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Pay as You Go: How to Avoid an Estimated Tax Penalty

By April 7, 2021April 14th, 2021No Comments

The US income tax system is what the IRS calls “pay-as-you-go,” which means that you can’t sit down to file your tax return in the spring and pay all of the taxes you owe for the previous year at once. Instead, you must pay estimated taxes throughout the year. For many people, this is simple. Your employer (or employers) takes care of the payments you owe the IRS throughout the year using what’s called withholding. Part of every paycheck is sent directly to the federal government, which you can see on your paystub, along with other deductions like Social Security tax and retirement contributions.

However, estimated tax payments get more complicated when you earn income in other ways, such as self-employment (including in the gig and sharing economies such as driving for Uber or dog walking through Rover), interest, dividends, alimony, rent, gains from the sales of assets, and prizes. These sources of income are not subject to withholding, so you need to pay taxes on them throughout the year on your own in most cases. These payments, determined using Form 1040-ES, Estimated Tax for Individuals, are due four times each year: April 15, June 15, September 15, and January 15 of the following year. If these dates fall on a Saturday or Sunday, estimated tax payments are due the following business day.

If you fail to pay estimated taxes on your income, you will likely owe the IRS an estimated tax penalty.

How to Avoid Estimated Tax Penalties

Avoiding an estimated tax penalty requires that you pay the vast majority of your income taxes on time throughout the year—long before you file your tax return. When you do prepare your taxes for the previous year, you must owe less than $1,000 in income taxes to the IRS to avoid a penalty for underpayment of estimated taxes or the payments you made should total “at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.” When your income exceeds the threshold amount, this becomes 110% of last year’s tax.

In order to avoid an estimated tax penalty, you should estimate your tax liability as accurately as possible each quarter. Many personal and professional changes can alter the amount of estimated taxes you owe and can make you more susceptible to an estimated tax penalty. Assess whether you had significant changes in income, got married or divorced, had a child, or started a second job. You must also ensure there were no changes in tax law that could impact how much you owe to the IRS.

In certain situations, the IRS can waive the estimated tax penalty. However, these circumstances are extreme, including casualty, disaster, retirement, or disability. It is not wise to count on these conditions to avoid an estimated tax penalty. If you need help avoiding an estimated tax penalty, contact the experienced tax professionals at East Coast Tax Consulting Group.

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You deserve the best in IRS tax representation, tax preparation, and tax planning services. At East Coast Tax Consulting Group, you’ll work with a licensed CPA who will handle your case from beginning to end. We invite you to contact our team to schedule a free, confidential consultation.