Since we are still slow on Philly sports news, we are going to get right into the topic of the week. As most of you know, the third quarter tax estimate deadline for individuals is less than 30 days away. Hopefully you have paid the correct estimates for the first two quarters! For those of you who are unsure if you met the minimum requirements for these payments, I am going to explain to how to keep you clear of additional tax penalties.
The General Rule of Thumb
The IRS will assess an underpayment of estimated tax penalty if you do not pay in at least the “safe harbor” payment, which is the lesser of 1) 90% of your current year tax liability or 2) 100% of your prior year tax liability (if your AGI is over certain thresholds, then the percentage increases to 110% of your prior year tax liability). Note that if you did not have any tax liability (see line 63 of your prior tax return), then there are no minimum payments that are required to be paid.
If you do not pay in equal installments, the IRS can assess penalties on the spread of the amount owed versus the amount paid in that time period. The first three installment payments are due on 4/15, 6/15, and 9/15. The last payment is due the following calendar year on 1/15.
How to Calculate the IRS “Safe Harbor” Payment
In general, to determine the “safe harbor” payment, you will first need to look at your prior year’s tax return line 63. This amount is your prior year tax liability. Starting with this multiply it by the percentage in #2. Then divide it by the quarter number you are paying (example: divide by three for the third quarter payment). From there, reduce it by any payroll withholdings, tax estimates previously paid, and/or known tax credits available. The resulting amount is the amount for #2 in the “safe harbor” analysis.
Now, let’s move to calculation in #1 of the “safe harbor” calculation. This is a bit more tricky as you will need to calculate your current year’s tax liability. Preferably with the help of your tax accountant, gather all your income and deductions to work up your taxable income figure. From there, you will need to calculate your tax liability using the IRS tax tables or brackets for the current year. Similar to the above, multiply this by 90% and divide by the quarter number you are paying. Once you have this amount calculated, determine if you have any additional tax liabilities, such as self-employment taxes, etc. Then reduce this by any payroll withholdings, tax estimates previously paid, and/or known tax credits available.
Once you have both of these amounts figured out, the minimum payment due is the lesser of the two numbers.
What is the Penalty for Not Paying?
The penalty is based on the IRS prescribed rate for the particular quarter. This rate is then used to figure a daily penalty rate percentage and this is multiplied by the number of days the payment is past due. If you owe a penalty, it is assessed when you file your tax return in April.
Please note that there are additional methods for calculating the penalty, such as the Annualized Income Installment Method, so please discuss this with your tax advisor before proceeding to calculate your penalty.
Should you have any questions on this topic, please do not hesitate to contact me directly!