As you know, we are in the thick of tax season, and I’m finding a lot of clients want to learn more about quarterly estimated tax payments. Perhaps the new tax laws changed their situation enough to warrant estimated tax payments, or perhaps they have experienced a life change, like retirement. Regardless, I thought it would be helpful to rerun, with updates, an article from a couple of years ago explaining the why, when, and how much of quarterly estimated tax payments.
Tax preparation consists of more than just preparing the prior year return. It prepares you for the current year tax liability by assessing the need for quarterly estimated tax payments, which are due in April, June, September, and the following January. The only cushion in avoiding under-withholding penalties without paying estimates is if the taxpayer’s bill, when all is said and done, is less than $1,000. Otherwise, under-withholding penalties may apply.
Quarterly tax estimates are usually needed when the taxpayer has income without the appropriate withholding to cover the tax liability. This happens when withholdings are not enough (resulting from taking too many exemptions against your wages) or ignored completely (not having any withholdings applied from retirement distributions or Social Security). Estimates may also become an issue due to income where withholdings are not an option, such as interest, dividends, capital gains, and flow-through or sole proprietor business income.
The IRS rules base expected withholdings on the prior year tax liability (2018). Depending on the taxpayer’s Adjusted Gross Income (AGI), either 100% or 110% of the prior year tax is expected to be paid in to avoid an underpayment penalty. If the taxpayer’s AGI is $150,000 or more, the higher 110% is expected. The goal of quarterly estimates is to protect the taxpayer from penalties. However, too much withholding is also to be avoided because it deprives the taxpayer from valuable cash flow.
The IRS understands that circumstances change tax liabilities from year to year. Therefore, there is an alternative to paying in a minimum of the prior year tax. The 90% rule is used in these circumstances and is calculated (I use the term loosely, because it is more of a guess) on the current year (2019) tax liability. This can be a challenge, because the due dates of the quarterly estimates occur before the actual tax liability is known.
You may ask, “Do I need to pay them if my preparer provides them?” The answer rests with you. I recommend you pay them. However, the worst-case scenario is you will need to pay the penalty on top of the tax due in April.