Tax Topic

Estimated Tax Payments

The US Treasury and IRS run a "pay as you go" system as far as how your Form 1040 taxes are collected. This means you are supposed to pay income tax throughout the year as you earn your income regardless of whether that income is wages/salary, investment income, rental income, etc. Most people have sufficient withholdings on their wage/salary income, but if you have other sorts of income, say interest, dividends, and/or capital gains, you must pay income taxes in four equal mid-year payments using Form 1040-ES or risk paying "estimated tax penalty." Estimated Tax Penalty is one of the least onerous IRS penalties. It's essentially interest at the going rate (currently 4% as of Q1 2017).

There are two safe harbors to avoid paying estimated taxes. If you pay 90% of your current year's tax liability into the IRS in the form of W-2 withholdings and equal estimated tax payments paid timely throughout the year (4/15, 6/15, 9/15, 1/15), you will not owe estimated tax penalty, basically a 10% buffer. Alternatively, if you pay in 100%/110% (depending on whether your prior year AGI is <= $150,000) of your prior year tax liability in the form of W-2 withholdings and equal estimated tax payments paid timely throughout the year (4/15, 6/15, 9/15, 1/15), you will not owe estimated tax penalty even if you have a very large tax due on April 15. In all cases, all tax due is due no later than April 15, otherwise you will incur a .5%-per-month late payment penalty (max 25%). And if you don't file your tax return timely, the separate late filing penalty is an additional 5% per month (max 25%).

Here is a link to the IRS instructions and form set for 2016 estimated payments: http://www.irs.gov/pub/irs-pdf/f1040es.pdf

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