic if you have an underpayment. The penalty is equivalent to interest on the amount of the underpayment. It's best to avoid the penalty, but the penalty will be minimal if the underpayment is small or is corrected within a short period of time.