Some of you are old pros at paying quarterly estimated tax payments and some of you may be wondering if you fall outside of these requirements. Ketel Thorstenson (KTLLP) serves a wide spectrum of clients who annually deal with the nuances of these quarterly filings, which are often necessary to avoid tax penalties.
Estimated tax payments are advanced payments you make to the IRS to fund the tax relating to income flowing to you from a business or large investment. Because this income is not subject to withholding by the payer, as such, you are generally required to calculate (estimate) the tax due and submit it to the US Treasury in four equal installments. For W-2 employees, their federal tax liability is withheld equally throughout the year.
The only reason estimated tax payments would not be equal is if your income fluctuated substantially throughout the year. An example would be the owners of a retailer who loses money for nine months out of the year, but when Christmas season rolls around they make all their income in a short window of time. In this situation, estimates can be submitted based on the annualized net income for the last part of the year.
So now the question is, “do I have to pay estimated tax payments?” The IRS expects taxpayers who owe $1,000 or more for the year to make either quarterly estimated tax payments or to have sufficient withholding, or both. Those required to pay quarterly are usually self-employed whether as a sole proprietor, a partner or as an S-Corporation shareholder. Or they could simply be individuals who did not withhold enough tax against their investment income. Or they could be an employee who simply claimed too many exemptions on his or her W-4. In the last case, rather than paying quarterly taxes, you can submit a new W-4 to your employer so more tax is withheld.
Generally, you can follow the safe harbor rule and pay quarterly installments equal to 100% of the previous tax year’s income tax liability. You may need to pay in 110% if your adjusted gross income is greater than $150,000. This allows the taxpayer to avoid the underpayment penalty, even if his or her income is skyrocketing as compared to the prior year. However, you do not have to pay the same amount as last year (safe harbor) if your circumstances have changed and your income is expected to decrease for the current year versus the prior year. You can still avoid penalty as long as tax payments exceed 90% of the current year liability. One funny thing is that the estimates are due on the 15th of the following months; April, June, September, and January. These are not equal quarters, but that has been the law for decades.
To calculate an estimated tax payment using the safe harbor rule, simply look at 100 or 110% of last year’s total tax liability, subtract your expected withholdings, and divide by (4) four. If your income is decreasing, you should prepare a projection of your tax liability so that you can send in reduced payments. We can assist you with that projection, or you can Google “income tax brackets and the current year” to figure out your current income tax rate. And don’t forget self-employment taxes. There is a link on the KTLLP website that provides you with the dates the estimated tax payments are due along with the corresponding payment period. Here is the link: https://ktllp.com/about-us/tax-faqs/
KTLLP would be happy to help you calculate your estimated tax liability for the year, and set up the estimated tax payments. If you have any questions contact the professionals at Ketel Thorstenson.