Note that you aren’t required to use the previous year’s income if doing so produces higher estimates than you would pay based on the current year’s income. Note also that although the general requirement is for estimated tax to be paid quarterly, you have a choice as to whether to make those payments based on income in each quarter or based on the entire year’s income. The “rotten system” actually works in your favor, allowing you to pay the tax owed on a large hit of income in the first quarter over the entire year, but allowing you to postpone payments if income is bunched in the last quarter.
There’s another way the system works in your favor if you have (or can contrive to have) income subject to withholding. Tax paid through withholding is treated as if paid over the course of the year, even if it was entirely paid in late December. Therefore, you can avoid an underpayment penalty by arranging with an employer to withhold extra dollars late in the year, or take money from an IRA late in the year to cover the tax bill, choosing to have the amount needed to cover it withheld and paid to the IRS rather than paid out to you. Note that the IRS withdrawal, including the amount withheld, would be taxable income, and potentially subject to penalty if you haven’t reached age 59½.
Not everyone has these options available, but here’s another point. The penalty for underpaying estimated tax is really just simple interest on the amount by which you underpaid. The interest rate is based on market rates, which are at historic lows. No one is going to be devastated by incurring this penalty. The greater concern in failing to make estimated tax payments is the risk of failing to keep enough money aside to meet the tax liability when April 15 rolls around, and more meaningful penalties come into play.
- This reply was modified 8 months, 1 week ago by Kaye Thomas.