The requirements for estimated tax payments are important to understand in order to avoid potential underpayment penalties. The IRS requires that once certain income thresholds are met, a specific amount of tax must either be withheld or paid by the taxpayer throughout the year.
For taxpayers who file based on a calendar year, quarterly estimated tax payment due dates are April 15th, June 15th, September 15th, and January 15th. The IRS requires that 25% of the total estimated tax be paid by these quarterly due dates. If the proper amount is not paid by each quarter, the IRS will assess an underpayment penalty based on the amount that was underpaid each quarter and the days the amount remained underpaid.
There are two ways that every taxpayer is allowed to calculate their estimated tax payments for a given year. First, taxpayers are allowed base their current year estimates on their prior year tax. This prior year safe harbor (amount at which no underpayment penalty is assessed) is dependent upon the level of income earned by taxpayers. For taxpayers with an AGI (adjusted gross income) under $150,000 ($75,000 if married filing separate) they are allowed to base estimates on 100% of the total tax paid in the prior year. For taxpayers with an AGI above $150,000 ($75,000 if married filing separate) they are required to make estimated tax payments based on 110% of the total prior year tax.
The second way the IRS allows taxpayers to calculate estimated tax payments is based on the current year tax. No matter the taxpayer’s level of income, the safe harbor is 90% of the total current year tax liability. This method can be more difficult to estimate as income and deductions may vary throughout the year. As some businesses, or other sources of income, may be seasonal, the IRS allows you to “annualize” income. Annualizing income means projecting the income that you have earned during a specific period, say 3 months, for the entire year as if that income would stay consistent each month for the remainder of the year. For instance if a taxpayer earned $30,000 from January to March, their projected total income for the tax year would be $30,000 / 3 months = $10,000 x 12 months = $120,000 for the year. The first quarter estimate would be calculated based on that level of income. If this method is desired to calculate quarterly estimates, a new calculation will be required each quarter to ensure that the proper estimates are paid.
Here are some examples of how to calculate estimated tax payments depending on the different situations:
100% Prior year safe harbor rules (AGI is less than $150,000)
If the prior year tax was $10,000, that same amount would be required to be paid by the end of the current tax year in even quarterly installments. The total due each quarter would be $10,000 / 4 = $2,500 per quarter.
110% Prior year safe harbor rules (AGI is greater than $150,000)
If the prior year tax was $20,000, the amount required to be paid by the end of the current tax year would be 110% of this amount or $20,000 * 1.10 = $22,000. This is the total amount that must be paid by the end of the tax year and the amounts due each quarter would be $22,000 / 4 = $5,500 per quarter.
90% Current year safe harbor rules (No AGI limitations, 35% tax rate)
If a taxpayer made $120,000 of taxable income from January 1 to March 31, they would divide their income by the number of months to get their monthly income, then multiply that number by 12 to project the entire year ($120,000/3 = $40,000* 12 = $480,000). Then multiply the result by your tax rate, assume 35% for this example, and multiply the tax by 90% to meet the safe harbor rules. ($480,000*35% = $168,000*90% = $151,200). This represents the amount you would have to pay in tax to the IRS for the calendar year. Only 25% of this amount ($37,800) would be due by April 15.
While these examples simplify the process, the actual calculation for projecting quarterly estimates can be complex and involve a variety of factors.
For taxpayers with an AGI under $1 million, California conforms to the same prior year safe harbor as adopted by the IRS. For taxpayers with over $1 million in AGI you will be required to base your estimates on 90% of your current year tax. Additionally, California requires that the payments be made as follows:
First Quarter – 30% of the total estimated tax
Second Quarter – 40% of the total estimated tax
Third Quarter – 0% of the total estimated tax
Fourth Quarter – 30% of the total estimated tax
These payment dates and thresholds are not required by all states. If you are required to file estimates for other states contact your tax advisor for more information.
This is a quick explanation of the process of calculating estimated tax payments. If you have any questions or concerns regarding your estimated tax payments, please feel free to contact us.