What You Need to Know About Estimated Tax Payments

Safe Harbor Tax Estimates

Your tax preparer gives you estimated tax payment vouchers with your tax return yearly for your benefit. Estimated tax payments are similar to the withholdings that employees see on their paychecks, which require you to pay in advance the taxes that most likely will be due with your next year tax return. Failing to do this leads to unnecessary penalties being owed on your federal return, even if you are due a refund when you file!

Windfalls, unanticipated revenues, multiple W-2s from different employers, and variable cash flow from self-employment all affect the estimated tax process in various ways. Taxpayers should contact their tax preparers if their situation changes and estimates may need to be revised.

You can avoid the penalty for failure to pay estimated tax by meeting one of the three safe harbor provisions:

1. Your estimated payment and withholding total at least 90% of the tax shown on the current year’s return. This is something your tax preparer can determine for you by using your last year tax return along with other information to calculate the current year tax liability.
2. Your estimated payment and withholding are at least 100% of the tax shown on the prior year’s return (called the no-estimate safe harbor), provided the prior year’s return covered a 12-month period.  An individual with adjusted gross income in excess of $150,000 ($75,000 for Married Filing Separate) in 2010 can avoid the estimated tax penalty by paying 110% of the amount of tax shown on the prior year’s tax return, provided the prior year was a full year.  No estimation of current year’s income is required if this option is available.
3. Installments are made on a current basis under an annualized income installment method. This is beneficial for taxpayers that do not receive their income evenly throughout the year. This method allows you to pay larger estimates during the periods that you earn more income and less during the less profitable periods (which can be helpful for small shop owners that operate mainly during the tourist seasons).

In order to avoid the penalty, you must choose one of these three options and use it for the full tax year and pay on time! Your tax preparer can help you decide which provision would be right for you. For more information about avoiding unnecessary and costly penalties or for any help with your tax and financial questions, please give us a call!