What to Know About Estimated Taxes

What to Know About Estimated Taxes

Background: U.S. tax law requires taxes to be paid on time. Wages are never a problem, because employers are required to withhold taxes out of each paycheck and send the tax directly to the IRS. But some taxable income is not subject to required withholding and therein lies the problem. If nothing is withheld, the IRS then requires the taxpayer to square up taxes quarterly. Someone who fully intends to pay the tax but thinks they can wait until the end of year and pay it all at once will get hit with a late payment penalty – with interest. According to Laura Saunders (no relation) of the Wall Street Journal, the IRS took in over $1.3 billion in tax penalties in 2024. Moving from working – where your employer is responsible – to retirement – where you are responsible – can trigger this issue.

Strategies to Avoid the Penalty:

1. Pay taxes as income comes in. You can go to the IRS website and make a tax payment at any time. If you have a quarter with income that had no withholding (self-employment, investment gains, capital gains or IRA distributions), consider getting online to make a tax payment.
2. Consider the “Safe-Harbor” rules. There are two basic “Safe-Harbor” approaches you can use when paying quarterly, estimated taxes:

• The IRS will give you a break if you pay at least 90% of your total tax for the year via withholding. So even if you misjudge a bit, you can avoid the penalty.
• If you think it will be hard to gauge income each month or quarter, you can pay based on last year’s taxes in four quarterly installments this year, and you will also avoid a penalty even if you were off. If your AGI is $150,000 or less, then you must pay 100% of last year’s tax over the four quarters. This safe harbor is 110% of last year’s taxes if your AGI is over $150,000. NOTE: You still have to spread it over 4 quarterly payments. Waiting until the end of the year will trigger the penalty.

3. Utilize the withholding “assumption.” When you have taxes withheld from a taxable withdrawal, the IRS assumes that the withholding was timely and paid equally over 12 months, even when it wasn’t. For example, if you make a large taxable IRA distribution in the 4^th quarter and you have a good handle on what your total taxable income will be for the year, just make sure your withholding on the IRA distribution gets you to the 90% safe harbor number described above and you should avoid a penalty.

Estimated taxes are yet another reason I believe a good tax preparer is worth his or her weight in gold. There are just too many ways to get caught in the estimated tax penalty trap.

Fun Fact: I am taking my winter break in Florida this week, along with my wife and my daughter…er dog, Ava. We’ve done the two-day drive to Florida several times now and Ava knows when we are getting close to the hotel after the first day of travel. She also seems to recognize certain food stops. Dogs can remember routes and specific locations though scent, visual landmarks and spatial memory. None of that explains why she was wearing sunglasses when we passed the Georgia/Florida border though.