The federal government enjoys receiving a steady stream of tax revenue throughout the tax year rather than a lump sum payment made at the end of the fiscal year. For this reason, employers are required to withhold federal taxes from employees and deposit them with the U.S. Treasury either quarterly, monthly or semi-weekly. However, certain taxpayers may be required to pay estimated taxes throughout the tax year to satisfy their legal obligations. If a taxpayer receives income not subject to withholding such as self-employment income, interest, dividends, rent, alimony, unemployment compensation or Social Security benefits, then he or she may have to make estimated tax payments. Generally speaking, taxpayers must pay at least 90% of the taxes they will owe through the tax year through either income withholding or estimated tax payments or else they may owe a penalty to the Internal Revenue Service.
Taxpayers subject to the estimated tax must make 4 required installment payments for each taxable year. 26 U.S.C. §6654(c)(1). Each required installment payment shall be 25% of the "required annual payment." 26 U.S.C. §6654(d)(1)(A). The due dates for the required installment payments are:
- 1st Payment - April 15th.
- 2nd Payment - June 15th.
- 3rd Payment - September 15th.
- 4th Payment - January 15th of the following tax year.
If any of the payment due dates are on a Sunday or holiday, then the payment is due on the next business day. If sent in the mail, the payment will be considered timely if the envelope is postmarked on or before the due date regardless of when the IRS actually receives it.
The "required annual payment" is the LESSER of one of the following:
- 90 percent of the tax shown on the return for the taxable year (or, if no return is filed, 90 percent of the tax for such year). 26 U.S.C. §6654(d)(1)(B)(ii). OR
- 100 percent of the tax shown on the return of the individual for the preceding taxable year (UNLESS the taxpayer did not file a return for that taxable year or the taxable year was less than 12 months). 26 U.S.C. §6654(d)(1)(B)(ii). However, the following limitations apply on use of the preceding year's tax:
- If the adjusted gross income of the individual on the preceding taxable year exceeds $150,000.00, then "110 percent" is substituted for "100 percent". 26 U.S.C. §6654(d)(1)(C)(i).
- If the individual's filing status in the preceding tax year was married filing separately and adjusted gross income exceeds $75,000.00, then "110 percent" is substituted for "100 percent". 26 U.S.C. §6654(d)(1)(C)(ii).
Taxpayers that may be required to make estimated payments include individuals, estates and trusts. Estates and trusts may have to make estimated payments based on the income generated during the tax year, not the corpus of the estate or trust ("Corpus" is the assets already possessed by the estate or trust at the beginning of the tax year). However, the following exception apply to certain estates and trusts:
- An estate of a decedent with a taxable year ending before the date 2 years after the date of the decedent's death does NOT have to pay estimated taxes for that taxable year. 26 U.S.C. §6654(l)(2)(A).
- A trust of a decedent with a taxable year ending before the date 2 years after the date of the decedent's death does NOT have to pay estimated taxes for that taxable year. 26 U.S.C. §6654(l)(2)(B). To qualify for this exception, the decedent's trust must be:
- All of which was treated as owned by the decedent (e.g. a grantor's revocable trust), AND
- To which the residue of the decedent's estate will pass under his or her last will and testament (or, if no will is admitted to probate, which is the trust primarily responsible for paying debts, taxes and expenses of administration).
- A charitable trust subject to taxes under 26 U.S.C. §511 or a private foundation is not subject to estimated taxes. 26 U.S.C. §6654(l)(3).
Any taxpayer who fails to make the required quarterly estimated payments will be liable for an underpayment penalty equal to the sum of the federal short-term rate plus 3% as described in Section 6621 of the Internal Revenue Code. 26 U.S.C. §6654(a). However, no penalty may be assessed if ANY of the following apply:
- The tax due for the year (after accounting for any federal income tax withheld) is less than $1,000.00. 26 U.S.C. §6654(e)(1).
- The taxpayer was a U.S. citizen or resident all year and had no tax liability for the preceding tax year. 26 U.S.C. §6654(e)(2).
- The IRS determined that the penalty would be against equity and good conscience because of casualty, disaster or other unusual circumstances. 26 U.S.C. §6654(e)(3)(A).
- The taxpayer retired after reaching age 62 or became disabled in the tax year in which estimated payments were due, and the underpayment was due to reasonable cause and NOT willful neglect. 26 U.S.C. §6654(e)(3)(B).
In cases where the taxpayer's income is subject to significant fluctuations from quarter to quarter during the tax year or it is difficult to determine what the required annual payment will be, then the taxpayer may elect to use the annualized income installment method to pay estimated taxes. This method can be calculated using IRS Form 2210 and may assist in decreasing or eliminating underpayment penalties when the taxpayer's ultimate yearly income is uncertain. In these circumstances, the taxpayer may benefit from the assistance of a skilled tax professional.
Due to the significant changes in the Internal Revenue Code after passage of the Tax Cuts and Jobs Act of 2017, the Internal Revenue Service announced that it was waiving the estimated tax penalty in tax year 2018 for any taxpayer that paid at least 85% of their total tax liability during the year through income withholding, estimated tax payments, or a combination of the two. Even if the taxpayer did not request a waiver of the penalty on Form 2210 during the 2018 return season, the IRS will now apply the abatement automatically. However, the 90% threshold will be active again for the 2019 tax year and applicable taxpayers should ensure that their quarterly payments are accurate to avoid the underpayment penalty.
If you have questions about estimated taxes or any other aspect of federal taxation, do not hesitate to contact the experienced tax professionals at Kershaw, Vititoe & Jedinak PLC today.