“Dear Gary, I see you sent me quarterly estimates to pay. Do I have to pay them? Can I pay less than you recommend?”
The above is one of the most asked questions I get from my clients. My response is normally along the lines of “No, you just have to understand the consequences of not paying them.”
The taxing authorities want their money early and do not want to wait until April 15th of the following year to get it. If they do have to wait until April 15th they assess an “Underpayment of Estimated Tax Penalty.” It is unfortunate that they use the word “penalty” as that tends to scare people; in actuality it is really just an interest charge.
Effective April 1, 2022 the Internal Revenue Service announced that this penalty will be increasing from 3% to 4% compounded daily. When it is explained that way, it isn’t quite as scary. Taxpayers who feel they can earn more than 4% on their money will choose to not make quarterly estimates and will gladly pay the penalty with their tax return.
The Internal Revenue Service breaks the year down into four periods and require payments to be made by April 15th, June 15th, September 15th, and January 15th of the following year to cover the tax for each one of these periods. These periods are used to determine if you have paid enough to avoid the penalty. In order to satisfy their requirement, you must have either paid:
- 90% of the current year tax or
- 100% of your prior year tax (110% if your previous year’s adjusted gross income was greater than $150,000)
There are a few other wrinkles to consider. If the amount you owe is under $1,000 there is no penalty assessed. There are also exceptions for reasonable cause, retirement, disability, etc.
Withholdings are also reported as evenly spread throughout the year no matter when they are actually withheld. This can cause taxpayers who have less withholdings in the current year than the previous year to be hit with the penalty even if they pay their quarterly estimates.
If an estimate is paid late, the penalty is assessed daily until it is received.
As I always tell my clients, it’s important to remember that these are estimates. If they were “actuals” we would all be in a lot of trouble.
Gary Weinman, C.P.A., is a Tax Partner at Katz, Nannis + Solomon, P.C. If you have any questions or would like to speak with one of our tax professionals, please contact our office at 781-453-8700.