Estimated Tax Penalty

October 21, 2014

Today we will discuss a possible way to avoid the estimated tax penalty for some taxpayers. Some individuals with substantial income in addition to salaries may find that the amount of tax withheld from their salaries isn't enough to cover their required estimated tax payments.

An individual subject to the estimated tax must pay 25% of the “required annual payment” for the current year on each of four installment dates. The four dates are normally April 15, June 15, September 15 and January 15 of the following year for a calendar-year taxpayer. 

The required annual payment is generally the lesser of 100% of the tax shown on the taxpayer's return for the preceding year or 90% of his tax for the current year. 

However, taxpayers whose 2013 AGI (adjusted gross income) was over $150,000 must pay the lesser of 110% of the tax shown on the 2013 return or 90% of their 2014 tax liability.  The applicable test is applied separately to each installment. Thus, a taxpayer may be penalized for the underpayment of estimated taxes for any installment for which the estimated tax payments plus taxes withheld from salary (and certain other payments) don't total at least 25% of the required annual payment. 

An individual who has underpaid an estimated tax installment can't avoid the penalty by increasing his estimated tax payment for a later period (although payment in a later period will reduce the period for which the penalty applies). 

But a possible solution is increased withholding. Income tax withheld by an employer from an employee's wages or salary is treated as paid in equal amounts on each of the four installment due dates unless the individual establishes the dates on which the amounts were actually withheld. 

Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates. This additional withholding could also come from a qualified retirement plan or Individual Retirement Account distribution.

 

Disclaimer: The items included in the Tax Tip Tuesday Video Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation. IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advise contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein 

 

 

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