Now's the time to determine how much, if any, estimated tax payment you need to make by January 15, 2020 to avoid being penalized for under-withholding for tax year 2019. You can do the work yourself, or work with your accountant. Here's a basic outline of what you need to know.
Uncle Sam’s tax code requires you to pay taxes as you earn income. If you’re a W-2 employee, your employer withholds your taxes from every paycheck, and that withholding is considered to be collected over the entire year.
The IRS has a tax withholding estimator on its website that most taxpayers can use to determine if they’re having enough tax withheld from earnings subject to withholding. You can over-pay your taxes, just to be safe, and get a nice refund next spring. But that’s essentially lending money to Uncle Sam, and he’s not giving you any interest on that.
Or you can let other people lend their money to Uncle Sam, and you can cut it a little closer by meeting one of three safe harbor rules.
Safe Harbor Rule #1: If you expect to owe less than $1,000 in taxes after subtracting your federal income tax withholding from the total amount of tax owed for the year, you're safe—no need to make an estimated tax payment in January.
Safe Harbor Rule #2: If you expect your federal income tax withholding (plus any estimated taxes paid on time) to amount to at least 90 percent of the total tax you'll owe this year, then you've met a safe harbor rule and you don't need to make estimated tax payments.
Safe Harbor Rule #3: If your income tax withholding (plus estimated tax payments) is at least 100 percent of the total tax on your 2018 return (or 110 percent if your adjusted gross income was over $150,000 and you file married filing jointly), you're not required to make estimated tax payments.
Read a clear explanation of safe harbor rules for how much withholding will keep you from an underpayment penalty by clicking here.
If you have other taxable income—say from investments, your Social Security benefits, or distributions from an IRA—you should be paying estimated taxes each quarter based on those earnings if you're not having taxes withheld. These quarterly estimated payments along with tax withholding should add up to what your tax liability is for the year.
If you don't make sufficient estimated tax payments as you earn income on which you did not have withholding, you may be required to file Form 2210 and be subject to penalties for underpayment of estimated tax. (Trying to complete Schedule AI on Form 2210 to avoid a penalty may be enough to convince you that making slightly larger than needed estimated tax payments is worthwhile.)
And while you're working on whether you need to make a payment by January 15th, you should think about using the IRS tax withholding estimator to make sure you're not over- or under-withheld for 2020. Uncle Sam will eventually get paid—no reason to let him borrow your money until it's actually due!
Disclaimer: This article is only intended to provide a general overview of important taxation planning concepts. This document is not intended nor should be considered as tax, accounting, or legal advice. Investec Wealth Strategies and its advisors do not provide tax, accounting, or legal advice. Since tax laws are always subject to interpretations and possible changes in the future, we recommend that you seek the counsel of your attorney, accountant, or other qualified tax advisor concerning your situation.