ESTIMATED TAX: PART 2 OF A THREE-PART SERIES HOW TO FIGURE THE AMOUNT OF ESTIMATED TAX YOU NEED TO PAY
April 2, 2014 – TaxTalk Blog
Remember the pay-as-you-go concept we talked about in the last blog? Well, instead of making estimated tax payments once a month, you only have to make four equal payments throughout the year. Installment payments are due the middle of April, June, September, and January (of the next year). For someone who estimates owing $1,224 in tax, he will make four estimated tax payments of $306 each ($1,224 due for the full year divided by four equal payments). This will pay the tax he owes as the year progresses.
Sometimes it is challenging to estimate how much income you’ll get. For example, you may have just started a business, recently retired, or just made some costly improvements, and you’re not sure how this activity will affect your bottom line. To make matters more difficult, there is a penalty due if you don’t make proper estimated tax payments, and no one wants to be in that situation. That said, there are a few exceptions, also known as safe harbors, available that will help ensure you won’t be in a penalty situation.
Exception 1 Prior Year’s Tax – Look to see how much tax you owed this past year. Make sure to prepay at least 100 percent of that tax evenly over the four installment due dates, and you won’t owe a penalty.
Example. When Tom filed his 2012 taxes, he realized he needed to be paying estimated tax. Not really knowing what to expect with his new business, he opts to use Exception 1 to figure how much estimated tax he should pay for the 2013 tax year. From his 2012 tax return, he adds his state and county tax due (before applying any of his credits for 2012) and comes up with $1,200 altogether. As long as he makes four even installment payments of $300 each ($1,200 divided by 4) by their due dates, he will not owe a penalty for the underpayment of estimated tax when filing his 2013 taxes regardless of how much he finally owes.
Exception 2 The 90% Rule – Evenly prepay at least 90% of your tax liability for the year and no penalty will be due.
Example. Cindy and Scott estimate they will make $40,000 this year. State and county tax due on that is $1,860. Ninety percent of that is $1,440. If they make four timely payments of $360 each ($1,440 divided by 4), they will owe no penalty as long as they owe no more than $420 ($1860 - $1,440) when they file.
Special Exceptions for Certain Farmers and Fishermen – If at least two-thirds (2/3) of your gross income is from farming or fishing, then two exceptions are available:
- Make only one estimated tax payment, due mid-January after the close of the tax year, or
- File your tax return and pay everything that is due by March 1 (no estimated tax payment required).
Check out the third blog of this series in a few days for information about how to make estimated tax payments and some final thoughts.
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