IRS penalties can be painful.
Most people avoid penalty if they owe less than $1,000 in taxes for the year, or if they paid at least 90% of the tax for the current year, or 100% of the tax of the previous year tax amount, whichever is smaller.
If your AGI is less than $150,000 (married, filing jointly) or $75,000 (single or filing separately) - you have to cover 100% of previous year income taxes.
If your AGI is over $150,000/$75,000 - you have to cover 110% of previous year income taxes.
Why would that matter?
If you have a significant income from your investments (capital gains or dividends) or rental income, the income tax is not automatically deducted. You are responsible for paying additional taxes yourself.
As I hit $100,000 in additional income coming from my "Cash flow" challenge account this year, I want to make sure not to be on the hook for this penalty.
How high is the penalty?
It is a 5% penalty.
It is calculated from the due date (see the quarterly due dates below) until the payment is made.
Usually the estimated payment are equal amounts, you can also make payments each month instead of quarterly.
With investments, you can't estimate the income accurately. If you didn't send equal payments, you may have to file IRS Form 2210 to explain why you didn't send equal payments.
By filing this form (Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts) together with your tax return you can show that your uneven estimated payments match up with the income that you received unevenly over the course of the year.
When to pay the IRS?
The are quarterly due dates for the quarterly estimated payments.
They are on April 15, June 15, September15 and January 15. If one of those dates falls on a Saturday, Sunday or legal holiday, the date moves to the next business day.
How to pay the IRS?
There are two ways:
1. If you have a job where the taxes are withheld, you can increase your paycheck withholding.
2. If you don't have traditional job, or you don't want to decrease the amount of your paycheck (in cases where the additional income is very variable), you can pay the IRS directly.
The online method may be the most convenient for many, but there are different payment methods listed on the IRS web site IRS.gov/Payments.
The difference between paying as payroll withholding versus estimated quarterly taxes is that the by paying quarterly you have to be more careful not to underpay for each quarter. The payroll withholding will be handled by IRS as the entire year independent of quarters.
