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Avoiding Estimated Tax PenaltiesFederal
tax law requires the payment of income taxes throughout the year as you earn your income.
This obligation may be met through withholding or quarterly estimated tax payments or
both. For 1999, if total tax minus withholding and payments is less than $1,000, you will
not be assessed a penalty for underpayment of estimated tax. However, if you overpay your
estimated taxes, you are in effect making an interest-free loan to the government, which
you would probably prefer to avoid. The penalty for underpayment is calculated as interest
on the underpaid balance until it is paid, or until April 15, 2000, whichever is
earlier. The interest rate on underpayments in 1999 is 8 percent for the fourth quarter of
1999, and the rates for 2000 will be announced quarterly by the Internal Revenue Service
(IRS). The rates are adjusted under a prescribed formula in response to changes in federal
short-term interest rates. Beginning in 1999, the interest rate on IRS overpayments will
conform to the same rate as underpayments.
- Methods for Avoiding Estimated Tax Penalties for 1999 Taxes. There are
several ways to avoid estimated tax penalties. The basic rule is to pay the required
amount by the end of the year through withholding and quarterly estimated payments. The
required amount will be one of the following, depending on the individual taxpayer’s
situation:
- 90 percent of the current year’s tax liability.
- 100 percent of the prior year’s tax liability (increases to 105 percent for
taxpayers who have adjusted gross income in excess of $150,000).
- 90 percent of the tax liability based on a quarterly annualization of current
year-to-date income
Penalties are based on the difference between the lowest amount required to be paid by
each quarterly payment date and the amount actually paid by that date. If payments are
based on one of the first two alternatives above, the annual required amount must be
divided equally among the four quarters to determine the cumulative amount due at each
quarterly payment date. In the case of annualized income, however, the amount due by each
payment date is determined based on income to date. Thus, the annualization method may be
the one for you to use if you accrue or receive much of your income during the latter part
of the year, because the annualization method allows for lower required payments in the
early quarters. Table 2-2 illustrates the amount required
to be paid (cumulatively) for 1999 taxes under each method by each date.
Table
2-2
Cumulative Amount of Estimated Taxes to Be Paid |
|
Due Date |
| 1999 Tax Payment
Methods |
15
April |
15
June |
15
Sept |
15
Jan |
| Current
year's tax |
22.5% |
45% |
67.5% |
90% |
| Prior year's
tax (safe harbor): |
25% |
50%
|
75% |
100% |
Tax on annualized
income
to date |
22.5%
|
45% |
67.5% |
90%
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Payments made through withholding from your paycheck (or from your pension or other
payments) are given special treatment. The IRS treats income tax that is withheld as
having been paid equally throughout the year (unless you prefer to use actual payment
dates). This lets you make up for underpaid amounts retroactively, because amounts
withheld late in the year may be used to increase the amounts deemed paid in earlier
quarters.
Thus, you may reduce or avoid underpayment penalties by adjusting withholding late in the
year, something you cannot do with quarterly estimated tax payments. If you find that your
payments to date are inadequate, you should arrange with your employer or pension provider
to adjust your withholdings to the extent possible to cover any anticipated shortfall. The
additional amount must be withheld before December 31 to apply to the current year’s
tax. If you cannot adjust withholding, you should at least make a prompt quarterly
payment, which will stop the growth of underpayment penalties.
- State and Local Rules. Most of the state and local taxing districts have
similar rules and penalties related to the prepayment of income taxes during the year.
Since many states have prepayment rules that vary from the federal requirements listed
above, you need to become familiar with the rules for the states and localities in which
you file returns and take the steps necessary to avoid underpayment interest and
penalties. You must therefore judge the adequacy of the tax payments to authorities at all
levels.
- Other Taxes. When computing your required estimated tax payments, do not overlook
the increasing number of "other taxes" that apply in addition to the regular
income tax. Some, such as the self-employment tax and the alternative minimum tax, have
existed for many years. Others, such as the employment taxes for domestic employees, are
relatively new.
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Tax Guide
