For some taxpayers, it is necessary for them to make estimated tax payments and the applicable rules for paying the minimum amount of estimated tax without triggering the penalty for underpayment of estimated tax.
Making Estimated Tax Payments as an Individual 1040 ES
Paying estimated taxes is a fine line between paying the government too much, and having them hold on to your money, or paying them too little, and be liable for a penalty when you file your annual tax return. This is why it is essential to understand Form 1040-ES and understand how to calculate and pay estimated taxes. The IRS provides Form 1040-ES for you to calculate and pay estimated taxes for the current year.
What do Individuals Need to Know About Estimated Tax?
Estimated tax is the method used to pay tax on income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents,alimony, etc.). In addition, if you do not elect voluntary withholding, you should make estimated tax payments on other taxable income, such as unemployment compensation and the taxable part of your social security benefits.
Who Needs to Make Estimated Tax Payments on Form 1040-ES?
Individuals must pay 25% of a “required annual payment” to the IRS by Apr. 15, June 15, Sept. 15, and Jan. 15, to avoid an underpayment penalty. (When that date falls on a weekend or holiday, the payment is due on the next business day.) This is what most people are referring to when talking about estimated tax payments. The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits.
High Income Individuals Making Estimated Payments
Certain high-income individuals must meet a more rigorous requirement when filing their estimated tax returns. This is to ensure that taxes are paid when income is earned to the IRS in certain employment of investment situations. If the adjusted gross income on your previous year’s return is over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year. Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employer from their paycheck. Estimated tax payments generally start affecting people when they are not paid a monthly salary or have income from other sources.
What is the Estimated Tax Underpayment Penalty?
If you fail to make the required payments, you may be subject to an underpayment penalty. The underpayment penalty equals the product of the interest rate charged by IRS on deficiencies, times the amount of the underpayment for the period of the underpayment. The penalty is avoided if you meet certain specified exceptions or waivers. Most individuals make estimated tax payments in four installments. For calendar year taxpayers (which is most individuals), the due dates are April 15, June 15, September 15 of the current year and January 15 of the following year.
You may be able to make smaller payments under the annualized income method. This method is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business that you operate in a resort area during June, July, and Aug., no estimated payment is required before Sept. 15. You may also want to use the annualized income method if a significant portion of your income comes from capital gains on the sale of securities which you sell at various times during the year.
When the Underpayment Penalty Does Not Apply?
The underpayment penalty doesn’t apply to you:
- if the total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
- if you were a U.S. citizen or resident for the entire preceding year, that year was 12 months, and you had no tax liability for that year;
- if you are a farmer or fisherman and pay your entire estimated tax by Jan. 15 of the following year, or pay your entire estimated tax by Mar. 1 of the following year and also file your tax return by that date; or
- for the fourth (Jan. 15) installment, if you aren’t a farmer or fisherman, file your return by Jan. 31 of the following year, and pay your tax in full.
Other Circumstances with no estimated tax penalties
In addition, IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable or against good conscience to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled.
You should also use Form 2210 (PDF) to request a waiver of the penalty for the reasons shown above.
If you had no tax liability for the prior year, you were a U.S. citizen or resident for the whole year and your prior tax year covered a 12-month period, then you do not have to file Form 1040-ES.