FS-2019-6, April 2019
The U.S. tax system operates on a pay-as-you-go basis. This means that taxpayers need to pay most of their tax during the year, as the income is earned or received. Taxpayers must generally pay at least 90 percent (however, see 2018 Penalty Relief, below) of their taxes throughout the year through withholding, estimated or additional tax payments or a combination of the two. If they don’t, they may owe an estimated tax penalty when they file.
The IRS has seen an increasing number of taxpayers subject to estimated tax penalties, which apply when someone underpays their taxes. The number of people who paid this penalty jumped from 7.2 million in 2010 to 10 million in 2017, an increase of nearly 40 percent. The penalty amount varies but can be several hundred dollars.
The Tax Cuts and Jobs Act, enacted in December 2017, changed the way tax is calculated for most taxpayers, including those with substantial income not subject to withholding. As a result, many taxpayers may need to adjust the amount of tax they pay each quarter through the estimated tax system.
Here are some simple tips to help taxpayers:
Who may need to pay estimated taxes
Individuals, including sole proprietors, partners and S corporation shareholders, may need to make estimated tax payments if:
- they expect to owe at least $1,000 when they file their tax return.
- they owed tax in the prior year.
Taxpayers who may need to make estimated tax payments include someone who:
- receives income that isn’t from an employer, such as interest, dividends, alimony, capital gains, prizes and awards.
- has tax withheld from their salary or pension but it’s not enough.
- has more than one job but doesn’t have each employer withhold taxes.
- is self-employed.
- is a representative of a direct-sales or in-home-sales company.
- participates in sharing economy activities where they are not working as employees.
Wage-earners and salaried employees can avoid estimated tax payments by having their employer withhold tax from their wages. To determine the right amount to withhold, use the Withholding Calculator, available on IRS.gov. Then, based on its recommendations, they can use Form W-4, Employee’s Withholding Allowance Certificate, to tell their employer how much tax to withhold from their pay. Anyone can change their withholding any time during the year.
When to pay estimated taxes
For estimated tax purposes, a year has four payment periods. Taxpayers must make a payment each quarter. For most people, the due date for the first quarterly payment is April 15. The next payments are due June 15 and Sept. 15, with the last quarter’s payment due on Jan. 15 of the following year. If these dates fall on a weekend or holiday, the deadline is the next business day.
Farmers, fishermen and people whose income is uneven during the year may have different rules. See Publication 505, Tax Withholding and Estimated Tax, for more information.
If a taxpayer doesn’t pay enough or pays late, a penalty may apply.
How to figure estimated taxes
The IRS recommends that everyone do a paycheck checkup early in 2019, even if they did one in 2018, to determine if they need to adjust their tax withholding or make estimated tax payments throughout the year. Although especially important for anyone with a tax bill for 2018, it’s also important for anyone whose refund is larger or smaller than expected. By changing withholding now or making estimated tax payments, any taxpayer can better ensure they get the refund they want next year. For those who owe, making estimated tax payments in 2019 is the best way to head off another tax-time surprise a year from now.
Taxpayers should also make adjustments throughout the year if changes occur. When figuring their estimated taxes each year, taxpayers need to account for life events, like marriage or the birth of a child, that may affect their taxes. They should also adjust for recent changes in the tax law.
Individuals, sole proprietors, partners and S corporation shareholders generally use the worksheet in Form 1040-ES. They’ll need to know their expected adjusted gross income. They’ll also need to estimate their taxable income, taxes, deductions and credits. Some taxpayers find it helpful to use information from their prior year’s tax return when they complete the worksheet. Their estimates should be as accurate as possible to avoid penalties.
Some taxpayers earn income unevenly during the year. For example, a boat repair business might do more business in the summer. Taxpayers like this can annualize their income. Under this method, they’d make unequal tax payments, based on when they receive their income, rather than four even payments. Doing so could help them avoid or lower a penalty because their required payment for one or more periods may be higher with this method. See Worksheet 2-9 in Publication 505.
How to pay estimated taxes
Taxpayers can pay online, by phone or by mail. The Electronic Federal Tax Payment System and IRS Direct Pay are two easy ways to pay. Alternatively, taxpayers can schedule electronic funds withdrawal for up to four estimated tax payments at the time that they electronically file their Form 1040.
Taxpayers can make payments more often than quarterly. They just need to pay each period’s total by the end of the quarter. Visit IRS.gov/payments for payment information.
Penalties related to estimated taxes
If a taxpayer underpaid their taxes they may have to pay a penalty. This applies whether they paid through withholding or through estimated tax payments. A penalty may also apply for late estimated tax payments even if someone is due a refund when they file their tax return.
In general, taxpayers don’t have to pay a penalty if they meet any of these conditions:
- They owe less than $1,000 in tax with their tax return.
- Throughout the year, they paid the smaller of these two amounts:
- at least 90 percent (however, see 2018 Penalty Relief, below) of the tax for the current year
- 100 percent of the tax shown on their tax return for the prior year – this can increase to 110 percent based on adjusted gross income
To see if they owe a penalty, taxpayers should use Form 2210.
The IRS may waive the penalty if someone underpaid because of unusual circumstances and not willful neglect. Examples include:
- casualty, disaster or another unusual situation.
- an individual retired after reaching age 62 during a tax year when estimated tax payments applied.
- an individual became disabled during a tax year when estimated tax payments applied.
There are special rules for underpayment for farmers and fishermen. Publication 505 has more information.
2018 penalty relief
The IRS is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. The penalty will generally be waived for any taxpayer who paid at least 80 percent of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two. The usual percentage threshold is 90 percent to avoid a penalty.
The waiver computation is normally reflected in commercially-available tax software and in the latest version of Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts, and its instructions.
This relief is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect an array of changes under the Tax Cuts and Jobs Act.
The updated federal tax withholding tables, released in early 2018, largely reflected the lower tax rates and the increased standard deduction brought about by the new law. This generally meant taxpayers had less tax withheld in 2018 and saw more in their paychecks. However, the withholding tables couldn’t fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions. As a result, some taxpayers could have paid too little tax during the year if they did not submit a properly-revised W-4 withholding form to their employer or increase their estimated tax payments.
The IRS and partner groups conducted an extensive outreach and education campaign throughout 2018 to encourage taxpayers to do a “Paycheck Checkup” to avoid a situation where they had too much or too little tax withheld when they file their tax returns.
Although most 2018 tax filers are still expected to get refunds, some taxpayers will unexpectedly owe additional tax when they file their tax returns.