What are Estimated Taxes?
Opting for estimated taxes is like choosing a payment plan with the Internal Revenue Service (IRS). Rather than paying a lump sum by mid-April, the incremental payment route that estimated taxes begets spaces out payments on a quarterly basis. Although some people prefer to settle payments at shorter intervals, estimated tax payments are due on April 15, June 15, September 15 and January 15.
There are exceptions to the rule, notably taxpayers whose income is uneven. Monthly payments are also possible, which give people the opportunity to budget their spending in accordance with their monthly allowances. You can even miss a monthly payment as long as you compensate for the deficit in the estimated payments that follow. However, the IRS is within its power to dispatch an estimated tax penalty if this deficit is not accounted for.
Penalty for Underpayment of Estimated Tax
All this to say that paying estimated taxes does not shield you from an IRS estimated tax penalty. Like any tax, there is no formula for avoiding penalties if the filing is incorrect or late—for the IRS, time is of the essence. It is better to make smaller payments than none at all. There even exists a penalty for filing taxes late if you owe nothing.
At the end of the day, estimated taxes remain taxes: paying them forward still requires you to pay. Like any payment plan, underpaying or missing payments to the point of owing money can incur a penalty. In 2016, an estimated tax penalty for an individual payer assumed the form of an interest charge at the rate of 4 percent. Note that this rate varies, as the IRS is responsible for setting it every quarter. You can calculate your penalty liability by filling out IRS Form 2210. But generally speaking, penalty for underpayment of estimated tax or penalty for not paying estimated taxes can be avoided if a person pays at least 90% of the tax for the present year. It is best to get ahead of a penalty and avoid it altogether.
Estimated Tax Penalty Calculator
The first step to avoiding an estimated tax penalty is to figure out how much you should be paying in taxes. To calculate your estimated taxes, find your unfunded tax liability on last year’s tax return and divide it by four, since as you know estimated tax payments are due each quarter. Subtract from your total liability any withholding you can anticipate having to pay this current year. Keep in mind that your withholding amount could be the same as last year’s. If it is not, make sure you use the new number so you can accurately predict what your estimated tax will be.
That said, this estimated tax calculator doesn’t take into account any changes to your income or deduction status. If these changes apply, you can use your current income to figure out what you owe. To that end, the IRS provides a worksheet called Form 1040-ES to determine the minimum amount you would need to pay in estimated payments to avoid a penalty. You will find the up-to-date figures for deductions and rates there. Other helpful worksheets are also available to you in Publication 505.
IRS Waiver of Penalty
If you have in fact accrued an estimated payment penalty, there are channels to dispute the charge. The IRS can dissolve a penalty if a taxpayer is deemed to have a legitimate reason for not paying on time. You essentially need to convince the IRS that your failure to pay happened for reasons outside of your control.
Another avenue to explore is a waiver reserved for first-time offenders. If it is your first time failing to file or pay, the IRS can waive a penalty. The first-time abatement penalty waiver (FTA) grants the IRS this power. There is no guarantee that you will get off the hook just because it is your first time, but it’s worth a try. It is difficult to predict whether the IRS would consider you eligible for this Hail Mary pass of a claim. This is partly due to the unfortunate fact that Reasonable Cause Assistant (RCA), the software that the IRS uses to assess a payer’s eligibility for amnesty, has been widely criticized.
You can make your request for this penalty waiver by either writing a letter or calling the IRS. Having your request in writing is preferable when dealing with the IRS, as hold times on the phone can be substantial and a written record adds to the strength of your case.
IRS Penalty Abatement
If you can’t figure out where you went wrong, know that a penalty can also be traced back to a mistake on your employer’s side. If your employer has withheld more than is due, you are entitled to request an IRS penalty abatement that should result in a refund. This is different from the FTA in that you still qualify if you have paid penalties in the past.
To request a refund, you must file IRS form 843 and supporting documents, such as a statement describing what qualifies you to receive a refund. However, you can only receive this refund within a certain timeframe. Depending on which date is later, you have either 2 years from the day you made the tax payment or 3 years from the day you filed the return.
Excessive Amount Penalty
But be careful, your claim could be refused, in which case the IRS is at liberty to tack on an additional penalty. If the amount you are asking to be refunded for is deemed excessive, you are at risk of owing the IRS an additional 20% of the requested amount. Again, you should be fine as long as you can prove that you have Reasonable Cause to appeal the amount at hand. Worst case scenario, if you are denied your refund or do not hear from the IRS for six months, you can always escalate the case and file a suit in a U.S. District Court or Federal Claims Court.