#Middlebury #IRS #MarkBurns
by Mark A. Burns
Last month we discussed the different methods you can use to pay your taxes to the IRS. This month we will discuss the timing of those payments if you want to avoid having to pay penalties to the IRS.
Our U.S. tax system is a “pay-as-you-go system,” which means you are supposed to pay your taxes throughout the year as you earn the income. There are two types of tax payments – withholdings and estimated payments.
If you have sufficient taxes withheld from your various income streams, you may be all set. But if your tax withholdings are insufficient to cover your full tax liability, possibly because you have other significant sources of income (e.g., self employment, investment, capital gains or rental income), then you should be making quarterly estimated tax payments.
There are two types of penalties the IRS imposes for not paying your taxes timely. The first is the penalty for “late payment” of taxes. You can avoid this by paying your full tax liability no later than April 15 each year, i.e., the due date of your tax return. The second penalty is the “estimated tax penalty,” and this relates to making insufficient payments quarter by quarter. To avoid the second penalty, you are not required to pay 100 percent of your tax liability. Rather you can avoid this penalty by ensuring that you satisfy one of the following exceptions allowed by IRS.
The first exception is the “safe harbor” and it is based on the prior year’s actual tax liability. As long as you pay in quarter by quarter a pro rata portion of 100 percent of your prior year’s taxes, then you will avoid penalties. (The 100 percent figure increases to 110 percent once your income is over certain levels).
The next exception allows you to base your quarterly payments on the current year’s estimated tax liability, and this allows you to make lower quarterly payments than the safe harbor exception above. This method is beneficial if you expect your current year’s taxes to be lower than the prior year.
A variation of this second exception is the “annualized” method. This method is most beneficial when your income is very unpredictable and/or earned unevenly throughout the year. Using this method, you take your actual income earned to date each quarter, then “annualize” that income amount and estimate your full year annualized tax liability. You then pay in a pro rata portion that is due for the quarter. This allows you to make lower payments when income is lower and then to catch up on a cumulative basis in those quarters when income is higher.
When evaluating the above exceptions, tax withholdings are considered to have been paid evenly throughout the year, whereas quarterly payments are considered made on the actual payment date.
Always consult a tax professional if you are uncertain about how tax matters might affect you.
READERS: Do you have a tax topic you would like Mark Burns to discuss in this column? If so, please send your column idea to Mark@DFSPC.biz.
Mark A. Burns, M.B.A., is a C.P.A. with Diversified Financial Solutions PC in Southbury. He can be reached at 203-264-3131 or Mark@DFSPC.biz.
