Do I really need to pay estimated taxes?
As a tax planning firm, one of our objectives is to keep our clients from being subjected to income tax penalties. In the absence of proper communication, planning the correct amount of estimated taxes to pay can be one of the trickier ones to get right. Why? Simply put, if you have income that your accountant doesn’t know about until you come to file a tax return, you could be facing estimated tax penalties (and a big tax bill).
When we prepare a tax return, not only do we need to get the tax for the previous year correct and paid, but we also need to present quarterly estimated tax payment amounts to our clients. When we do that, we often get asked – do I really need to pay these? We will attempt to bring a little more clarity to this issue with this article.
Who needs to pay estimated taxes?
According to the IRS, estimated taxes are required in the following situations:
Individuals, sole proprietors, partners and S corporation shareholders generally have to pay if they expect to owe more than $1,000 in tax when the return is filed.
Corporations generally have to make estimated tax payments when the estimated tax due is over $500.
If estimated taxes are not paid and the balances due are greater than the amounts above, you could be subject to estimated tax penalties. I say that one could be subject to penalties, because we do have certain “safe harbors” that can spare us from penalties.
Estimated Tax Safe Harbors
You can generally avoid the estimated tax penalty when the following conditions are present:
The balance due is less than $1,000 for individuals OR
If at least 90% of the tax for the current year, or 100% of the tax of the previous year is paid through withholdings or credits during the year. Please note that for high earners, the amount is 110% of the previous year’s taxes.
There are other reasons that can get you out of penalties but would require proof of some kind of hardship. Those are outside the scope of this article.
Are you still with me? If not, I understand but would urge to you keep reading because we have a solution for this mess.
It’s all about the planning
As you can see, it can be easy to drop yourself into a safe harbor if you deposit quarterly based on the previous year’s taxes. If you have relatively stable income, you can probably bank on this method to keep you out of the penalty box. If your income is prone to rise and fall, we can have issues. When income is rising, we may avoid estimated tax penalties but STILL have a large balance due with the tax return. Big balances due can be ok as long as you know they are coming and pay them by the original due date of the return.
If income is falling, and you pay the standard estimated taxes to keep you in a safe harbor based on last year’s taxes; you could end up paying far more than is needed to the government and have to wait until your return is filed to get it back. Not good for cash flow.
It’s all about the solution
When you have an accountant that works with you monthly, that accountant has a far better picture of where your business and profits are heading throughout the year. We can take one or two opportunities during the year to look at where we are at, forecast the full year, project the tax, and then compare that to what we think will need to be paid. Furthermore, we can take this opportunity to look at potential tax reduction strategies.
This is but a brief introduction to the world of estimated taxes. The bottom line is, if we give you estimated tax vouchers, you probably need to pay them. If you are interested in setting up monthly services and taking advantage of tax planning meetings, feel free to schedule a call with us.