Estimated tax

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

Requirements
The requirements for paying tax are given in IRS Form 2210. The minimum amount to be paid is the smallest of: The 100%/110% rule is often known as the safe harbor. If you pay this amount, you can avoid an underpayment penalty regardless of what happens to your taxes during the year.
 * 90% of the tax for the current year (including other taxes due on the income tax form, such as self-employment tax)
 * $1,000 less than the tax for the current year (only if paid by withholding)
 * 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)

1/4 of the amount must be normally be paid by each of the four deadlines: 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. 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.

Annualized income option
Since the tax due at the end of the year is not known during the year, the IRS also provides an option to pay the tax for each period by the 15th day after the period. The periods are commonly called "quarters", although they are not of equal length, ending on March 31, May 31, August 31, and December 31; the due dates are the same as for the standard method.

To use this method, fill out Schedule AI on IRS form 2210. Each quarter's share of the tax is computed by annualizing the income; for example, the first quarter's tax is based on four times the income for the first quarter, reduced by the standard deduction or four times the itemized deductions for that quarter. Withholding is still normally treated as being paid equally in each quarter, but you may choose to treat withholding as paid when it was actually taken.

How to pay
If you do not have enough tax withheld, but you have payments on which withholding is possible, you can avoid estimated tax by increasing the withholding on those payments. You may file a W-4 with your employer requesting an additional dollar amount withheld, or a W-4P with your pension provider requesting withholding from your pension. (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 withholding, requesting a waiver of the penalty, or 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 will usuallly 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.