Estimated Taxes by Don Fitch CPA (877)CPA-Help

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Estimated Taxes

OVERVIEW

Congress has provided two complementary methods to ensure the current
payment of taxes by individuals as income is earned. The first method --
withholding -- is intended to satisfy the tax obligations of most wage
earners. The second method -- payment of estimated taxes -- covers
situations in which there might be inadequate withholding (when a person
has a high salary or investment income) or no withholding (when a person
is self-employed or has no income except for investments). This chapter
discusses the rules relating to the payment of estimated taxes.

The Code does not directly impose an obligation on an individual to pay
estimated tax; however, it imposes a penalty if estimated tax payments are
inadequate. Individuals thus face the choice of either making adequate
estimated tax payments on a timely basis or incurring a penalty.

To avoid the penalty under Code Section 6654, an individual taxpayer must
timely pay the amount of each required installment. A required
installment is 25 percent of the "required annual payment," unless the
taxpayer chooses to annualize his income. The required annual payment
is the smaller of:

(1) 90 percent of the tax shown on the current year's tax return, or

(2) 100 percent (or a higher amount for high income taxpayers) of the
tax shown on the taxpayer's return for the preceding taxable year,
provided the preceding taxable year consisted of twelve months and a
return was filed for such preceding taxable year.

PRACTICE TIP: Exception 1 can be satisfied by paying the tax in equal
installments or in installments based on each period's earnings
placed on an annualized basis.

OBSERVATION: As a result of economic disruptions stemming from the
September 11, 2001, terrorist attacks, many taxpayers have found that
their income for the current year will be substantially less than
previously expected, and that their tax liability for the current
year will be lower than the total of the estimated tax payments they
have already made. The IRS has announced that it will allow taxpayers
to redesignate estimated income tax payments as tax deposits to
satisfy their obligation to deposit employment taxes, including
withheld income tax. Announcement 2001-112, 2001-2
C.B. 494. To make this redesignation, the taxpayer should contact the
IRS through its Disaster Relief toll-free number: 1-866-562-5227.

For purposes of the estimated tax rules, the term "tax" means income tax
(including the alternative minimum tax) and self-employment tax, reduced
by any credits against tax (other than the credit for taxes withheld).
Code Section 6654(f). Amounts withheld from a taxpayer's wages or as
backup withholding are treated as a payment of estimated tax and divided
equally among the required installment dates, unless the taxpayer
establishes the actual dates withheld. Code Section 6654(g).

OBSERVATION: Dividing the tax equally among the required installment
dates benefits a taxpayer who is underpaid at year end. If she makes
up the deficit with additional withholding, she not liable for the
penalty for any underpaid withholding period.

The due dates for required installments are April 15, June 15, September
15, and January 15 of the following taxable year. A taxpayer uses Form
1040ES, Estimated Tax for Individuals, to compute and pay estimated taxes.

CAUTION: Household employment taxes are included in determining the
amount of estimated tax payments. IRS Publication 505,
Tax Withholding and Estimated Tax.