The last of the four estimated tax payments for calendar year 2011 is due Jan. 16 (the fourth estimated tax payment is ordinarily due Jan. 15, but that day is a Sunday this year). Have you paid in enough during the year? If not, what will happen and what can you do about it?
How much do you have to pay?
Ideally, the four estimated tax payments you make each year will add up to your tax liability for the year. However, if your income varies substantially from year to year (as it does for many real estate professionals), it can be hard to estimate how much you must pay during the year. If you don’t pay enough estimated tax, the Internal Revenue Service will impose a penalty.
Fortunately, there is a way to avoid having to estimate how much you’ll make this year. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:
- 90 percent of your total tax due for the current year; or
- 100 percent of the tax you paid the previous year; or
- 110 percent if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns).
Have you already paid enough?
By this time you should have a pretty good idea of what your income for the year will be. If you’re reasonably sure that your income for the year will be at least 25 percent less than what you earned last year, you can forgo the last estimated tax payment due on Jan. 16. You have already paid enough estimated tax for the year.
What if you’ve paid too little?
The IRS imposes a money penalty if you underpay your estimated taxes. Fortunately, the penalty is not very onerous. You have to pay the taxes due plus a percentage penalty for each day your estimated tax payments were unpaid.
The percentage is set by the IRS each year. Currently, it’s about 3 percent. This is the mildest of all IRS interest penalties.
Many self-employed people decide to pay the penalty at the end of the tax year rather than take money out of their businesses during the year to pay estimated taxes. If you do this, though, make sure you pay all the taxes you owe for the year by April 15 of the following year.
If you don’t, the IRS will tack on additional interest and penalties. The IRS usually adds a penalty of 0.5 percent to 1 percent per month to a tax bill that’s not paid when due.
Because the penalty is figured separately for each payment period, you can’t avoid having to pay it by increasing the amount of a later payment. For example, you can’t avoid a penalty by doubling your Jan. 15 payment to make up for failing to make your Sept. 15 payment.
If you miss a payment, the IRS suggests that you divide the amount equally among your remaining payments for the year. But this won’t avoid a penalty on payments you missed or underpaid.
The IRS will assume you’ve underpaid your estimated taxes if you file a tax return showing that you owe $500 or more in additional tax, and the amount due is more than 10 percent of your total tax bill for the year.
If you have underpaid, you can determine the amount of the underpayment penalty by completing IRS Form 2210: Underpayment of Estimated Tax by Individuals, and pay the penalty when you send in your return.
Tax preparation programs can do this for you. However, it is not necessary for you to compute the penalty you owe. You can leave it to the IRS to determine the penalty and send you a bill. If you receive a bill, you may wish to complete Form 2210 anyway to make sure you aren’t overcharged.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.