Options for Making Estimated Income Tax Payments

In today’s economy, very few people are paid once per year. Employees on payroll usually are paid weekly or twice a month. To keep cash coming in the door in order to make these payments, their employers continuously monitor receipts and accounts receivable and collect payments for services. 

The federal government is not much different. With so many payments going out every month, the government needs a continuous in-flow of cash. Tax withholding deposits by businesses are a primary source of funds for the federal government, but that then brings up the question – how does the government collect taxes from individuals who don’t receive a paycheck? 

This situation is much more common than it may seem. Small business owners are unlikely to draw regular paychecks from their business. In some business entities, like partnerships, owners are specifically not allowed to be on the payroll.  Plus, many individuals receive passive income in the form of rents, royalties, and dividends.

To receive funds continuously and treat all taxpayers as equally as possible, Congress put in place a system of “pay as you go.” Individuals who expect to owe more than $1,000 in taxes after withholding and credits are required to make estimated tax payments. Taxpayers who fail to timely make sufficient estimated tax payments are subject to a penalty.    

The calculation of the penalty is complex, and as with most tax rules, there are a myriad of exceptions and special considerations for certain types of taxpayers. In general, however, individual taxpayers must pay estimated tax payments in an amount at least equal to 90% of the tax shown on their tax return for the current tax year.

Projecting a taxpayer’s current-year tax liability in advance may be challenging. Taxpayers may have difficulty determining their estimated tax amount. To avoid an underpayment penalty, taxpayers can use an alternative to the 90% of tax threshold.  This alternative is commonly referred to as the “safe harbor” method.

Under this “safe-harbor” method, a taxpayer who reported up to $150,000 of adjusted gross income on his or her prior-year tax return will not be subject to an underpayment of estimated tax penalty if he or she makes timely estimated tax payments equal to at least 100% of the tax shown on that prior-year tax return.  Taxpayers who reported adjusted gross income of over $150,000 on their prior-year tax return can use the same safe-harbor calculation too, but they must pay 110% of the prior-year tax instead of 100%.

There is also a special method for taxpayers who earn income unevenly during a year. These taxpayers may be able to reduce their estimated tax installment payments for one or more quarters (and avoid or minimize a penalty for underpayment of estimated tax) by using the annualized income installment method.

Estimated tax payment due dates do not conform to standard calendar quarters. The first quarterly estimated payment is due April 15, concurrent with the return filing requirement for the prior year. The subsequent three quarterly payments are due June 15, September 15, and January 15.  Thus, the number of days per quarter varies from 60 days in the second quarter up to 120 days in the fourth quarter. 

The IRS expects all taxpayers to satisfy one of the two estimated tax payment methods for 2020 estimated tax payments by January 15, 2021. If you would like to discuss how Weaver can help you with your estimated tax payments and avoid or mitigate a penalty for underpayment of estimated tax, contact us. We are here to help.

Authored by Bryan Prewitt, Senior Tax Manager.

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