Many people mistakenly believe tax withholding will be adequate and possibly guess at a “cushion” for estimated quarterly tax payments. A second mistake is thinking the IRS means what they say in using the term “quarterly.” If only it were that straightforward.  

The IRS estimated tax payment quarters are not every three months. Instead, they are due April 15, June 15, September 15, and January 15 of the next year. That’s certainly not every three months on a regular, non-IRS, calendar. 

Given recent changes in the market over the past year, there’s now a lot more strategy at play.  

Why pay estimated taxes? 

Simply put, investors, sole proprietors, partners, LLC members, or S corporation shareholders typically need to pay quarterly estimated tax payments – or face penalties since this income doesn’t have any taxes withheld. Tax withholding on retirement plan income and Social Security is possible but often overlooked and seldom adequate.  

A general rule of paying at least 90% of your current year’s tax liability ratably through withholding and estimated taxes will avoid penalties. But what if 90% is hard to determine because of uneven or irregular income? We’ll get to that later. 

Enter “safe harbors,” a technique where your income can explode, yet penalties are avoided, always remembering in April when your return or extension is filed that you may owe a large balance.  

What’s your safe harbor? 

Well, there are actually two “safe harbors:”  

• If your prior year’s income was less than $150,000, you only need to ratably pay in 100% of that year’s liability for this year to be penalty protected. It can be through any combination of withholding and estimated tax payments. 
• If you had more than $150,000 of the prior year’s income, you should ratably pay in 110% of your prior year’s tax liability in estimated tax payments throughout the year to avoid penalties. Again, you can do this through any combination of withholding and estimated tax payments. 

Let’s get practical. What could impact your estimated taxes? 

If you expect your income to be down from the prior year, you should pay 90% of your current year’s tax liability and perform projections each quarter to determine the amount you need to pay to hit 90%.  

Say you had a great year in the market in 2021 with lots of capital gains. Why base your 2022 estimated payments on the prior year? Paying 110% of non-recurring income is ludicrous. Now you must make quarterly projections, which is a pretty common situation for many taxpayers. 

If you expect your income to be up from the prior year, then you should pay 110% of your prior year’s tax liability. You can win a big Powerball lottery prize and still be protected from penalties. 

What if your income is not earned evenly during the year? Now you must guess your 90% for 2022. There is an obscure option to “annualize,” to treat each quarter as if it were a small year. If you didn’t earn anything in the first quarter, you might not owe for that quarter. This gets done for each quarter, saving cash flow with a settle-up toward the 90% target later or at the end of the year.  

Here’s another trick: withholding can be disproportionate during the year and yet be treated as ratable, even though not, or when needed specifically allocated to quarters. Two options that can help. 

Should you worry about the IRS? 

The IRS is not who you want to owe money to, and you do not want them to be your bank. They may look at your return differently, maybe even flag your return, and if you need an appeal, they’ll check if you’ve paid your taxes on time. If you haven’t, they may not give you relief to avoid a penalty.  

Something to consider: if you’ve overpaid, think long and hard before asking for a refund if you need money for your estimated payments. Given the processing delays at the IRS and low interest rates, a refund may not come until the second or third estimated payment is due. We have seen some delays take over a year. Why run that risk and be out the money for estimated taxes while the IRS still has your refund money?  

Sounds easy, right? Not so quick 

The best recommendation is to reach out to the Friedman + Huey team of professionals to ensure you’re within safe harbor, avoiding penalties, and not float an interest-free loan to the government. Click here to learn how we can help you make accurate projections to strategically manage your withholdings, estimated tax payments and, in the long run, create an effective tax payment strategy.  

This information is general, not specific, and is only meant to give perspectives on matters discussed which may change without notice. It is not intended to be tax or financial advice.  Information has been obtained from various sources believed to be reliable, but interpretations and accuracy are not assured. Please contact us for any questions you may have or to revisit your planning strategies.