Your tax return preparer has just finished preparing your return on April 15 and sends
you a draft along with a cover letter stating that you owe taxes. The tax due is
significant, and you start panicking.
First and foremost, this is a surprise. Secondly, remember that you are paying a tax
liability on income you received in the prior year. There is nothing more painful than
paying a tax bill on cash you have already spent.
So, what could have been done differently?
There is an important difference between a tax return preparer and a tax planner or
strategist. A tax return preparer’s role is primarily to prepare and file required tax forms.
A tax planner focuses on helping taxpayers proactively manage their tax obligations
throughout the year. This proactive planning can add meaningful value for individuals
and business owners.
One effective tool that can help reduce stress and avoid unexpected tax bills is knowing
how to manage estimated tax payments.
When Are Taxes Actually Due?
While an individual or corporate tax return is generally due on April 15 (or the extended
due date), taxes themselves are not all due on that date. The IRS expects taxpayers to
pay taxes as income is earned throughout the year.
For calendar-year taxpayers, most taxes for the preceding year should be paid by
January 15. As a result, even if a tax return is timely filed by April 15 and the balance is
paid at that time, failure to pay penalties and interest may still apply.
Underpayment Penalties and Safe Harbor Rules
If taxpayers do not make timely and sufficient estimated tax payments, they may be
subject to underpayment penalties, even if the full tax liability is paid with the annual
return.
The IRS provides safe harbor rules to help taxpayers avoid these penalties. In general,
penalties may be avoided by paying at least:
- 90% of the current year’s tax, or
- 100% of the prior year’s tax (110% for higher-income taxpayers)
The IRS imposes penalties when required estimated tax installments are not paid by
their due dates. These penalties are calculated for each underpaid installment using an interest rate that is adjusted quarterly. In most cases, there is no reasonable cause exception for these penalties.
Making estimated payments throughout the year can also help manage cash flow and
avoid large year-end tax bills.
Taxpayers Commonly Impacted by Estimated Tax Requirements
Estimated tax payments commonly impact, but are not limited to, the following
taxpayers:
-
Owners of Rental Property
Rental income is generally not subject to withholding, so owners are responsible
for paying estimated taxes as income is earned. -
Single-Member LLC Owners
Single-member LLCs are disregarded entities for federal tax purposes. The
owner reports the income on their personal return and is responsible for paying
estimated taxes throughout the year. -
Partners in a Partnership
Partnerships are pass-through entities. Partners must pay tax on their distributive
share of partnership income, guaranteed payments, and certain gains or losses
as income is earned. -
Shareholders of S Corporations
S corporation income, losses, deductions, and credits pass through to
shareholders, who must report their pro rata share on their individual tax returns.
Estimated taxes are required throughout the year, and failure to make sufficient
payments may result in underpayment penalties.
Key Tax Planning Considerations for Estimated Tax Payments
Below are common planning considerations for small business owners regarding
estimated tax payments:
-
Safe Harbor Rules
Use IRS safe harbor provisions to help avoid penalties by paying the lesser of:
90% of the current year’s tax liability, or
100% of the prior year’s tax liability (110% if prior-year AGI exceeds $150,000 for
individuals or $75,000 if married filing separately) -
Annualization Method
For businesses with fluctuating or seasonal income, the annualized income installment
method allows estimated payments to be based on actual income earned during each
quarter. This can reduce required payments during lower-income periods. -
Increase Withholding Late in the Year
If a shortfall is discovered later in the year, increasing wage withholding for the owner or
spouse, or requesting additional withholding on a year-end bonus, may help.
Withholding is generally treated as paid evenly throughout the year. -
IRA Distribution Withholding
In certain situations, a taxpayer may take a distribution from an IRA and elect to have
taxes withheld. The withheld amount is treated as paid evenly throughout the year. Any
redeposit of funds should be evaluated carefully based on individual circumstances. -
Timely Payments
Estimated tax installments for calendar-year taxpayers are generally due on:
- April 15
- June 15
- September 15
- January 15
Late payments may result in penalties even if the total tax is ultimately paid. If a due
date falls on a weekend or legal holiday, the payment is due the next business day.
How the Annualization Method Works
Under the annualization method:
- Taxable income is calculated year-to-date for each quarter
- That income is annualized to project a full-year equivalent
- Tax is computed on the annualized income
- Required installments are determined based on cumulative percentages
- Prior required installments are subtracted to calculate the current payment due
If the annualized method results in a lower required payment than the standard method,
the lower amount may be paid for that quarter. Any remaining tax is paid in later
installments. This approach allows payment of lower estimated taxes in the first half of
the year and catch up when income is received, improving cash flow and minimizing
overpayments.
Conclusion
Estimated tax payments are an important consideration for individuals and business
owners with income not subject to withholding, and understanding the timing and
requirements can help reduce surprises at tax time and support more consistent cash
flow. Please contact us for more tax advisory and tax planning.
Devon Kwande, CPA is a seasoned Tax Planner and Tax Strategist for individuals and businesses. He also assists with State and Federal Tax compliance matters for entities in Receivership. You may also contact Devon if you need compensation consulting services including pay program design, incentive plan design, compensation studies and pay equity analysis.
