Estimated tax - Bogleheads (2024)

This article contains details specific to United States (US) investors. It does not apply to non-US investors.

The US tax law requires tax to be paid on income at about the same time it is received. Many taxpayers pay income tax by withholding from salary or from other payments. If the withheld tax is not enough, taxpayers must pay a sufficient amount ofestimated tax during the year or pay a penalty.^[1]

Requirements

To see if you owe a penalty, complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals, Estates and Trusts).

• Form 2210
• Instructions: IRS website or PDF

Safe harbors

There are three “safe harbors” that, if you meet the criteria for any on an annual basis, make it so you owe no underpayment penalty and probably don't need to file Form 2210. These are all covered in Part I of Form 2210.

1. The total tax shown on your current year tax return, including self-employment and other taxes, minus any refundable credits, and minus the amount paid through withholding, is less than $1,000.
2. You withheld at least 90% of the amount calculated (before subtracting withholding) for harbor #1.^{[note 1]}
3. You withheld at least 100% (110% if your adjusted gross income for that year was more than $150,000, or $75,000 if married filing separately) of your "prior year’s tax" (see Form 2210 instructions for what "prior year's tax" includes).

If you make estimated tax payments instead of or in addition to withholding, and don't meet any of the safe harbors, no penalty is due if you meet safe harbor criteria #2 or #3 for each estimated tax "quarter".The payment deadlines for these "quarters" are normally April 15, June 15, September 15, and January 15 of the following year.^{[note 2]}

The simplest method to test this is Part III of Form 2210, with both tax due and withholding assumed to have been 25% of the total each quarter, and estimated tax payments credited in the quarter paid. If the previous year's tax overpayment is applied to the current year's estimated tax, it is treated as having been paid on the April 15 deadline unless the overpayment is the result of a tax payment made after that date.^{[2][note 3]}

A slightly more complicated method is to use your actual withholding amount for each quarter. This can be advantageous if your actual withholding was higher earlier in the year, e.g., if you worked a W-2 job the first half of the year and switched to self-employment for the last half.

The most complicated method is the annualized income option using Schedule AI of Form 2210. See that section for details.

While the law specifies a minimum payment to avoid the underpayment penalty, you can always pay more. In general this means you are giving a no-interest loan to the IRS, but there can be good specific reasons: for example, making a larger payment in January if you want to receive I Bonds as part of your income tax refund.

There is a separate requirement to file a Form W-4 for salary correctly, claiming the proper amount of withholding to cover the estimated tax due on the salary, and to file an updated Form W-4 when a change in your tax situation would cause the old W-4 to have too little tax withheld. You can also have tax withheld from pension payments by filing Form W-4P and from certain federal payments, e.g., Social Security benefits, by filing Form W-4V.^[3]

Annualized income option

Since the tax due at the end of the year is not known during the year, the IRS provides an option to pay the tax for each period by the 15th day after the end of the period. The periods end on March 31, May 31, August 31, and December 31 and are commonly called "quarters", although only two of the four periods are a quarter of a year, i.e., 3 months long.

To use this method, fill out Schedule AI on IRS form 2210.^[4] The form looks at the cumulative periods: January 1 - March 31; January 1 - May 31; January 1 - August 31; and January 1 - December 31. Each cumulative periods share of the tax is computed by annualizing the income; for example, since the first cumulative period is 3 months or 3/12^th of the year, your income is annualized by multiplying by 12/3 or 4. Similarly, since January 1 - May 31 is 5 months or 5/12 of a year, your income is annualized by multiplying by 12/5 or 2.4.Itemized deductions are annualize the same way, but your full standard deduction is used for each cumulative period if greater than your annualized itemized deductions.^{[note 4]}

How to pay

If you wish to increase the amount of tax withheld, you can file a new W-4 with your employer or request withholding from withdrawals from tax deferred accounts (e.g., required minimum distributions) as well as from pension payments and social security benefits (as previously mentioned).

(If you are converting a Traditional IRA to a Roth IRA, you may not want withholding to be taken from that payment, as this will be considered money withdrawn from the traditional IRA and not converted. Unless you then make up for the withholding with other money, this will reduce the amount added to the Roth IRA, and will subject you to a 10% penalty on the amount not converted if you are under age 59-1/2.)

If you do not pay by withholding, you may fill out IRS Form 1040-ES to compute the estimated tax you need to pay. You may pay by check with the vouchers on Form 1040-ES, pay electronically at Electronic Federal Tax Payment System, or use any of the other methods described at Payments | Internal Revenue Service.

The penalty

If you do not make the estimated tax payments by the due date, the penalty is computed on IRS Form 2210.^[2] The penalty is essentially an interest payment, charged for every day that the payment was late. Therefore, if you pay a few days late, or underpay by a few dollars, the penalty will be very small.

In most situations, the IRS will compute the penalty; you only need to file the form if you are annualizing income or treating withholding as paid when it was actually withheld, requesting a waiver of the penalty, or you filed a joint tax return for one year but not both.

Reducing or eliminating the penalty

If you discover mid-year that you should have been paying estimated tax, you may be able to eliminate the penalty by increasing withholding. Even if the withholding is done late in the year, the IRS will treat it as meeting the quarterly due dates. If you cannot increase withholding, paying as soon as possible will reduce the penalty.

If you are required to pay estimated tax because of a mid-year increase in income, you can pay estimated tax for the appropriate quarter and avoid the penalty by filing Schedule AI with Form 2210.

State taxes

States have similar requirements for estimated taxes, but the rules vary by state. Check with each state tax bureau for the safe harbor exemption, due dates, the amount which must be paid for each period, the procedure for paying estimated tax if necessary and the penalty interest rate. For example, in California,^[5] 30% of estimated tax must be paid in the first quarter, 40% in the second quarter, and 30% in the fourth quarter, and taxpayers with CA adjusted gross income over $1M cannot use 110% of the prior year's tax as a safe harbor. In Maryland,^[6] the safe harbor is always 110% of the prior year's tax, and the interest rate on underpayments is much higher.

Estimated tax and withholding penalties also apply to non-resident state income tax. If you are paying non-resident tax to a state for the first year, your prior year tax will be zero, and thus there will usually be no requirement to pay estimated tax. However, if you paid non-resident tax in the previous year and have income from that state in the current year, you will probably need to have tax withheld or pay estimated tax.

Notes

References