Estimated Tax Series Part 2: How to Estimate Payments
May 17, 2017
Last time, we talked about how estimated tax payments are made in four equal installments throughout the year: 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.
It can be challenging to estimate how much income you’ll make. For example, if you just started a business, recently retired, or just made some costly improvements, you may be uncertain about how that affects your bottom line. To make matters more difficult, you may owe a penalty if you don’t make proper estimated tax payments. There are a few exceptions, or safe harbors, that will help you avoid a penalty
Exception 1: Prior Year’s Tax – Look at your most recent tax return and find how much tax you owed. Prepay at least 100 percent of this tax evenly with the four installments and you won’t owe a penalty.
Example. When Tom filed his 2016 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 2017 tax year. From his 2016 tax return, he adds his state and county tax due (before applying any of his credits for 2016) and comes up with $1,200. As long as he makes four even installment payments of $300 each ($1,200 divided by 4) by the due dates, he will not owe a penalty for the underpayment of estimated tax when filing his 2017 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 amount is $1,860. Ninety percent of that tax amount is $1,440. If they make four timely payments of $360 each ($1,440 divided by 4), they will not owe a penalty as long as they owe no more than $420 ($1860 - $1,440) when they file.
Special Exceptions: Farmers and Fisherman – If at least two-thirds of your gross income is from farming or fishing, then two exceptions are available:
-Make only one estimated 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.)
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