Why do I have to make estimated payments?
Federal and California State income taxes are pre-paid.
For most people who are paid through payroll, this means that the estimated taxes are withheld from your paycheck throughout the year, and then you file a return to claim a refund or make up the balance due. But if you have multiple sources of income, or receive your income without having any withheld for tax, you may become subject to estimated taxes and underpayment penalties.
There are times when you would want to make extra payments – if you have a profit on the sale of capitalized assets such as the sale of a house or stocks, or if you have large gambling winnings to report, or make taxable withdrawals from your retirement accounts. But for most people, tax estimates are about avoiding underpayment penalties. To avoid penalties, a tax payer wants to satisfy any one of the ’Safe Harbor’ guidelines.
- The first safe harbor guideline is based on the current year tax. Calculate your estimates income tax and subtract any refundable credits – if the difference is less than $1,000 ($500 for California) then you do not need to make any estimates.
- For the second breakpoint, take your figure from above, multiply by 90% and subtract your withholding (withholding only, not your estimated payments) – if the difference is less than $1,000 ($500 for California) than you meet the second guideline of withholding at least 90% of the current year tax.
Relying on either of these can be risky, unless you have control of your own salary and withholding. It is generally better to use the prior year tax harbors to be considered penalty proof.
- Another safe harbor is based on the prior year’s adjusted gross income. If your AGI was $150,000 or less ($75,000 for married filing separate) and you have at least 100% of the prior year’s tax in estimates and withholdings you will not have any penalty. If your AGI exceeds these limits, then your estimates and withholdings must be 110% to reach safe harbor.
Using the prior year tax liability for your tax withholding is the most reliable method, but you must have all of your tax payments made through withholding or timely quarterly estimates to avoid penalties. 15 days after the quarter ends – 4/15, 6/15, 9/15, and 1/15 – you must make a quarterly estimate (25% per quarter for Fed, 30/40/0/30% for CA). If an estimate is late they will apply penalties, but the rate is very low so as long as you make it up as soon as possible it should not be a large amount due.
Generally, our office will calculate any estimated payments necessary to prevent penalties when we prepare your prior returns and extensions. Obviously this requires some guesswork, and if a significant event occurs changing your financial situation we are not aware of, we cannot guarantee 100% that you will avoid any penalties. But if you keep us up to date with what’s happening, we can help you avoid most of them.