Estimated tax

🇺🇸

The US tax law requires tax to be paid on income at about the same time it is received. Many taxpayers pay income tax by withholding from salary or from other payments. If the withheld tax is not enough, taxpayers must pay a sufficient amount of  estimated tax during the year or pay a penalty.

Requirements
To see if you owe a penalty, complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals, Estates and Trusts).


 * Form 2210
 * Instructions: IRS website or PDF

There is an exception to the penalty as well as “safe harbors” so you neither have to file Form 2210 nor pay a penalty.

Exception:


 * The total tax shown on your tax return less any payments and refundable credits minus the amount paid through withholding is less than $1,000.

Safe Harbors:


 * 90% of the tax for the current year (including other taxes due on the income tax form, such as self-employment tax)
 * 100% of the tax for the previous year (110% if your adjusted gross income for that year was more than $150,000, or $75,000 if married filing separately)

There are four payment deadlines: normally April 15, June 15, September 15, and January 15 of the following year.

Tax paid by withholding is treated as paid in four equal amounts, 1/4 on each of the four due dates, but you may choose to treat withholding as paid when it was actually taken.

Estimated tax payments are credited on the date paid. If the previous year's tax overpayment is applied to the current year's estimated tax, it is treated as having been paid on the April 15 deadline unless the overpayment is the result of a tax payment made after that date.

There is a separate requirement to file a Form W-4 for salary correctly, claiming the proper amount of withholding to cover the estimated tax due on the salary, and to file an updated Form W-4 when a change in your tax situation would cause the old W-4 to have too little tax withheld. You can also have tax withheld from pension payments by filing Form W-4P and from certain federal payments, e.g., Social Security benefits, by filing Form W-4V.

Annualized income option
Since the tax due at the end of the year is not known during the year, the IRS provides an option to pay the tax for each period by the 15th day after the end of the period. The periods end on March 31, May 31, August 31, and December 31 and are commonly called "quarters", although only two of the four periods are a quarter of a year, i.e., 3 months long.

To use this method, fill out Schedule AI on IRS form 2210. The form looks at the cumulative periods: January 1 - March 31; January 1 - May 31; January 1 - August 31; and January 1 - December 31. Each cumulative periods share of the tax is computed by annualizing the income; for example, since the first cumulative period is 3 months or 3/12th of the year, your income is annualized by multiplying by 12/3 or 4. Similarly, since January 1 - May 31 is 5 months or 5/12 of a year, your income is annualized by multiplying by 12/5 or 2.4. Itemized deductions are annualize the same way, but your full standard deduction is used for each cumulative period if greater than your annualized itemized deductions.

How to pay
If you wish to increase the amount of tax withheld, you can file a new W-4 with your employer or request withholding from withdrawals from tax deferred accounts (e.g., required minimum distributions) as well as from pension payments and social security benefits (as previously mentioned).

(If you are converting a Traditional IRA to a Roth IRA, you may not want withholding to be taken from that payment, as this will be considered money withdrawn from the traditional IRA and not converted. Unless you then make up for the withholding with other money, this will reduce the amount added to the Roth IRA, and will subject you to a 10% penalty on the amount not converted if you are under age 59-1/2.)

If you do not pay by withholding, you may fill out IRS Form 1040-ES to compute the estimated tax you need to pay. You may pay by check with the vouchers on Form 1040-ES, or pay electronically at Electronic Federal Tax Payment System.

The penalty
If you do not make the estimated tax payments by the due date, the penalty is computed on IRS Form 2210. The penalty is essentially an interest payment, charged for every day that the payment was late. Therefore, if you pay a few days late, or underpay by a few dollars, the penalty will be very small.

In most situations, the IRS will compute the penalty; you only need to file the form if you are annualizing income or treating withholding as paid when it was actually withheld, requesting a waiver of the penalty, or you filed a joint tax return for one year but not both.

Reducing or eliminating the penalty
If you discover mid-year that you should have been paying estimated tax, you may be able to eliminate the penalty by increasing withholding. Even if the withholding is done late in the year, the IRS will treat it as meeting the quarterly due dates. If you cannot increase withholding, paying as soon as possible will reduce the penalty.

If you are required to pay estimated tax because of a mid-year increase in income, you can pay estimated tax for the appropriate quarter and avoid the penalty by filing Schedule AI with Form 2210.

State taxes
States have similar requirements for estimated taxes, but the rules vary by state. Check with each state tax bureau for the safe harbor exemption, due dates, the amount which must be paid for each period, the procedure for paying estimated tax if necessary and the penalty interest rate. For example, in California, 30% of estimated tax must be paid in the first quarter, 40% in the second quarter, and 30% in the fourth quarter, and taxpayers with CA adjusted gross income over $1M cannot use 110% of the prior year's tax as a safe harbor. In Maryland, the safe harbor is always 110% of the prior year's tax, and the interest rate on underpayments is much higher.

Estimated tax and withholding penalties also apply to non-resident state income tax. If you are paying non-resident tax to a state for the first year, your prior year tax will be zero, and thus there will usually be no requirement to pay estimated tax. However, if you paid non-resident tax in the previous year and have income from that state in the current year, you will probably need to have tax withheld or pay estimated tax.