The IRS requires individuals who earn income that is not subject to withholding, such as earnings from sole proprietors, partnerships and S-corps, interest, dividends, rents, and alimony, to pay quarterly estimated tax payments, also known as “estimates.” If these payments are on your to-do list, here are a few things you should know:
How are estimated tax payments calculated?
The easiest way to calculate estimates is to follow the “safe-harbor” rule. Safe-harbor requires your current year tax payments to be at least 100 or 110 percent of last year’s taxes, depending on your income. This involves looking at your prior year tax liability, reducing it by your withholding, and dividing the remainder by four. The result will loosely equal your quarterly estimate payment. This approach is considered “safe” because it calculates your payment based upon statute.
If you do not follow the safe-harbor rule, you project your income and pay estimates based on 90 percent of your current year projected tax. Although this process is more complicated, it is useful if your income varies or is less than the previous year’s.
If you don’t pay your estimates, the IRS will levy an underpayment penalty, which is currently 5 percent. However, if you must take money out of a high rate of return investment or strap your business for cash to pay your estimates, it might make more sense to forgo paying estimates and pay the relatively mild penalty.
How has the recent tax reform impacted estimated tax payments?
The changes brought about by the Tax Cuts and Jobs Act (TCJA) lowered the withholding on wages. Because of this, many taxpayers may be under-withheld for 2018.
How can my tax advisor help?
Changes in your business could significantly impact your estimated tax payments, so it’s important to keep your tax advisor in the loop. For instance, if your 2017 revenue was especially high due to a few large projects, it might mean that your 2018 income will be lower. Basing your 2018 estimates on 110 percent of your 2017 tax could cause you to significantly overpay your income tax.
On the other hand, if 2017 was a slow year, but you expect 2018 to be gangbusters, consider using the 100 or 110 percent safe-harbor calculation. This would allow you to pay enough to avoid underpayment interest while potentially deferring payment of the full balance. Keep in mind, however, that this might result in a large balance due in April, for which we can help you plan.
If you’re wondering how the TCJA may have affected your quarterly estimates, your tax advisor can run an end-of-the-year projection to figure it out. We can help you with this and other matters related to your estimated tax payments, so don’t hesitate to give us a call.