Avoid penalties: Follow estimated tax payment rules

Do you have income not subject to withholding? That’s where estimated taxes come in.

Examples of income from which taxes are not often withheld include interest, dividends, gains from the sale of assets and self-employment income.

The tax law does not require estimated payments but imposes a penalty on individuals for failure to pay enough tax either through withholding or estimated taxes. To avoid an underpayment penalty, an individual needs to make four installment payments of estimated taxes based on their required annual payment.

The required annual payment is either:

  1. 90 percent of the current year’s tax, or
  2. 100 percent of the tax shown on the prior year’s return (110 percent of the prior year’s tax when the adjusted gross income is greater than $150,000).

Any amount paid through federal income tax withholdings is considered an estimated payment and would reduce the required payment amount under either of the situations above. This in turn would reduce the amount of the four estimated payments.

These four required estimated payments should be for the same amount of money unless the taxpayer is using the annualized installment method.

The annualized installment method may be used if the taxpayer does not receive income evenly throughout the year. Thus, the four required estimated payments can be for different amounts.

Special rules apply for farmers and fisherman who are allowed to make one estimated payment during the fourth quarter of the year if they meet certain criteria.

The due dates for the estimated payments are the same whether the individual uses the regular or the annualized installment method. The due dates are as follows:

  • April 15 – 1st quarter payment
  • June 15 – 2nd quarter payment
  • Sept. 15 – 3rd quarter payment
  • Jan. 15 of the next year – 4th quarter payment

Form 1040-ES is used to figure the required installment of estimated taxes. The attached voucher can be clipped off and sent in with the payment. This voucher helps the IRS process the payment to the appropriate account.

Any federal income taxes withheld from an individual’s wages are deemed to be estimated payments of tax. These taxes are deemed to be paid ratably throughout the year.

A failure-to-pay penalty will not apply to an individual whose tax liability for the year is less than $1,000 after credits for withheld taxes and refundable personal credits.